Introduction to Consent to Settle Provisions
In the complex world of Directors and Officers (D&O) liability insurance, the authority to settle a claim is a frequent point of contention. Unlike many general liability policies where the insurer has the absolute right to settle, D&O policies often contain Consent to Settle provisions. These provisions recognize that a settlement can imply wrongdoing, potentially damaging the professional reputation of a director or officer.
However, this right to refuse a settlement is not absolute. To protect the insurer from being held responsible for escalating costs after a reasonable settlement offer has been rejected by the insured, the Hammer Clause (technically known as the 'Cooperation and Settlement' or 'Limitation of Liability' clause) is triggered. This article explores the mechanics of these clauses, essential for anyone studying for the practice D&O questions and seeking to master the complete D&O exam guide.
The Mechanics of the Hammer Clause
The Hammer Clause essentially states that if the insurer recommends a settlement that is acceptable to the claimant, but the insured refuses to consent to that settlement, the insurer’s liability is capped. From the moment of refusal, the insurer is no longer responsible for the full extent of the eventual judgment or the ongoing defense costs.
The 'Hammer' refers to the financial pressure placed on the insured to accept a reasonable offer. If the insured chooses to continue litigating to clear their name, they must bear a significant portion of the financial risk if the final outcome is worse than the proposed settlement.
Comparison: Hard Hammer vs. Soft Hammer Clauses
| Feature | Hard Hammer (Standard) | Soft Hammer (Modified) |
|---|---|---|
| Insurer Liability Cap | Limited to the amount of the original settlement offer. | Limited to the settlement offer PLUS a percentage of the excess. |
| Defense Costs | All defense costs stop at the date of refusal. | Insurer continues to pay a percentage of defense costs. |
| Risk to Insured | High; insured pays 100% of costs above the offer. | Moderate; shared burden between insurer and insured. |
| Commonality | Standard in basic policies. | Often negotiated for high-level D&O programs. |
The 'Soft Hammer' Evolution
Recognizing the harshness of the traditional hammer clause, many modern D&O policies utilize a Soft Hammer Clause. This modified version provides a compromise. Instead of the insurer’s liability being strictly capped at the settlement offer, the insurer agrees to pay a predetermined percentage of the costs exceeding that offer.
Typical 'Soft Hammer' ratios include 70/30, 80/20, or 90/10. In an 80/20 scenario, if an insured refuses a settlement, the insurer will pay the original settlement amount plus 80% of any additional judgment and 80% of the defense costs incurred after the refusal. The insured is responsible for the remaining 20%.
Impact of a Refused Settlement
Exam Tip: The 'Consent' Requirement
Strategic Implications for Directors and Officers
The presence of a Hammer Clause significantly alters the legal strategy during a claim. Directors must weigh the value of their reputation against the potential out-of-pocket costs of a trial. Because D&O claims often involve complex allegations of breaches of fiduciary duty, the 'Soft Hammer' is a highly sought-after endorsement.
- Reputation Management: Directors may feel compelled to settle even if they believe they are innocent to avoid the financial 'hammer.'
- Liquidity Concerns: A 'Hard Hammer' can create significant personal financial exposure for directors if the corporation cannot indemnify them.
- Defense Control: Once the hammer is triggered, the insurer may have less incentive to provide a robust defense, as their financial exposure is limited.