Directors and Officers (D&O) insurance policies provide protection for company board members, executives and managers from claims arising from their decisions and actions within the scope of their regular duties. COVID-19 means this insurance is more important than ever as related lawsuits may be launched by shareholders, competitors, customers, vendors, suppliers, employees or regulatory authorities.
Directors are under increased scrutiny and pressure
The constantly changing and uncertain circumstances that flow from the COVID- 19 outbreak have put immense pressure on management to make wide-ranging decisions to protect the interests of the workforce, the business itself, as well as clients and wider stakeholders. Necessary decisions may include assessing risk exposure, putting in place contingency plans in a timely manner, enabling staff to work from home, making staff redundant to reduce costs as revenues decline, funding remote working and adequate IT capabilities, shutting down production, or taking out a loan to bridge a period of tight cash flow.
The increased risk of insolvent trading
COVID-19 has made it even harder to recognise the precise point in time at which insolvency cannot reasonably be avoided. This is difficult to pinpoint in normal circumstances.
For many companies, revenues are under pressure and customers may be slow to pay bills. Further, there is uncertainty as to when restrictions are going to be lifted. A director who continues with normal trading past a point when liquidation or administration cannot be reasonably avoided may be liable for wrongful or (more unusually) fraudulent trading. Directors now not only need to consider the solvency of the company but also assess its financial prospects.
The Australian Government has recognised the risks faced by companies as a result of COVID-19 by enacting The Coronavirus Economic Response Package Omnibus Act 2020 (Cth). This legislation provides an expanded safe harbour for directors, in addition to the safe harbour provided under section 588GA of the Corporations Act 2001 (Corps Act).
The new section 588GAAA, provides that personal liability will not apply if a debt is incurred in the ordinary course of the company's business for a six-month period from 24 March 2020. The minimum amount for a statutory demand has also been increased from $2,000 to $20,000. This is effectively a six-month amnesty on insolvent trading and provides some much needed breathing space to navigate these unprecedented times.
These new measures do not however lessen a director's duty to perform their role with due diligence and skill. In fact, questions will be asked whether sufficient steps were taken to prepare the company for the fallout from COVID-19. There will undoubtedly be an increased risk of claims against directors and officers for allegedly failing to respond efficiently and effectively to the crisis.
Notifying insurers on potential claims
D&O policies typically require companies to provide notice of a claim during the policy period in which the claim is made. These policies also give insureds the option to report circumstances that may reasonably be expected to give rise to a claim in the future. Boards should be vigilant about the impact of COVID-19 and consider notification of circumstances where the situation suggests that there may be a reasonable expectation of a claim under the policy. For example, COVID-19 may cause a rise in dissatisfaction from the company's stakeholders or scrutiny from a regulatory authority. A general blanket notice of "coronavirus circumstances" will not be enough. The notification will need to be precise and particularised to avoid the risk that insurers will reject the notification.
If the insurer accepts the notice of circumstances, any future claim will be deemed to have been made during the policy period in which the insured submitted the notice of circumstances and any related claims and costs would fall in the same policy year. If there are changes in those specific circumstances, companies should consider updating the notification.
It is possible that insurers may respond to COVID-19 by imposing an exclusion at renewal. Therefore, any notification must be carefully considered.
Greater emphasis should perhaps also be placed on the importance of maintaining continuity with insurers, to minimise the risk of claims falling between any gaps between one policy period and the next.
Consequences for the D&O insurance market
Potential claims arising from COVID-19 are likely to further reduce insurers' appetite for growth in D&O risk. The immediate impact of the pandemic is already noticeable at renewal.
In the short term, there will be:
- increased scrutiny of the financial health of a company, which may include the application of more insolvency restrictions
- questions around COVID-19 preparedness both from a business continuity perspective and how the company is looking after and communicating with its employees
- some insurers are applying a COVID-19 exclusion across the board, meaning that market capacity is further squeezed and restructuring programs could minimise the impact of coverage restrictions
- difficulty in obtaining D&O insurance – at least one insurer has ceased to consider a new business whilst they review their book and their longer-term strategy
- longer sign off or approval process at insurers and therefore longer lead times for renewal quotes. Also expect a reluctance to extend cover, even for short periods.
While the insurance market is well placed to continue functioning as near to normal as possible by taking advantage of quoting and binding risks electronically, it will inevitably take longer to renew placements over the coming months. The situation is constantly evolving.
We strongly recommend that you seek advice from lawyers experienced in dealing with D&O claims. Recognise potential issues now and take necessary steps to be in the best position possible should a claim be brought against you which would be required to be referred to your D&O underwriter.
When the dust settles after COVID-19, we anticipate that there may well be a new battle ground in the area of D&O insurance. Holding Redlich is experienced in resolving coverage disputes and is able to assist in any dispute with insurers.
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.