A Hammer Clause is usually a part of a directors and officers or errors and omissions insurance policy. The main purpose of this policy is to allow the insured to choose if they want to settle for what is offered or accepted by the “injured” party. Also known as the consent to settle provision, without this provision in a policy the insured would be at the mercy of the insurance carriers desire to settle. Frequently the recommended settlement is the better outcome financially, but the Hammer Clause can help a business determine if they want to fight the suit in court in an attempt to preserve the precious image of the company.
A Hammer Clause kicks in when the insured refuses to settle for an amount the insured recommends. In many cases the insurance carrier will recommend to settle for an amount they feel confident will be less than the defense and indemnity costs will be. The insurance carrier deals with these situations fairly frequently and they have reliable data to help them predict how much defense costs will be. Business owners do not deal with getting sued frequently. At least not if they are good business owners. The clause is typically there to encourage the business owner to settle for the recommended amount. In turn, the insured is penalized for not accepting the settlement only if the judgment amount plus defense costs exceed the amount for which the claim could have been settled. Frequently lawsuits among businesses are a time when pride and emotion can effect the judgment of many good business owners. The Hammer Clause is there to prevent this or if it does not prevent it, it spreads the risk to the business owner who is taking on the additional risk.
There are several different ways these clauses can be arranged. The most common are the Full Hammer and the Modified Hammer Clause. The Full Hammer states that if the insured refuses to settle for the recommended amount they take on the full amount of the settlement costs. The Modified Hammer is set up to give the insured the option of refusing to settle, but requiring the to still take on some of the costs if those costs amount to more than what was originally offered to settle for. Typically, if the insured refuses to settle than the costs will be shared at an amount of 50/50, but it is not uncommon for policy to go higher to a 70/30 split of the costs.
The important thing to take away from this is that Hammer Clauses exist and this is something you should always speak with your agent about. A full Hammer Clause is taking a lot of risk and it puts you at the mercy of whether your insurance carrier wants to settle quickly. For most businesses some version of a Modified Hammer Clause is what suits the needs of the business best. This will allow you to make the decision yourself if it is worth the reputation of your business to risk losing in court, while spreading some of the risk back on the insurer.