A Director who believes that he does not require a Directors and Officers Liability Policy because his company will always protect him, is mistaken.
Whilst a Company may indemnify its Directors for actions brought against them, the scope of protection is limited and may well be removed if:
i) the Company becomes insolvent
ii) the Company has insufficient funds
iii) the Company is the claimant
iv) the protection is withdrawn.
v) they are no longer Directors of the Company.
Most importantly indemnification by the Company is only permissible when a claim is successfully defended.
A Director's liability is a personal liability which continues whether or not he remains in the employment of the Company.
WHO IS PROTECTED BY THE POLICY?
A policy is normally arranged in the name of the Parent/Holding Company and provides protection to the Directors and Officers of that Company and also to:-
1) The Directors and Officers of all subsidiary companies,
2) The Directors and Officers of all subsidiary companies acquired or created during the period of the policy.
The policy may also be extended to provide what is termed as 'Outside Board' protection. This extension protects the Directors and Officers of the Parent Company, or of any subsidiary, whilst appointed to act as Directors of a Company outside the main group, so long as the appointment is at the request of a group company. This extension is often sought by Banks, Financial Institutions and larger Companies which require one of their Directors to represent them on the board of a Company in which they have some financial investment or other interest, but which is not a subsidiary.
WHAT PROTECTION IS PROVIDED TO DIRECTORS AND OFFICERS BY A DIRECTORS AND OFFICERS LIABILITY POLICY?
The policy protects the Directors and Officers against:-
1. Legal costs in defending allegations or suits brought against them alleging wrongful acts.
2. Any awards granted to the claimants against the Directors and Officers, including out of court settlements.
A wrongful act is:-
- Breach of duty
- Neglect
- Error
- Omission
- Mis-statement
- Misleading statement
- Breach of trust
committed solely by reason of their status as Directors or Officers of the insured companies.
WHAT PROTECTION IS PROVIDED TO THE COMPANY BY A DIRECTORS AND OFFICERS LIABILITY POLICY?
The policy will reimburse the Company for any amounts which it is required to pay on behalf of the Directors and Officers in respect of legal actions alleging wrongful acts committed by them.
HOW DOES THE A DIRECTORS AND OFFICERS LIABILITY POLICY OPERATE?
The Policy is made up of two insuring clauses:
Insuring Clause 1 - Insurers agree to pay on behalf of the Directors and Officers all loss arising out of a claim for a Wrongful Act
Insuring Clause 2 - Insurers agree to pay on behalf of the Company all loss arising out of a claim for a Wrongful Act by the Directors and Officers, for which the Company is permitted or required by law to grant indemnification to the Directors and Officers.
(It should be noted that many policies agree only to "reimburse" rather than "pay on behalf of". This is an important distinction.)
The Policy has two levels of deductible (self insured excess)
1. In respect of claims under Insuring Clause 1 where the Insurers are directly protecting the Directors and Officers, there is normally a small deductible for each Director and Officer and also an aggregate, per claim for all the Directors and Officers.
2. In respect of claims Insuring Clause 2 a higher deductible applies to each claim.
One of the main features of the policy is that in the event of a claim being brought against the Directors and Officers, the Insurers will appoint lawyers, at Insurers expense, to handle the litigation on behalf of the Directors and Officers.
The policy provides protection in respect of all claims notified to Insurers during the period of the policy, regardless of when in the past the act giving rise to such claim is alleged to have occurred
If the Directors or Officers become aware of a circumstance that might give rise to a claim and notify such to their Insurers during the policy period, then any subsequent claim is covered by the policy, regardless of when the actual claim is made.
EXTENSIONS TO THE BASIC POLICY
Certain insurers are now offering extensions to further increase the available protection.
1. Pre-determined allocation
Many law suits against Directors and Officers also enjoin the Company as a defendant. Because a standard policy only protects the Directors and Officers, insurers exclude that part of the claim which they maintain should be allocated to the Company. This leads to disputes. To avoid such disputes, it is possible to agree an extension to the policy whereby a pre-determined allocation is agreed in advance of any claim as to the percentage of the total claim/defence costs which the insurers will pay. Typically this allocation would be that 70% of the claim would be payable by the Insurers and 30% by the Company.
2. Entity coverage/prospectus liability
Where a Company makes a public offering in the USA, any claim subsequently brought by an investor will enjoin both the Company and the Directors. Insurance is available to cover 100% of such claims and is frequently purchased for a fixed period of three years as a separate policy to cover the specific offering. The benefit of having a separate policy is that both the Directors and the Company guarantee themselves full protection by means of a policy with its own aggregate limit. This policy covers the period of greatest risk, i.e. a period of three years following the date of the public offering.
THE MAIN EXCLUSIONS
1. Bodily Injury, Sickness, Disease, Death, or Damage/Destruction of Property
Whilst this is a standard exclusion, it is important to ensure that the policy only excludes claims 'for' and not 'arising out of' any of the above. There are cases where the Company and its shareholders suffer a financial loss arising out of one of these events and bring an action against the Directors and Officers to recover their loss. If the exclusion in the policy prohibits claims "arising out of" these events the subsequent shareholder action is uninsured. In other words the 'for' wording includes consequential loss whereas the 'arising out of' wording excludes this protection.
2. Liability based upon or arising from Seepage, Pollution or Contamination
The policy is not designed to protect the Directors and Officers for claims arising out of pollution. Companies which face this exposure may insure this exposure under a separate policy.
Some insurers will agree to provide limited protection to the Directors and Officers but only for defence costs.
3. Liability of a Director or Officer to restore or account for Remuneration paid to him for which he is not legally entitled
The basis of this exclusion is that the Director or Officer has suffered no loss. He is merely required by law to restore what he has improperly obtained.
4. Insured versus Insured
Policies normally exclude claims brought by one Director against a fellow Director or by the Company against a Director unless such claim is instigated by a third party such as a shareholder. It is possible to broaden the scope of the policy to permit or include Director versus Director suits but only for cases of wrongful termination. In certain circumstances, it may also be possible to delete the Director versus Director exclusion in its entirety.
5. Liability of a Director or Officer in carrying out, or failing to carry out, Professional Services for a Fee to a Third Party (Professional Indemnity Exclusion)
A Directors and Officers Liability Policy is designed to protect individuals acting in their management capacity and not in their capacity as professional advisors to clients, the exposure to which is properly the realm of a Professional Indemnity Policy.
There are companies in which the dividing line between acting as a Director or acting as a professional advisor can be unclear. It is possible to negotiate with Insurers to delete the "Professional Services Exclusion" or to clarify precisely to which activities this exclusion relates.
An example might be the case of the Directors of an Investment Fund, where it could be deemed that their choice of Investment Manager and general involvement in the decision making for the Investment Fund is a professional service. Here, it would be imprudent to permit Insurers to exclude claims arising from these activities as they are in fact the main duties of the Director of such a Company.
FRAUD AND DISHONESTY
All policies exclude liability due to or resulting from any dishonesty, fraud or malicious conduct by a Director or Officer.
Legal action against Directors and Officers almost invariably contains some allegation of fraud. For this reason two important extensions are available:
Severability
Protection is available whereby the dishonesty of one Director is not imputed to another. In other words the policy would include protection for claims brought against Directors who were not involved in a fraud, even though as Directors they are held liable for the fraud.
Innocent Until Proven Guilty
A policy may include defence costs being paid by Insurers, at their discretion, in defending an allegation of fraud. The only proviso is that if the legal action were to be successful and fraud proved, the Director must reimburse the insurer for the defence costs they have paid.
Most policies are much more limited. They state that Insurers will not advance the costs of such actions but will only reimburse the Director for his legal costs after a successful defence (by which time he may be bankrupt!).
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.
