Gaining an insight on Hammer Clause is a prerequisite while availing of a Directors and Officers Liability Insurance policy. In order to know the impact of the hammer clause, one has to assess the financial repercussions of this clause on the claim settlement amount of such a policy.
This clause provides the power to the insurer to reduce their limit of liability. A settlement amount is proposed by the insurer, out of good faith, in order to settle a claim by an out-of-court settlement and to avoid court proceedings. In case the insured does not accept this settlement amount, this clause puts a stipulation on claim payments. There are various restrictions and conditions such as caps on the amount of money an insurer is liable to pay or exclusion of defence cost being imposed on settling claims under the hammer clause, if the insured does not accept the proposal of the insurer.
For example: If the insurance company has recommended an amount of Rs.50 lacs as a settlement amount, but the insured refuses to settle a case. After court proceedings, if the actual cost is Rs.55 lacs, then under the hammer clause, an insurance company is liable to pay only Rs. 50 lacs. This is because initially the insured has refuted the proposed settlement amount provided by the insured in good faith. The logic is that the insured, out of hubris, did not accept the recommended settlement amount, hence later on he has to bear the financial consequences of court proceedings.
So if you are purchasing a D&O liability policy, it is always advisable not to have a “Hammer Clause” in your policy even if the cost of insurance is thereby increased. Since this clause will put restrictions or a capping on the claim settlement amount. At the worst case of a harsh hammer clause, it also negates the defence cost, it will only provide the settlement cost amount.
The other type of hammer clause is modified hammer clause which is quite liberal and takes on some percentage of defence cost and even some of the cost of the additional amount of settled claim say 50% or 70%.
Although “Hammer Clause” is considered a negative imposition on your policy, it helps to assess whether you need court proceedings or not since businesses are not well versed with litigation costs and procedures but insurance companies out of their expertise and experience hold a good amount of accountability in their computation of recommended settlement amount so one can avoid hefty litigation or defence cost and go for out-of-court settlement with the help of insurance company. Losing in court because of adverse judgement also damages the reputation of the company and invites financial crises. So it is always recommended to study the pros and cons of hammer clause before purchasing directors and officers (D&O) liability insurance.
Case of Hammer Clause:
Aditya Limited has availed Directors and Officers Liability Policy with “Hammer Clause”. One of their clients has filed a case against breach of contract and the insurance company has recommended a sum of Rs. 20 lacs but the company refuses to accept it and goes for court proceedings. So, in this case, the limit of liability is Rs. 20 Lacs and any additional cost will not be borne by the insurance company.
Hammer Clause is also known as “Consent to settle clause” and “ Blackmail Settlement clause”. This clause is a method or disguise to limit the liability of the insurer and protect the interest of the insurance company during a claim settlement.