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Law \ Legal

Thinking About Follow-Form Excess Insurance


Many D&O insurance programs consist of multiple layers of insurance arranged with a layer of primary insurance and one or more layers of excess insurance. In order to ensure that the insurance in the program operates consistently and uniformly, the excess insurance is usually written on a so-called “follow form” basis, meaning that the excess insurance incorporates the primary’s policy’s terms and conditions, subject to any express provisions in the excess policy to the contrary. A recent case from the Court of Appeal for Ontario considered the meaning and impact of excess follow form coverage in the context of a dispute over whether a policyholder could exercise an option to purchase extended reported period coverage from its excess insurer. The decision, while arguable unremarkable in and of itself, nevertheless may have some important lessons for excess insurers. A copy of the Ontario Appeal Court’s July 13, 2022 decision can be found here.

 

Background

Cronos manufactures and markets cannabis and cannabis-derived products. Cronos maintained a program of D&O insurance for the policy period February 27, 2019 to February 27, 2020. The program consisted of a primary $5 million and an excess $5 million layer.

 

As the insurance program approached its expiry dates, Cronos sought and the primary and excess insurers offered renewal terms. However, just before the renewal date, Cronos announced that it would delay its 2019 forth quarter and full-year earnings release. Upon this news, the primary and excess insurers withdrew their renewal quotes. Cronos and the primary insurer negotiated a 13-month extension of the primary policy. The excess insurer did not agree to an extension.

 

In early March 2020, two securities class action lawsuits were filed in the United States against Cronos and certain of its officers. On March 17, 2020, Cronos announced that its financial statements for the first three quarters of 2019 would be restated and reissued.

 

The primary policy contained an Optional Extension Period (OEP) provision allowing the policyholder, within 30 days of policy expiration, to purchase an extension of the policy’s discovery period to cover claims made against the insured after the expiry the policy’s initial term, as long as the wrongful acts giving rise to the claims were committed during the original policy period. The primary policy’s stated premium for the OEP option was double the amount of the primary policy’s expiring premium. The excess policy is a follow form policy – that is, it is subject to the same terms, conditions, limitations, and exceptions as are contained in the primary policy, with certain exceptions. As the appellate court later noted, “the OEP option is not identified as an exception.”

 

On March 25, 2020, Cronos provided the excess insurer with written notice that it was electing to exercise the OEP option. As premium for the extension, Cronos paid double the amount of the premium of the expiring excess policy.

 

The excess insurer took the position that the excess policy did not contain the OEP option, and further the excess insurer rejected coverage for the March 2020 securities class action lawsuits.

 

Cronos filed an action seeking judicial declarations that under the excess policy it was entitled to purchase OEP coverage at a premium that was twice the premium of the expiring excess policy. The trial court judge held that the excess policy, which was follow form to the primary and had no exception to the follow form coverage for the OEP option, gave Cronos the contractual right to exercise an OEP option, and that the correct premium for the OEP option was double the original premium of the excess policy. The excess insurer appealed.

 

Key Policy Terms

Condition 2 of the Excess Policy specifies that:

 

This Policy is subject to the same terms, conditions, limitations, and exceptions (except as regards the premium, the amount and limits of liability, any deductible or self-insurance provision, the obligation to investigate and defend and the renewal agreement (if any) as are contained in the Primary Policy.

 

Condition 6 of the Excess Policy provides that

 

No amendment to the Primary or Underlying Policy during the Period of Insurance, in respect of which the primary or underlying insurers require an additional premium or a deductible, shall be effective in extending the scope of cover of this Policy unless and until agreed in writing by the Company.

 

The July 13, 2022 Opinion

In a July 13, 2022 opinion written by Justice David Brown for a unanimous three-judge panel, the Court of Appeal of Ontario rejected the grounds of appeal advanced by the excess insurer and dismissed the appeal. In reaching this conclusion, the appellate court relied heavily on the reasoning of the court below.

 

The appellate court quickly rejected the excess insurer’s argument that the OEP provision was not a follow-form term, largely in reliance on the lower court’s observation that the OEP option was not one of the matters expressly excluded from follow-form coverage under Section 2 of the excess policy.

 

The appellate court also rejected the excess insurer’s argument made in reliance on Section 2’s exclusion of “renewal agreements” from the follow-form coverage. The appellate court said, in reliance on the lower court, that “the exercise of the OEP option did not give rise to a policy renewal,” and the appellate court further quoted the lower court as noting that Cronos was “specifically denied the chance to renew both the Primary Policy and the Excess Policy. It was the non-renewal event that triggered the right to exercise the OEP.” The language of the primary policy, the appellate court noted, “treated the OEP option as a different creature from the renewal of the policy.”

 

The appellate court also rejected the excess insurer’s argument that the primary insurer’s agreement to extend the primary policy for 13 months ran afoul of the provision in Section 2 of the excess policy that “the Primary and Underlying Policy will be maintained in full effect during the full currency of the policy” and of the provision in Section 8 that no amendment to the primary policy would affect the scope of coverage under the excess policy “unless and until agreed in writing by [the excess insurer].” The appellate court found that the primary policy’s 13-month extension did not affect the excess insurer’s coverage and the excess insurer was not bound by the terms of the extension.

 

Finally, the appellate court rejected the excess insurer’s arguments concerning the calculation of premium for the OEP option, essentially holding that the primary policy’s provision that the OEP option would cost double the amount of the policy premium was equally effective with respect to the excess policy. The appellate court expressly rejected that the premium for the exercise of the OEP option should be calculated at a significantly greater multiple.

 

Discussion

There is a certain way to read this decision as simply the logical playing out of the excess policy’s follow-form coverage. The excess policy expressly provided that it was follow-form to the primary except as to a short list of items expressly reserved from the follow-form coverage. The OEP option was not among the items expressly reserved from the follow-form coverage, and so the OEP option was by operation of the follow-form provision part of the excess policy and therefore available for the policyholder to exercise.

 

However, there are some unusual features to this situation that suggest a little further thought may be required. The first unusual feature is that the policyholder was exercising the OEP as to the excess policy without at the same time exercising the option as to the primary policy. It may not be unprecedented for a policy holder to elect extended reporting period coverage as to the excess but not as to the primary, but it certainly is rare. One might well ask if this was the kind of circumstance that the parties anticipated when they entered into the insurance contracts.

 

There is another unusual feature about this case that is worth noting, although it is not a point that the appellate court chose to emphasize. This particular feature has to do with the fact that between the end of the policy period of the excess policy and the date on which the policyholder exercised the OEP option for the excess policy, the insured company was hit with two U.S. securities class action lawsuits having to do with events and circumstances that took place prior to the policy expiration. Thus the situation here is that if the insured can exercise the OEP option as to the excess policy, then the insured will have secured excess insurance coverage for the claims. If the insured does not have the option, then the insured does not have excess insurance coverage for the claims and the excess insurer is off the hook. In other words, the appellate court’s resolution of the parties’ dispute has very real practical implications.

 

While these considerations do put the court’s decision in a different light, in the end it is hard to escape the logic of the court’s decision – that is, that since the OEP provision was not one of the matters excepted from the follow form coverage, the OEP option was part of the excess policy’s follow form coverage and therefore the option was available to the policyholder.

 

The sting for the excess insurer — that it potentially could get hit was losses from two securities lawsuits that came in after the policy expired — underscores the extent and importance of the follow form coverage. While I understand that the excess insurer may be smarting from this situation, the fact is that if an excess insurer wants to be able to argue that there are aspects of the primary policy that the excess insurer does not want to incorporate within the follow form coverage, the excess insurer needs to say so, at the outset and before there is a claim. The implication for excess insurers is they need to consider all that might be encompassed with the follow form coverage, including seemingly peripheral features such as extended reporting period coverage.

 

Some readers will question whether the fact that this decision was the product of a Canadian court affects the decision’s significance. There is no doubt that the court referred to principles of construction and interpretation under applicable Canadian law. However, many of the basic principles about excess insurance to which the court referred substantially overlap with equivalent principles under U.S. law. Obviously, the court’s ruling does not represent binding precedent in any U.S. court but it at least theoretically could have persuasive power. But in any event for me the significance of this case not with respect to what formal legal authority it may represent but rather with respect to what the decision says about the obligations of excess insurers and how follow form coverage operates. Any insurer in the business of providing excess insurance will want to read and understand this decision, regardless of where they are providing insurance.

 

One final thought has to do with the crisis that hit both the policyholder and the insurers just before policy expiration. It is always difficult when the crisis hits right on the eve of renewal and it is clear that the cascade of bad news on cusp of renewal knocked everybody involved back a step. On the other hand, the way that an insurer reacts to a crisis says a lot. Here, the way that the excess insurer responded to this situation certainly tells me everything I need to know about this particular insurer.

 

Special thanks to one of my Canadian readers for sending me a copy of the Court of Appeal’s opinion.



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