There are currently significant deficiencies in the legal protection function of the D&O insurance.

1. Refusal to provide benefits without a determination of a knowing breach of duty

Although general insurance terms and conditions now consistently stipulate that the insurer is only released from liability after a legally binding determination of a knowing breach of duty by the insured person, coverage of legal defense costs is still refused in individual cases on the grounds that the insurer was deceived at the time of conclusion or extension of the contract because the insured person had already knowingly breached obligations at that time.

This was most recently practiced, for example, in the Wirecard case. A group of approximately twenty insured persons were affected, against whom prosecutorial investigations and civil proceedings had been initiated.

The insurance terms and conditions stipulated that the insurer waives any rights of avoidance or withdrawal due to fraudulent deception at the time of conclusion or extension of the contract. Instead, fraudulent deception during contract conclusion or renewal, or a breach of the duty to disclose, should only be borne by the insured person who committed the deception or breach of the duty to disclose, and should result in that person’s exclusion from insurance coverage.
Furthermore, liability claims based on a knowing breach of duty by the insured person against whom the claim is made should be excluded from insurance coverage. The insurer bears the burden of explanation and proof in this regard. In cases of doubt regarding the existence of a knowing breach of duty, the insurer promises to cover the costs of defense until a legally binding determination of a knowing breach of duty is made.

However, it is by no means certain that the insurer will adhere to its promises.

The insured person, who is usually already specifically dependent on legal defense services due to ongoing public prosecutorial investigations and/or civil proceedings, is forced in these cases to pursue legal action against the insurer in parallel. Since a favorable coverage judgment for the insured person is usually only expected after several years of litigation, the insured person is required to bear their own legal defense costs in the investigation and/or civil proceedings, as well as in the coverage dispute with the insurer, until then. While so-called coverage protection policies are available on the market that may reimburse the insured person for the costs of the coverage dispute, this does not eliminate the coverage deficit. Until a final decision is reached in the coverage dispute against the insurer, the insured person is required to cover their legal defense costs in the investigation and/or civil proceedings.

If the insured person is financially unable to cover their defense costs, an application for a benefits order should be considered. In a decision dated December 11, 2020 (case no. 7 W 29/20) and a judgment dated July 7, 2021 (case no. 7 U 19/21), the Higher Regional Court of Frankfurt am Main stated, among other things, the following: The issuance of a benefit order aimed at satisfying insurance claims cannot be refused on the grounds that the (alleged) knowing breach of duty committed by the insured person simultaneously constitutes fraudulent deception toward the insurer. In cases where the insurer has promised provisional defense costs in the insurance terms and conditions in case of doubt as to the existence of a knowing or intentional breach of duty on the part of the insured person and has waived their right to reimbursement even in the event of a subsequent judicial determination of such a breach of duty, the insured person would be entitled to a provisional legal protection claim and thus a right to an injunction within the meaning of Section 935 of the Code of Civil Procedure (ZPO).

According to the Higher Regional Court of Frankfurt, there was also grounds for an injunction: A request seeking full satisfaction of the alleged claims could exceptionally be asserted in proceedings for a preliminary injunction if the insured person urgently requires immediate satisfaction to avert an existential emergency and if there is a high probability, almost almost certain, that they will prevail in the main proceedings. Furthermore, due to the unavoidable delay, obtaining an order in ordinary proceedings must not be reasonable for the insured person, and failure to perform must threaten them with serious disadvantages that are not disproportionate to the damages that the insurer could suffer.

Such an existential emergency would be affirmed, for example, if the applicant is exposed to numerous civil and criminal claims, all of his assets have been seized as a result of these proceedings, and he has lost his professional and economic livelihood due to his imprisonment. He would then lack the urgently required funds to finance his defense against the liability and attachment claims. This is not precluded by the possibility of applying for state legal aid. By taking out the D&O insurance, the insurer made a far-reaching promise of benefits, which it cannot withdraw from by referring to legal aid. This does not correspond to the owed insurance coverage, which provides for the remuneration of a lawyer based on a fee agreement and not on the basis of the German Lawyers’ Act (RVG). If the insured person is unable to defend himself effectively, he runs the risk of losing his entire economic livelihood. He therefore cannot be referred to the theoretical possibility of being able to assert claims for damages after years of litigation. It is precisely against such risks that the D&O policy should protect the insured person.

2. Discontinuation of benefits despite a promise to cover legal defense costs

Even a promise by the insurer to cover the insured person’s legal defense costs often offers no guarantee that the insurer will actually reimburse the legal defense costs until the conclusion of any criminal and/or civil proceedings.

According to the general terms and conditions of insurance, legal defense costs paid by the insurer are credited towards the insured amount (so-called crediting clause). Since no insurer is willing to assume the entire risk for larger financial service providers and companies, so-called insurance towers often exist, consisting of a primary insurer and a series of subsequent excess insurers. Primary insurers regularly offer coverage of between €15 and €25 million.

In more extensive liability cases, which often affect numerous insured persons, significant coverage gaps arise due to the involvement of multiple insurers. The crediting of defense costs calibrates the coverage amount. The primary insurer’s coverage amount may – as in the Wirecard case – be exhausted even during the course of criminal and/or civil proceedings. Since the individual insured person does not know to which other insured persons the insurer has already provided coverage and to what extent, the insured person may be surprised by the insurer’s suspension of benefits even during the course of criminal and/or civil proceedings.

The insured person cannot under any circumstances rely on the excess insurers providing coverage – as the Wirecard case also clearly demonstrated.
The question of whether the offsetting clause is effective is controversial in the literature and has not been resolved by the highest courts. In a decision dated November 29, 2024 (case no. 7 U 82/22), the Higher Regional Court of Frankfurt am Main stated that such clauses withstand a content review and that the insured persons are not otherwise deserving of protection.
The Higher Regional Court was not concerned about the insured persons’ inability to assess the current level of the available coverage amount. In any case, the disadvantages of an offsetting clause – the reduction of the coverage amount due to defense costs up to its complete exhaustion, with corresponding consequences for any possible indemnification claim – are clearly evident in the insurance terms and conditions for insured persons. The offsetting clause is therefore not opaque.

Equally, an offsetting clause does not jeopardize the purpose of the contract. The insured persons’ unified insurance claim encompasses both legal protection and indemnification as equal primary obligations, usually successively over time. Therefore, offsetting costs due to legal protection at most limits the indemnification claim. The policyholder must ensure a sufficiently high coverage amount for legal protection and indemnification.

Finally, in view of the mix of high, unforeseeable defence costs, complex liability issues and a larger circle of insured persons typical for D&O, a set-off clause does not deviate from a statutory model – according to which an insurer must reimburse defence costs even to the extent that they exceed the insured sum (Section 101 (2) Sentence 1 of the Insurance Contract Act).

The Higher Regional Court also rejected the arguments regarding the abuse of law in the basic insurer’s defense of performance: The coverage commitments issued before the basic insurance sum was exhausted always referred to the consequences of the cost allocation and therefore did not create a legitimate expectation that costs would be covered beyond the exhaustion of the insurance sum – even if the coverage commitments were qualified as declaratory acknowledgments of debt. The Higher Regional Court of Frankfurt further ruled that the distribution of the coverage amount among the insured persons by the basic insurer according to the priority principle – based on the chronological sequence of receipt of invoices – was permissible. The potential unequal treatment of insured persons seeking insurance coverage later in time was inherent in this system and evident to all parties involved, and its occurrence was equally likely for all insured persons.

The ruling dramatically highlights the pitfalls of currently standard D&O insurance policies for insured persons: The more complex the insured event and the larger the circle of insured persons, the more likely they are to be forced to proceed on a contingency basis in civil and criminal proceedings. The consequence of the offsetting clauses and the priority principle is not only that, after an unsuccessful defense against a claim, indemnification from claims for damages is no longer possible due to the exhaustion of the insured sum. Rather, the continuously declining level of the insured sum during an insured event means that the insured persons who simultaneously access it may be faced with complete exhaustion in ongoing criminal and civil proceedings. This sudden exhaustion can largely bring an ongoing proceeding to a standstill, which may have only been initiated following encouraging signals or commitments of coverage from the insurer. It can also nip the defense ability of insured persons who are only sued at a later date in the bud because no more funds are available for them.

The offsetting clause is by no means as transparent as the court believes: In particular, the risk that the insured sum will be fully exhausted before an insured person first makes a claim against the primary insurer due to the priority principle – and thus the access of other insured persons – is not clearly apparent. Indeed, the priority principle is neither mentioned in the insurers’ terms and conditions, nor did a corresponding contractual provision exist in the Frankfurt proceedings. The Frankfurt Higher Regional Court cannot point to any established contractual practice in favor of the priority principle, nor to a prevailing opinion in case law or academia.

An appeal has been filed against the Higher Regional Court’s ruling with the Federal Court of Justice. The Federal Court of Justice may provide clarity on this matter.

3. Conclusion

Policyholders are advised to resolve these deficiencies through negotiations when concluding and/or renewing D&O insurance. Ensuring that legal defense costs are actually covered promptly after the initiation of prosecutorial investigations or civil claims could, for example, be achieved by the insurer assuming the obligation to pay upon first request, i.e., without prior verification of whether the conditions for its obligation to pay are met. It could also be agreed that legal defense costs would be provided up to the amount of the defense sum, but would not be credited towards it, and that each insured person would receive legal defense costs up to a certain minimum amount.

Insured persons are recommended to take out individual criminal and civil legal expenses insurance with maximum amounts appropriate to their personal risk situation.