D&O Liability Insurance Guide
Increasing scrutiny of corporate behaviour and a claim-friendly legal environment have accelerated claims for Wrongful Acts made against directors in recent years. There have been many allegations including breach of duty, neglect, breach of contract, breach of employment legislation and breach of health and safety legislation.
What are the duties and responsibilities of directors and officers?
Company directors and officers now face unlimited personal liability for their actions and this personal liability exposes them to a potential loss of personal assets.
The Companies Act 2006 codified certain common law and equitable duties of directors for the first time. The Act sets out seven general duties of directors which are:
- to act within powers in accordance with the company’s constitution and to use those powers only
- for the purposes for which they were conferred;
- to promote the success of the company for the benefit of its members;
- to exercise independent judgement;
- to exercise reasonable care, skill and diligence;
- to avoid conflicts of interest;
- not to accept benefits from third parties;
- to declare an interest in a proposed transaction or arrangement;
- it is increasingly difficult for directors to keep up to date and fully understand all the responsibilities and duties required from them leading to directors frequently being held personally liable for claims of breaching duties or responsibilities that they are unaware of.
What is Directors’ & Officers’ (D&O) Liability Insurance?
Company Directors’ & Officers’ Liability Insurance (also known as D&O) provides financial protection for the directors and officers of a company in the event of an action being brought against them.
Individual D&O cover is also available, popular with individuals who have multiple directorships and wish to ring-fence their own insurance limit to ensure this cannot become exhausted through actions un-related to their own. Spouses and heirs can also be covered under this type of policy.
Who is it designed to cover?
A D&O Insurance policy provides directors and officers with financial protection against actual or alleged or actual ‘’wrongful acts’’ when carrying out their duties. The inclusion of ‘Entity Cover’ provides protection where claims are also made against the company and not just individuals.
Why should we purchase it?
Legal actions can be brought by many different parties including investors, shareholders, staff members, disgruntled customers or even liquidators. These claims may well be frivolous or malicious in their nature but will still require defending which can involve significant quantities of both time and precious finances.
How does it work?
The policy is designed to pay for any defence costs and financial losses that occur up to the limit of the policy within the policy parameters.
A typical D&O policy will normally be constituted of the below Insuring Clauses:
- Side A cover provides cover for the individual directors and officers for those situations where they have been accused of committing a Wrongful Act and their company is either unwilling or unable to indemnify them.
- Side B cover operates where an individual has been or may be indemnified by their company. This Insuring Clause benefits the company by reimbursing the indemnification and thus acting as balance sheet protection.
Who pays for it?
D&O policies are funded by the company unless an individual chooses to purchase a policy to cover a number of directorships with a ring-fenced limit.
Is coverage for past and future D&Os included?
All current, future and past directors and officers of a company and its subsidiaries are typically covered for:
- Wrongful acts which include reporting errors, inaccurate or inadequate disclosure of company
- accounts and failure to comply with regulations or laws.
- Shareholder actions where claims are filed on behalf of shareholders for improper management.
- Employment Practices (EPL) & HR issues such as employee discrimination claims including unfair
- dismissal, harassment, or failure to promote a person.
- Environmental Liability claim defence costs.
- Defence costs for the legal process.
- Outside board directorships and non-executive positions are also regularly covered.
- “Claims Made” policy means that claims are covered if made whilst the policy is in effect or within a contractually agreed extended period.
- Period of coverage is usually 12 months or an Extended Reporting Period (ERP) can be negotiated to extend to up to 72 months.
- Premium is the cost of insurance determined by domicile, activities, public/private, assets etc.
- Aggregate Limit (typically purchased in £1m denominations) denotes the total amount that the insurer is prepared to pay under the policy during the period of coverage after which the policy is exhausted.
- Deductible (also known as an Excess) is the amount borne by the insured for each and every claim. This is usually £Nil if the claim is brought against the individuals, but normally has a Side B “Company Reimbursement” amount which will be recovered by insurers if the Company is able to fund it.
- A Prior & Pending Litigation Exclusion precludes coverage for claims from litigation that was brought prior to, or was pending at, the inception of the policy.
- Extensions include additional limits for non-executives, crisis loss or emergency costs cover and representation for investigations.
What is not covered?
Standard exclusions that are not covered by a D&O policy include:
- Proven dishonest, fraudulent, criminal or malicious acts
- Criminal fines and penalties
- Bodily injury
- Criminal or intentional non-compliant acts.
Innocent directors remain fully covered if they are co-defendants, even if the acts of their colleagues were intentional or fraudulent.
Who needs D&O Insurance?
Historically, it was larger companies who were the first to purchase D&O insurance on a large scale. In more recent times it is the directors of SME companies that are now widely purchasing this type of protection as it is becoming more relevant to them in this ever-increasingly litigious environment.
The purchase of D&O insurance may also be driven by investors in the company, particularly at venture capital stage, who will usually require the company to put D&O cover in place at the time, or shortly after the investment is made.
It is now quite commonplace that when directors are appointed (executive of non-executive) they will request that D&O insurance be in place as a condition of employment, as they would not want to expose their own personal assets.
Who can make claims?
D&O claims can be made by internal parties (internal liability) as well as third parties (external liability).
Potential sources of internal claims include the company itself, subsidiaries and other insured individuals (D&Os).
Potential sources of external claims include creditors, employees, shareholders, customers, suppliers, competitors, tax authorities, government departments and regulators.
D&O Claims examples
- The directors of a company were sued by an ex-director for allegedly conspiring to deny him the pension benefits that he was entitled to. Defending the claim personally cost the directors of the firm and significant five figure sum.
- The directors of a company allowed their company to continue to trade although they knew that insolvency was inevitable. During this period a significant VAT liability was created which could not be collected by HM Customs & Revenue as a result of the insolvency.
- A managing director and several senior staff faced a criminal prosecution for allegedly breaching health and safety legislation, these alleged actions resulted in the accidental deaths of two employees.
- A business was being investigated for polluting a waterway, a senior member of the organisation was required to give evidence resulting in significant legal representation costs.
- An investor had been given certain representations about the trading position and solvency of a company which transpired to be misleading. The investor subsequently brought an action against the directors for misrepresentation.
- An employee was sacked immediately for racially abusing and being physically violent to a colleague resulting in an unfair dismissal claim against the employer. The employer’s legal costs were covered by a D&O liability policy.
Trends in Claims
2000-2008 saw a steady increase of claims activity brought against directors and officers. The global financial crisis accelerated this trend, which continues to date. Notification levels of claims brought against directors in 2011 onwards has been consistently 20% above the peak years of 2009 and 2010.
Top 5 sources of exposures by nature of loss
- Regulatory & Criminal actions including investigations and proceedings brought by regulatory bodies.
- Bankruptcy actions including claims brought by receivers for continued trading whilst insolvent, or asset stripping.
- Company v Insured actions including claims brought by or on behalf of the company by shareholders for breach of fiduciary duty resulting in a depletion of assets.
- Co-defendant actions including claims brought by third parties against the company for anti-competitive behaviour or misrepresentation and naming a director or officer as co-defendant.
- M&A actions including claims brought by minority shareholders alleging unfair treatment or valuation in a sale, acquisition or merger.
How much will this insurance cost?
D&O products are relatively inexpensive and potentially represent good value for money considering the size of the claim limits that insurers put at risk.
D&O insurers calculate the premium based on various aspects of the business for example industry sector, company size and profit, prior claims record, domicile and international activity (particularly US exposure) and debt levels.
GBP5,000 Company Reimbursement
GBP15,000 Company Reimbursement
What limits of cover do I need?
The limit of indemnity that should be chosen depends on your perception of the exposure you face and how much you are prepared to spend to mitigate the risk. It is relevant to bear in mind that this type of coverage protects the personal assets of the directors and officers.
Many smaller companies purchase a limit of up to £10 million. The limits required can vary greatly and is one of the key factors in underwriting such a policy. Protean is well placed to offer the informed and independent advice which you may need to ensure you don’t pay for an unnecessarily high level of cover.
How does the policy’s limit of liability apply?
Typically, the policy limit is an annual aggregate that applies for all claims that fall within the policy terms. This limit is the total amount the insurer is willing to pay out regardless of the number of individual claims and the accumulation of the defence costs. If claims and defence costs accumulate to the amount of the limit, any further costs on existing/new claims are not covered by the policy.
The policy limit is shared amongst executive and non-executive directors who receive the same treatment in the event of a claim. Extensions are now available which give additional segregated limits for non-executive directors in the event of policy limit exhaustion. Recently, some D&O policies for ‘commercial’ companies (i.e. non-financial) have been written on an ‘any one claim’ limits (compared with aggregate limits) which are capable of paying up to the limit of the policy for multiple claim events during the policy period.
Why don’t companies indemnify their directors and officers?
Some companies do indemnify their directors and officers. However, in certain situations companies may have insufficient funds to do so, as many claims against directors are from investors and/or creditors which are more likely to arise when the company becomes insolvent.
Without corporate indemnity or insurance, directors and officers would be left to use their own personal assets to pay for their defence and any settlement due.
What about non-executive directors?
It is the assumption held by some that non-executive directors cannot be held liable for their actions in the way executive directors can. This is, in fact, incorrect and non-executive directors receive the same treatment as executive directors. This is due to non-executive directors becoming increasingly accountable for their actions under changing legislation and regulatory framework. Extensions are now available which give additional segregated limits for non-executive directors in the event of policy limit exhaustion.
What if the company merges or is bought?
Most D&O policies include a “change in control” provision. If the company is merged or bought, the policy will stay in force for the remainder of the policy period, but only for claims based on wrongful acts before the change goes into legal effect.
The D&O policy does not cover fraudulent acts, how will a director defend a fictitious claim?
Defence costs incurred for such a claim are typically covered by the policy until such time as the wrongful conduct is determined to have “in fact” occurred, or until there is a final adjudication. This means that a settlement without an admission of wrongdoing usually does not trigger the exclusions.