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The Hammer Clause

 It’s not an uncommon scenario: An association is sued for something it vehemently denies and to which it strongly objects. In fact, the basis of the lawsuit is an action or a theory that is out-and-out offensive to the group, or the proposed settlement requires an admission of wrongdoing from the association or someone within it, when the association says nothing was done to require such an admission.

The association enacts its D&O policy and begins working with the insurance company’s preferred attorney. After several weeks or months, a settlement offer is made. The attorney tells the association he or she wants to accept the offer and that the insurance company will pay to settle the case.

“But wait!” protests the association. “This case is totally offensive to us, and we don’t want any hint of admitting to wrongdoing here. We don’t want to settle!”

Unfortunately for them, the policy they signed likely says they either have to settle at the insurance company’s decision, or that the insurance company will pay a final verdict up to the agreed-upon settlement amount, but any moneys spent after that must come from the association’s own coffers.

It’s called a “hammer clause,” and it’s a common bit of phrasing in D&O policies. The problem, experts say, is that association executives frequently sign policies without understanding exactly what the hammer clause means if a case ends up moving forward and a settlement deal is put onto the table.

In the sample policy used for this article, the hammer clause reads as follows:

“If the COMPANY is willing to accept the judgment of a court or any settlement offer, and the INSURED is not willing to accept such judgment or settlement, the COMPANY may pay to the INSURED the amount of the judgment or settlement (less any remaining deductible amounts). The COMPANY shall then be relieved from any further liability for any DAMAGES, CLAIMS EXPENSES, or any duty to defend.”

In other words, the insurance company will pay off the amount of the settlement and then excuse itself completely from any further settlements, judgments, or expenses incurred by the association going forward.

“The carrier’s not there to defend a principle,” says Lou Novick. “The carrier’s there to defend a claim. If the association feels the case is groundless or they want to fight it to the death on moral grounds, that’s their decision. But the insurance company won’t do that.”

Simply put, while ethical questions may be huge to the association, they’re simply not to the insurance company. What a settlement may or may not say to the association’s members and potential members is of no concern to the insurers, who would just as soon rather make it all go away for as few dollars as possible than fight it out over principles.

Attorney Jeff Glassie says the hammer clause is typical for D&O policies but often surprising to association executives who do find themselves facing a proposed settlement in a case they feel has absolutely no merit.

“It’s the insurance company’s money,” he explains. “It makes a certain amount of sense from that perspective. It would be great if the insurance company was required to abide by everything the association said in a defense suit. As a practical matter though, they’re not going to give you that right.”

Some attorneys recommend that associations try to ensure that their policies give them some say in whether a case is settled before judgment, but they admit that such leeway is rare, especially when high dollars can be involved.

“The insurance company is going to manage the litigation,” says Glassie. “They’re going to decide how to defend the case, period.”

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