ABA Section of Business Law

ABA Section of Business Law
Business Law Today
September/October 1999

---

Seeking cover in the Age of Litigation

Business insurance: What you need to know

By GARY LOCKWOOD

Lockwood is a partner at Lord, Bissell & Brook in Chicago. He is chair of the Section’s Business Insurance Committee.

To a business person, liability seems to lurk around every corner. And that’s why there is business insurance. Let’s look at the need and the kinds of response.

In our system of justice, each person, including fictional ones such as corporations, partnerships and other business entities, has certain rights. Likewise, each person owes a duty not to wrongfully invade another legally recognized right. Where there has been a wrongful invasion, the law imposes a liability to correct any damage caused by the invasion. This liability is most often satisfied by the payment of money and in certain cases where that payment will not completely remedy the injury, injunctive relief may be ordered.

Sometimes, where the danger posed by someone’s wrongful activity affects not just single individuals but rather society at large, the government is given the power to police such activity and to mandate remedies. Think of the government’s power to order the clean-up of polluted sites or how it can demand the recall of a dangerous product.

We have this system to avoid that older and more uncivilized method of frontier justice embodied in the duel and the gunfight. Considering that the United States is perhaps the most litigious nation in the world, if every dispute were settled with weapons instead of laws, we might disintegrate into armed conflict. A few sobering statistics:

• According to a recent study of 12 industrialized nations prepared by Tillinghast-Towers Perrin, 1994 tort costs of the United States were found to be 21/2 times the average tort costs of all the countries studied.

• The number of cases filed each year in the U.S. District Courts has increased more than 18 percent in four years, from 229,850 cases in 1993 to 272,027 cases in 1997.

• A record 3.1 million lawsuits were filed in Ohio courts in 1996. It has been estimated that approximately 80 million lawsuits are filed in the United States each year — an average of 152 lawsuits a minute!

• The 1998 Directors and Officers Liability Survey by Tillinghast-Towers Perrin reports that the average cost to defend a lawsuit against directors of a commercial corporation is now in excess of $800,000.

• Product-recall situations can also be enormously expensive. This summer, Coca-Cola Enterprises recalled about 14 million cases of its product sold in Europe. The cost of the recall has been estimated to be at least $60 million.

These figures must make businesses and those individuals who are associated with them sit up and take notice because litigation involving business issues is one of the largest subsets of all litigation. Not only are business entities at risk, but those individuals who are directors, officers, employees or agents of business entities are also at risk. It cannot be overemphasized that any individual who is involved with a business today may, under certain circumstances, have his or her personal assets exposed to claims and lawsuits arising out of the business.

Although not an exhaustive list, the following are currently some of the most active sources of liability for businesses and the individuals associated with them.

Securities law — The Securities Act of 1933 and the Securities Exchange Act of 1934 are two federal statutes that affect publicly traded corporations. The first statute contains liability provisions that may affect corporations, their directors, officers and others such as lawyers and accountants, in connection with the issuance of shares to the public. The latter is concerned with the liability of publicly traded corporations, their directors, officers and others for inadequate reporting and for material misrepresentations made to investors in the "aftermarket," that is, to those investors who are not buying their shares directly from the corporation but, rather, are purchasing shares on one of the national securities exchanges. During the 1970s, ’80s and into the ’90s, the federal securities laws constituted one of the most potent sources of liability for commercial corporations and their directors and officers.

Congress passed the Private Securities Litigation Reform Act of 1995 in response to what the business community alleged were unfair abuses by the plaintiffs’ bar of the 1933 Act and the 1934 Act. The Reform Act was enacted with the hope by its supporters that it would deter so-called "strike suits," which allegedly were filed against companies and their directors and officers based on nothing more than a drop in stock price. The fear of such strike suits was especially prevalent among the high-tech companies of Silicon Valley, whose stock prices have been notoriously volatile.

Whatever the hopes of its champions, the legislation did not end the proliferation of shareholder suits filed under the federal securities laws. In fact, in the three full years since its passage, the number of securities-litigation cases in federal courts has increased 134 percent, from 102 filings in 1996 to 239 filings in 1998.

The Reform Act also resulted in the development of companion filings in state courts. Its stay provisions forced the plaintiffs to find another way to obtain the facts needed to support their federal allegations. They found such a way by filing state court actions simultaneously with their federal cases. This allowed the plaintiffs to pursue discovery in state court while waiting out the stay in federal court.

One move required a counter move. The business community went back to Congress, which in 1998 passed the Securities Litigation Uniform Standards Act of 1998, requiring all securities class-action litigation involving stock traded on a national exchange to be filed in federal court. A total of 31 state court actions had already been filed in 1998 prior to the passage of the Uniform Standards Act.

The 1995 Reform Act also provided a "safe harbor" for so-called "forward-looking statements." This provision provides that statements about the future prospects of a company that are made in corporate publications, press releases and even speeches are not actionable under the securities laws if they are made in good faith. Nevertheless, the act does not contain a similar safe-harbor provision for misstatements made in a company’s audited financial statement. According to a PricewaterhouseCoopers 1998 Securities Litigation Study, prior to 1995, accounting cases comprised about 25 percent of all cases filed. In 1998, however, such cases comprised 47 percent of the total.

Y2K — As of May 24, 1999, a total of 69 Y2K litigation cases had been filed in the federal courts. More than half of these are product-liability cases involving breach-of-contract or breach-of-warranty theories. The prospects for continued and increased litigation stemming from the Y2K problem are uncertain primarily because no one seems able to predict accurately what will actually happen when the new century arrives.

Environmental law — The Comprehensive Environmental Response, Compensation and Liability Act of 1980 gives to the federal government power to remediate pollution at sites where there has been a release of hazardous substances. CERCLA allows the federal government to shift the cost of the cleanup to any "responsible party." This term is defined to mean any current owner or operator of the site, any person who owned or operated the site at the time the hazardous substances were released, any person who generated the hazardous substances, and any person who transported the hazardous substances to the site. The term "owner or operator" is circularly defined in CERCLA to mean "any person owning or operating [a] facility." The courts have been left to determine who is an owner or operator.

Intellectual property law — The law recognizes a property right in names, inventions, designs, art works, trademarks, trade secrets, etc. Anyone who misappropriates or misuses intellectual property without authorization can be liable to its owner.

Advertising injury — So-called "advertising injury" is an off-shoot of intellectual property law. Our daily lives seem to bring us in constant contact with ads that reach out to us from billboards, TV commercials, magazine spreads and even direct mailings. These days, it seems, advertising is the fuel that runs the commercial arena. In this lies some degree of danger for the companies who publish the ads because their very publication poses the risk of disparaging another’s goods or services.

Employment law — Employment claims arise under common law and also under federal, state and local statutes. The law concerning employees is in an enormous state of flux. The common law and the statutory law continue to evolve, providing new and complex causes of action and theories of liability that have turned this area into one of the fastest growing sources of liability for businesses and the individuals associated with businesses. EEOC complaints have doubled from 1991 to 1997 and the average verdict for employment-practices liability claims is now around $300,000, up from $168,000 in 1990.

In the face of large liability exposures, businesses and those who are associated with them should make every effort to avoid losses or to mitigate such losses if they occur. There are a myriad of ways to do so, including education and training of employees, indemnification agreements, as well as auditing of safety procedures.

Obviously, one of the best ways to mitigate the kind of losses mentioned above is to transfer them to an insurer through the purchase of business-liability insurance. These are some of the options:

• Mutual insurers — A mutual insurer is owned and operated by and for the benefit of policyholders, who control the company through election of the directors. In this way, they are like shareholders in other corporations. Mutual insurance companies are not, however, operated for profit. Unused money earned by the corporation is returned to the policyholders as dividends.

• Stock insurers — Stock insurers are corporations that happen to be in the insurance business. Stock insurers are usually public companies whose stock is traded on a stock exchange. Like other commercial corporations, a stock insurer will have a board of directors as well as officers and employees.

• Lloyd’s insurance — Lloyd’s of London is famous as an insurer of unusual risks. However, it is not an insurer at all, but, instead, is the name given to a marketplace in London where individuals, called "Members" or "Names," have historically gathered to underwrite insurance for his or her own account. Today, corporations may also become Names at Lloyd’s. At Lloyd’s, the Names are organized into syndicates who operate through an appointed individual called the underwriter. The underwriter may, but need not be, a Name.

Risks are presented to the names by a Lloyd’s broker who brings each request for insurance into the "Room" at Lloyd’s and circulates it to various syndicates who, acting through the underwriter, may each accept a portion of the risk. When the broker has 100 percent of the risk insured, he or she will then see to it that an insurance policy is issued. This type of underwriting, called Lloyd’s insurance, is also the norm at the Illinois Insurance Exchange in Chicago.

• Self-insurers — Self-insurance is the process of insuring one’s self. In most insurance programs, the insured holds a small percentage of risk and the insurer assumes the remainder. The portion of the risk that is held by the insured is called a "retention" or "deductible" and this portion is a form of self-insurance. Businesses often self-insure for a larger portion of the risk and sometimes for all of a risk. Sometimes this is done because insurance is not available. At other times it is done because it is believed that self-insurance will be cheaper than paying premiums to an insurer.

Predictable risks like fire and property damage risks are often self-insured. Specialty risks, such as directors’ and officers’ liability, are seldom self-insured because of the unpredictability of the risk and the severity of losses that can occur.

• Primary vs. excess insurance — Insurers may be primary insurers or they may be excess insurers. A primary insurer is one that has issued an insurance policy that will respond first, before any other insurer, to a loss suffered by an insured. An excess insurer, on the other hand, responds to losses only when the limits of liability of the underlying insurers’ policies have been exhausted. An excess insurer is "excess" because there is another insurer — the primary insurer — that will have to respond first to a loss.

• Licensed vs. surplus lines insurance — The insurance industry in the United States is regulated at the state level. Each state tends to have a separate regulatory scheme. All states require under most circumstances that insurers wanting to do business in the state must be licensed or "admitted" in that state. Thus, insurers who wish to do business nationwide must obtain licenses in all or most of the states. Generally, licensed insurers must have their policy forms approved by the state insurance department before the forms can be sold in the state. For insurers with national businesses necessitating a license in a multitude of states, getting approval of policy forms from each state can be very time consuming.

Many states allow unlicensed insurers to do business in the state under rules called "excess and surplus lines" rules. An insurer doing business in a state but having no license there is called a nonadmitted carrier. There are some advantages to being a nonadmitted carrier. For example, nonadmitted carriers are not required to submit policy forms for approval and they can therefore be more flexible about policy language and they can respond more quickly to the needs of a policyholder. Also, they do not have to pay many of the state taxes and fees imposed on admitted insurers. That can mean that their policies are cheaper.

However, a big disadvantage that a nonadmitted carrier has is that states prohibit brokers from placing business with nonadmitted carriers unless they have first successfully tried to place that business with a licensed insurer.

• Claims-made vs. occurrence forms — Insurance products are issued on policy forms that are called either "claims-made" or "occurrence" forms. The words "claims-made" and "occurrence" refer to the event that will trigger the coverage under the insurance policy. The same event may have dramatic insurance consequences depending on whether the policy is a claims-made form or an occurrence form.

Claims-made policies are triggered on the date when a claim, as defined in the policy, is made against the insured. A typical claims-made policy insures against loss arising from a claim. The policy is triggered if the claim is made against the insured during the policy period. The time when the activity that led to the claim occurred is generally irrelevant under a claims-made policy.

Occurrence policies are triggered by the timing of the occurrence that gives rise to the claim. The timing of the claim itself is generally irrelevant under an occurrence policy.

Most liability risks can be covered by insurance and over the years many special business-liability insurance products have been developed to respond to the needs of businesses and the individuals associated with them. Among those products are directors’ and officers’ liability insurance, employment-practices liability insurance, professional-liability insurance, environmental-liability insurance, product-recall insurance and intellectual property infringement insurance.

Because of court decisions in many states, other types of policies, such as general liability insurance, may also apply to cover certain aspects of the business-liability exposures mentioned in this article. The articles in this section will focus specifically on insurance coverage for many of the types of risk mentioned above.