What is a 'Hammer Clause'?

For executives and board members, and also for most professionals, your actions have big effects on others. Consequently, they need special insurance, such as a Professional Liability policy or a Directors & Officers policy. In these policies, there is almost always a 'Consent to Settle' clause, often referred to as a 'Hammer Clause', that puts restrictions and conditions on settling claims. 

Professional Liability, Errors & Omissions, Directors & Officers, and other liability policies typically contain a 'Hammer Clause'. However, you won't find the words 'Hammer Clause' anywhere in your policy. Rather, you'll find a section titled: "Consent to Settle". This section of the policy is going to put a stipulation on claim payments, often to your detriment, and it comes in many variations.

What a Hammer Clause Entails

The Hammer Clause was made to entice you to settle a claim out-of-court instead of following a lawsuit to its final court-appointed judgment. Insurers do this to limit their liability and reduce defense costs (lawyers are expensive!). However, if you feel like the lawsuit is excessive, or worse yet, if you know that the lawsuit is frivolous, settling can seem like the worst option. Moreover, there are often reputational damages occurred when settling, since settlements can be seen as an 'admission of guilt', resulting in a poor public image. 

What a Hammer Clause Can Look Like

The insurer and their lawyers are going to try to pay the minimum amount to settle a claim, and part of this is making settlement offers with the plaintiff and the plaintiff's lawyers. Should they come to an agreeable settlement, the Hammer Clause is going to be triggered. Assuming it is a 'Hard' Hammer Clause, you'll now be forced to choose between agreeing to the settlement or paying for continued defense costs yourself, along with the difference between the ultimate judgment and the settlement amount should the ultimate judgement be higher than the initial settlement offer.

Hammer Clause Variations

There are multiple variations of the Hammer Clause, the harshest being the Hard Hammer Clause, seen above that limits the judgement payout to the initial settlement amount and ceases all ongoing defense coverage. So, if the agreed settlement amount was $500,000 and you refused, you would immediately be responsible for all ongoing defense and court costs, and if the final judgement exceeded $500,000, you would be responsible for every dollar excess of $500,000. 

A common, less-harsh Hammer Clause example would be one that provides coverage for a certain percentage of the ongoing defense cost and excess settlement, such as 50%. So, again, using an agreed settlement of $500,000 that you refused, you'd immediately be responsible for paying 50% of the ongoing defense and court costs and you'd be responsible for paying 50% of the judgement in excess of $500,000. 

Recap

Special attention needs to be taken when you buy one of these more complicated policies. Knowing ahead of time how a claim will be defended and paid-for can change how you approach decisions!