As a means of attracting and retaining qualified directors and officers, corporations have chosen to shield their directors and officers from personal liability. The Supreme Court of Canada has recognized that protection from liability is necessary to promote entrepreneurialism.1
A corporation, if it so chooses, to indemnify directors and officers against all costs reasonably incurred through any criminal, civil, administrative or investigation deriving from the director's or officer's association with the corporation.2 However, in order for the director or officer to take advantage of these protections, they must:
- Must have acted honestly and in good faith with a view to the best interest of the corporation; and
- In a situation involving criminal or administrative proceeding that is enforced by a monetary penalty, the director or officer must have had reasonable grounds to believe their conduct was lawful.3
As such, a corporation is not permitted to indemnify a director or officer where the two prerequisites are not fulfilled. A caveat that should be appreciated is that although the federal statute provides an option to corporations to purchase insurance for its directors and officers,4 corporate bylaws tend to impose a duty to purchase and maintain insurances for its director and officers.
D&O Liability Insurance
"Director and Officer Liability Insurance" refers to three types of insurance products. The first product provides coverage to individual managers from the risk associated with the execution of their office. If the directors and officers have not been indemnified by the corporation, the coverage limit on this product tends to equal the amount directors and officers are legally obligated to pay arising out of a claim of a wrongful act.
The second type of insurance product reimburses the corporation for its indemnification obligations. Insurance companies are able to take an off-coverage position where the corporation has indemnified a director or officer when the director or officer has acted in contravention of the prerequisite listed above, or where the director or officer are in a civil action led by the company in a derivative suit.
The third type of insurance product provides protection to the corporation against security litigation in which the corporation itself is a party to the litigation. This type of coverage renders unnecessary the dispute between insurance companies and corporate defendants over which share of the settlement will be absorbed by the insurance company and the corporation.
Director and Officer Liability tend to operate for a one-year term. During this coverage period, the insurance will respond to all claims. If a claim arises in this one-year period but is not discovered until the second year, the insurer will still likely have to cover any loss arising, subject to any restrictions or exemptions.5
As with any insurance policy, the policy will contain a clause outlining the maximum amount in which the insurer is liable to pay in the coverage period. However, what makes Director and Officer Liability insurance different than most conventional insurance policies is that these policies are "self-consuming", which means that the coverage limit includes all legal expenses spent in defending the claim.6
Director and Officer Coverage Exclusions
Director and Officer Liability Insurance tend to have three exclusions:
- The "fraud" exclusion encapsulates acts of deliberate fraud or unjust personal enrichment.
- The "prior claims" exclusion captures claims that were in effect or pending prior to the start of the policy.
- The "insured versus insured" exclusion for litigation taking place in between insured persons. As such, coverage would also be excluded for litigation that arises between the corporation and the directors and officers.7
The fraud exclusion is included to prevent directors or officers from benefiting from their own malfeasance. Canadian courts have recognized American case-law in this respect, as the Jon S. Nicholls v Zurich American Insurance Group clearly states:
The Personal Profit exclusion in the D&O Liability policy is drafted in clear and specific language. The reasons for such an exclusion are equally clear -- to prevent the looting of corporate assets by directors and officers and then, after being forced to remit the funds, turning to an insurer seeking indemnification for their wrongful acts under a directors and officers policy.8
In addition to the three principal exclusions outlined above, Director and Officer Liability Insurance tend to exclude claims also prohibited under a Commercial General Liability; for instance: bodily injury, property damage, intentional torts such as invasion of privacy, libel or slander.9 Lastly as the Court of Appeal in Ontario ruled in Boliden Limited v Liberty Mutual Insurance Company, Director and Officer Liability Insurance can also exclude coverage relating to environmental and pollution risks.10
1 Blair v. Consolidated Enfield Corp. , 4 S.C.R. 5.
2 CBCA, s. 124 (5): Despite subsection (1), an individual referred to in that subsection is entitled to indemnity from the corporation in respect of all costs, charges and expenses reasonably incurred by the individual in connection with the defence of any civil, criminal, administrative, investigative or other proceeding to which the individual is subject because of the individual's association with the corporation or other entity as described in subsection
- , if the individual seeking
- was not judged by the court or other competent authority to have committed any fault or omitted to do anything that the individual ought to have done; and
- fulfils the conditions set out in subsection (3).
3 CBCA, s. 124: ) A corporation may indemnify a director or officer of the corporation, a former director or officer of the corporation or another individual who acts or acted at the corporation's request as a director or officer, or an individual acting in a similar capacity, of another entity, against all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by the individual in respect of any civil, criminal, administrative, investigative or other proceeding in which the individual is involved because of that association with the corporation or other entity (Emphasis added).
- 4 CBCA, s 124(6): corporation
may purchase and maintain insurance for the benefit of an
individual referred to in subsection (1) against any liability
incurred by the individual
- in the individual's capacity as a director or officer of the corporation; or
- in the individual's capacity as a director or officer, or similar capacity, of another entity, if the individual acts or acted in that capacity at the corporation's request.
5 A. Baker (July 2007) Directors' and Officers' Liability Insurance: An Overview - Part 1, 23 CAn. J. Ins. L. at page 63,
8 Jon S. Nicholls v Zurich American Insurance Group (2003) 244 F. Supp 2d 1144; 2003 U.S. Dist. LELXIS 2058 at pages 40-41.
9 B.Reiter (2006) Directors' Duties in Canada, CCH Canadian Limited, Toronto, ON, page 164.
10 Boliden Limited v Liberty Mutual Insurance Company (2008), ONCA 288 (CanLII)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.