Hedge fund liability insurance in the form of errors and omissions (E&O) professional liability insurance and directors and officers (D&O) insurance can afford protection to hedge fund managers and their hedge funds as well as their respective officers, directors and employees, against claims for alleged errors, omissions, negligent acts, misstatements, misrepresentations and breaches of duties. For an overview of D&O policies as they relate to hedge funds, see “Hedge Fund D&O Insurance: Purpose, Structure, Pricing, Covered Claims and Allocation of Premiums Among Funds and Management Entities
,” Hedge Fund Law Report, Vol. 4, No. 41 (Nov. 17, 2011). However, with increasing regulatory scrutiny resulting in heightened criminal prosecutions and enforcement activity affecting hedge fund managers and their employees, insurers are raising premiums with respect to such liability coverage and carefully examining policies to determine whether hedge fund manager insureds have breached terms or misrepresented facts. Identified breaches or misrepresentations, in turn, may allow insurers to claw back defense costs previously advanced, or avoid or reduce payouts. Historically, insurers have been reluctant to bring such breach of contract suits against their insureds for fear of alienating existing customers and diminishing new business. However, a recent declaratory judgment action initiated by insurer XL Specialty Insurance Company (XL) – a well-known underwriter in the hedge fund D&O space – may portend a trend towards more aggressive litigation by insurers. The litigation is also a timely reminder that D&O insurance agreements are not adhesion contracts. Underwriters are typically amenable to negotiating at least certain provisions, and managers are well advised to negotiate because form agreements often reflect the experience of underwriters in avoiding or excluding claims. See “Regulatory Compliance Association Hosts Program on Increased Risk for Hedge Fund Directors and Officers in the New Era of Heightened Regulation and Enforcement
,” Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009). This article summarizes XL’s Complaint and highlights the relevant provisions from the insurance application and policy.