The ACE Report is a periodic publication distributed to policyholders and other interested parties as a service by ACE. Its purpose is to address insurance concerns worldwide, as well as present timely information on current developments in liability issues surrounding directors and officers. The Editor of The ACE Report is Dan A. Bailey, a lawyer at Arter & Hadden in Columbus, Ohio, USA and a respected voice in the complex area of directors and officers liability.

Although prepared by professionals, this publication should not be utilized as a substitute for legal counseling in specific situations. Readers should not act upon the information contained herein without professional guidance.

D&O EXPOSURES FOR ENVIRONMENTAL DAMAGE
The astronomical costs attributable to compensation for, cleaning up and preventing environmental damage is quickly making environmental liability issues one of the most important legal frontiers of the decade. State regulators have identified tens of thousands of so-called "Superfund" sites requiring clean up of hazardous substances which were improperly disposed or stored at the site. The average response costs for a Superfund site approximate $20 million. And that's only one type of environmental damage. The crippling effect of asbestos claims to entire industries and the more than $2 billion in costs incurred by Exxon as a result of just one oil spill serve as grim examples of two out of dozens of other types of environmental-related risks.

A critical question is who will pay for this damage. Historically, the federal government, corporations with some connection to the environmental damage and general liability insurance companies have borne most of the burden. However, as the magnitude of exposure continues it escalate, those historical deep pockets are beginning to pursue with increased vigor additional targets to help share the financial burden.

Directors and officers of corporations and their liability insurers historically were not targets of environment-related claims unless their corporations were insolvent and they were personally perceived as deep pockets worthy of pursuit. Even then, they faced liability exposure only if they personally participated in the conduct causing the environmental damage. Today the economics and dynamics of the current environmental crisis have made directors and officers personal targets in an increasing number of cases and have resulted in some courts subjecting directors and officers to a standard of conduct tantamount to strict liability for environmental losses.

STATUTORY BASIS FOR D&O LIABILITY
A panoply of state and federal statutes now exists which seeks to prevent various types of environmental damage and to define the rights and liabilities of various parties having some relation to environmental damage. Examples of federal statutes include the Clean Water Act; the Clean Air Act; the Resource Conservation and Recovery Act; the Comprehensive Environmental Response, Compensation and Liability Act; the Rivers and Harbors Act; the Oil Pollution Act; the Toxic Substances Control Act and the Surface Mining and Control Act.

These statutes are broad in scope. For example, most impose liability upon any "person" who owns or operates a polluting facility or who participates in a pollution activity. Directors and officers are considered "persons" for purposes of these statutes and therefore may incur the same degree of liability exposure as their corporation. Some of these statutes permit not only the Environmental Protection Agency (EPA) but also third parties injured by environmental damage to obtain recovery through civil lawsuits from persons who violate the statutes.

SUITS BY REGULATORS AND INJURED PARTIES
Not only are environmental statutes written broadly, but they have also been interpreted quite broadly by regulators and the courts. In several recent lawsuits brought by federal and state regulators, courts have concluded that a strong public policy of cleaning up the environment justifies the adoption of an unusually harsh liability standard for directors and officers in the environmental context.

These courts have formulated a so-called "prevention test" which imposes liability even if the director or officer did not participate in or direct the activity causing the environmental damage. Instead, liability is imposed if the director or officer could have prevented or abated the environmental damage based upon his power to control the practice and policy of the corporation and his specific responsibility for health and safety practices. Because senior officers almost by definition have power to control the practices and policies of their corporations and have responsibility for heath and safety practices, this standard of liability comes dangerously close to imposing strict liability upon directors and officers merely by virtue of holding their corporate office.

Continued pursuit of this and similar types of broad liability theories against directors and officers is likely. Regulators contend that corporate America will not clean up the environment unless and until officers and directors are themselves faced with personal liability for clean up costs. The U.S. Department of Justice has stated that the pursuit of individuals for environmental damage is the core of the government's enforcement strategy in this area.

Courts sympathetic to this philosophy are creating a different set of rules for establishing personal liability of directors and officers in environmental cases than in other types of cases. Most people understand and accept the traditional concept that director and officer liability is based upon the individual's participation in wrongful act or omission. However, liability imposed merely by virtue of holding a corporate title or office is a significant departure for the traditional concept and may have the ironic consequence of further aggravating damage to the environment.

If this form of strict liability gains further judicial support and publicity, some knowledgeable and qualified managers may be scared away from serving companies with identifiable environmental risks. At a time when the service of the most talented directors and officers is greatly needed, the legal climate may encourage such talent to go elsewhere.

SUITS BY SHAREHOLDERS
As corporate loss exposure relating to environmental damage has been escalating, it is not surprising that shareholder claims against directors and officers relating to that liability loss has increased as well. These shareholder suits typically appear as either derivative suits brought by shareholders on behalf of corporations or as direct claims by the shareholders against the corporation and its directors and officers. Such suits can have the indirect effect of transferring a significant portion of the corporation's environmental liability to the directors and officers even in cases where the regulators and injured third parties are inclined to look only to the corporation for recovery.

Shareholder derivative suits against officers and directors seek recovery for damages to or losses suffered by the corporation itself. Large environmental incidents which cause substantial loss to the involved corporation, such as Union Carbide's Bhopal incident and Exxon's Valdez incident, typically generate shareholder derivative suits alleging that the defendant directors and officers negligently caused, permitted or failed to mitigate the corporation's massive loss.

A new basis for environmentally-related derivative suits may now be emerging. Various social-activist groups are successfully sponsoring shareholder resolutions at many major corporations to mandate greater environmental accountability by the corporations. These resolutions require the implementation of "Valdez Principles", which call for the corporations to curtail air and water pollution, conserve energy, market safe products, pay for damage caused to the environment, and make regular reports on environmental matters to the shareholders. If directors and officers of corporations which have adopted these Valdez-type resolutions fail to comply with their mandate, derivative suits against the directors and officers are likely to follow.

Direct shareholders' suits against directors and officers typically allege securities law violations based upon improper disclosure of various environmental related matters. Shareholders frequently allege, for example, that the directors and officers failed to fully and timely disclose the extent of loss the corporation expects to incur from a known pollution incident or the adequacy of internal procedures and safeguards to prevent or respond to a pollution incident.

SUITS BY OTHER POLLUTERS
As if exposure to injured third parties, the regulators and the shareholders were not enough, directors and officers are now being faced with yet another source of environmental claims – other polluters. Environmental lawsuits by regulators are most frequently filed against major corporations, who are perceived as deep pockets and worthy of pursuit. Many of those targeted corporations are now seeking to spread their liability by suing other corporations, including relatively small companies, who may have contributed to the environmental damage for which the major corporation may be found liable. These claims for contribution can be asserted not only against such other corporations but also their directors and officers, particularly when the corporations are insolvent or financially unable to fund the contribution claim. Thus, directors and officers of virtually any type and size of corporation now face potentially devastating environmental liability exposure.

D&O INSURANCE COVERAGE
D&O insurance carriers have historically excluded coverage for pollution claims. As the frequency of those claims increases, the extent of coverage, if any, will become critical.

Corporate Officers & Directors Assurance, Ltd. ("CODA"), managed by ACE, is one of the only D&O insurers to provide full pollution coverage to directors and officers. ACE will follow the CODA coverage, thus also insuring pollution exposures. The pollution exclusions contained in other D&O policy forms vary significantly. Some exclude only claims "for" pollution, thus presumably affording coverage for shareholder suits. Others contain a broader exclusion applying to claims "based upon or arising out of" the pollution. Another variable is the type of pollution referenced. Some exclude only claims relating to "hazardous substances", while others reference virtually any type of pollutant.

HIGH COST OF PRODUCT HYPING
A June, 1991, jury verdict in California demonstrates the potential liability exposure to directors and officers relating to the common practice of hyping a new product before that product is in marketable form. In a class action securities fraud case involving Apply Computer, the jury ruled that two senior officers of Apple violated the federal securities laws and were responsible for the resulting $2.90 drop in the company's stock price due to misleading statements about a new disk drive. Although the jury has not finally determined damages, it is estimated that the award will approximate $100 million.

In a 1982 press release, the defendants boasted that "the Apple drives ensure greater integrity of data that high-density drives". However, at the time of that press release, Apple officials allegedly knew of serious problems, as evidenced by an internal memorandum warning that the drives show "a very high failure rate", and "we suspect most of them will fail during the warranty period". The defendants argued that although they knew of the problem, they expected to be able to correct it and in fact did.

Although the verdict is not on appeal, the case serves as a vivid example that securities law requirements for truthful and accurate disclosures supersede business traditions and marketing considerations. In addition, the case is likely to encourage other claimants to either commence or more boldly prosecute other types of securities law claims against directors and officers.

NEW TIME LIMIT FOR RULE 10B-5 CLAIMS
In a surprising opinion issued June 20, 1991, the U.S. Supreme Court created for the first time a uniform, relatively short time limit in which lawsuits under Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder must be filed. That statute and rule, which courts have called "catch-all" securities anti-fraud provision, are the most frequently cited basis for director and officer liability under the federal securities laws.

The Court's decision in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson holds that this type of securities fraud case must be filed within one year after the discovery of the facts constituting the violation and no later than three years after the violation took place. Prior to this decision, virtually all courts applied to Section 10(b) claims the statute of limitations applicable to the most analogous state law. This resulted in differing statutes of limitations depending upon which state law was used. Typically, those state laws permitted a shareholder or other injured individual to commence the lawsuit up to six to ten years after discovery of the securities violation. Thus, the new one year/three year time limit is much shorter than what was previously recognized by the courts. However, it is currently unclear whether this new, shorter statute of limitation will be a significant benefit to directors and officers in defending securities fraud claims. If the claim is based upon alleged misrepresentations or omissions in a stock offering, this shortened statute of limitation may be helpful to defendants and will give directors and officers some peace of mind that claims arising out of a stock offering cannot be brought more than three years after that offering.

Unfortunately, the far more typical shareholder class action claim against directors and officers alleges that the defendants continued to misrepresent or disclose material information over an extended time period, thereby causing an artificially high or low market price for the stock during that extended time period. Once the curative disclosure is made and the market price is corrected, shareholder class action lawsuits are usually filed within days, if not hours. In that situation, this new statute of limitation will merely serve to limit the class period to three years and will not create a defense to the entire lawsuit. Because significant damages typically are realized over the course of a three year class period, this new ruling will be of very limited, if any, benefit to defendants in the "typical" securities fraud lawsuit.