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What is Directors’ and Officers’ Liability and Why is it Needed?
As a Company Director there are a number of responsibilities placed upon you to act with care, in good faith and within the law, to act in the best interests of the company and indeed a responsibility to ensure that other Directors do likewise. Should someone allege that you have not met any of these responsibilities then a claim may arise against you personally.
Broadly speaking, personal claims or proceedings against directors or officers can be as a result of any decision made or act carried out in the workplace however innocuous it may have seemed at the time.
It is a common misconception that the effects of issues within one’s employment, such as those noted below, are limited solely to the workplace, this is not the case and indeed a person’s livelihood could be at risk even if the claim submitted is spurious and without foundation.
There is however insurance protection available by way of a Directors’ and Officers’ policy which will cover defence costs and awards arising as a result of an alleged or actual Wrongful Act by an Insured Person.
A Wrongful Act includes:
- claims for breach of duty, breach of trust, negligence, defamation, breach of warranty of authority;
- allegations of involuntary, constructive or gross negligence manslaughter or claims under health and safety legislation;
- legal representation costs for individuals at other official examinations, enquiries or investigations;
- claims arising from pollution.
Although the Limited status of a company provides some protection for shareholders, this does not extend to a Director or Officer whose personal liability and exposure remains unlimited. And unfortunately, depending on the circumstances of a claim, you may not be able to rely on the Company providing financial assistance on the event you are personally sued.
Who Does the Policy Protect?
The definition of a Director and Officer under the policy is deliberately wide, as an example the Aviva policy will cover “Any natural person who was, is or becomes during the Period of Insurance a Director, Officer or Member of the Company”
These people are further defined within the Aviva wording:
Director – Any natural person who was, is, or becomes during the Period of Insurance a director of the Company including a de facto or Shadow Director.
Officer – Any Employee of the Company whilst acting in a managerial or supervisory capacity; or, any Employee of the Company who, whilst acting as an employee, is joined as a party to any action against any Insured Person
Member – A member of a limited liability partnership formed under the Limited Liability Partnerships Act 2000 or any subsequent amendment or re-enactment
So while you may be confident that all of your company’s directors are aware of their legal responsibilities, it is vital to understand that problems can be caused inadvertently by individuals at many levels of an organisation.
Who May Make a Claim against a Director or Officer?
- Government/Regulatory Bodies
- Third Parties
- Other Directors
Which Limit Should I Choose?
The Limit of Indemnity for a Director’s and Officers policy is usually on an “aggregate” basis meaning that it is the maximum amount insurers will pay during any one period of insurance. Some insurers may set the limit for “any one claim” so you could have multiple claims in the same policy year up to the limit of indemnity, but this is less common in this market. The Limit usually includes defence costs and expenses so this should be taken into account when deciding.
In broad terms, it is recommended that the Limit of Indemnity exceeds the total gross assets of the business. Limits start at £250,000 and can go up to in excess of £10,000,000 depending on the Company profile.
Claims Made or Claims Occurring
The majority of policies in the professional and management liability fields operate on a “claims made” basis. This means that the policy that responds, and governs the terms of the cover, is the one that is in force at the point a third party makes a claim against an insured. This is as opposed to a “losses occurring” basis, where the policy that responds is the one in force when the loss or damage occurs.
Because of the claims made nature of the policy, in the event you no longer want to purchase directors and officers liability or indeed sell your business or stop trading then we highly recommend “”Run Off” cover is purchased to ensure that the policy is kept open to pick up any claims from the time you wanted cover/were trading.
Is there an Excess or Deductible?
Not usually – insurers consider that if a claim is going to be received it is going to be substantial and therefore the application of small deductibles is not beneficial to either party.
The exception to this is for Companies with an US exposure, a typical deductible for a claim arising from the USA is $50,000.
What isn’t Covered?
Modern Directors & Officers Insurance policy wordings are very wide, especially those from the major carriers. However they do by no means cover any claim may arise. Whilst not an exhaustive list a few common exclusions are listed below:
- Known claims and circumstances – By definition, insurance aims to protect policyholders from unforeseen risk. Hence, there is no reason for an insurer to cover a loss or potential loss which will certainly occur. This is clearly understandable from an insurer’s perspective, as they do not wish to issue coverage and receive their premium, only to then to immediately pay it back out in claims. For example, if a new D&O policy is incepted today, it will not cover a potential employment dispute that an organisation’s management was aware of prior to today. In this scenario, the employment dispute in question will have to be covered under a past D&O policy, or not be covered at all.
- Catastrophic hazards – D&O policies are likely to exclude hazards that are deemed to be catastrophic for an insurer’s own financial position. A catastrophic hazard is a situation considered so destructive, that an insurer could not realistically cover the cost of pay-outs in the event that it occurred. Examples include losses resulting from nuclear events, war, terrorism and instances of environmental damage. While some more modern policies may not explicitly exclude some of these risks, the existence of catastrophic loss exclusions are not just limited to D&O policies. In fact, they often appear in other insurance classes too
- Conduct exclusions – Insurers are legally prohibited from covering criminal or fraudulent conduct, because any attempt to do so would undermine the fundamental principles of the law. Dishonest acts by any individual, resulting in illegal profit or remuneration such as those generated by insider trading or embezzlement, are excluded. While conduct exclusions aim to discourage inappropriate behaviour, it’s important to note that an insurer will generally advance defence costs to an individual accused of these offences. This is done so on the presumption of innocence, as a formal court ruling or admission of guilt is required to decline coverage completely
- Insured vs Insured – D&O traditionally excludes claims brought against directors and officers by others insured under the same policy. This discourages infighting among senior management by removing an insurer’s backing and also removes any incentive for collusive behaviour. While this behaviour is generally uncommon, directors or officers have been known to concoct claims against themselves in order to recover losses resulting from an organisation’s poor performance. Insured vs. insured exclusions are for the most part, standard. However, there are a range of common carve-backs. These include adding coverage back in for derivative claims, cross-claims, bankruptcy claims and employment-related claims. Modern policies may contain a more favourable consensual claims exclusion, which only excludes claims when it can be ascertained that management has deliberately invited or solicited litigation, rather than excluding all claims that are brought by those who are also insured.
- Major shareholder – Another type of exclusion, that is a slightly different take on the insured vs. insured exclusion, is the major shareholder exclusion. The major shareholder exclusion aims to exclude coverage for any claims by a claimant who owns more than a certain percentage of a company, typically 10-15%. The rationale behind this form of exclusion is to remove any incentive for collusion and infighting between shareholders and management. It also encourages shareholders who hold a significant stake in a business, to take a proactive approach in staying informed of their investments
Corporate Legal Liability/Entity Cover
Whilst the primary purpose of Directors and Officers insurance is to protect individuals and their assets this can also be extended to protect the Company. This is especially important if only the Company is listed in a writ as the “trigger” for a D&O policy is the naming of a specific or group of directors.
The inclusion of corporate legal liability/entity cover extends the existing policy to also indemnify the Company for actions it may face.
Typical situations where Entity defence cover would be relevant would include:
Identity Fraud in establishing that someone has fraudulently entered into an agreement with a third party by representing themselves as the entity.
Corporate Manslaughter in defending a prosecution brought under the Corporate Manslaughter and Corporate Homicide Act
Breach of Contract Investigations in defending a claim which alleges breach of contract for goods or services provided.
Pollution in defence of an allegation that a director, officer or employee has committed a wrongful act which results in pollution.
Regulatory – Health and Safety and the like.
- A fire at the Company’s premises causes significant damage. It is subsequently that the Director responsible for arranging the Company’s insurances had inadvertently failed to keep the insured values up to date and correct which caused a significant underpayment on for the fire loss. The other Directors decided to sue the Director responsible for the insurances for the shortfall.
- Two directors of a company which was in liquidation, with a total deficit of £216,000, were held jointly for £75,000 damages (plus interest and costs) arising from wrongful trading whilst the company was insolvent
- A fatal accident on-site led to an investigation by the police and the Health & Safety Executive. Charges of manslaughter and Health & Safety breaches were made against the company and its directors.
- When a business was investigated for polluting a stream, a manager in the organisation was required to give evidence at an enquiry. The D&O liability policy covered their legal representation costs.
- When two bakery employees were killed whilst attempting to repair machinery, the MD and several managers were prosecuted for breach of Health & Safety legislation. Their D&O liability policy covered legal costs of £890,000
- Corporate Legal Liability – leaseholders of a block of flats brought an action against the Residents’ Management Company for failing to appoint a building company in timely fashion to repair external brickwork on the building. Damage had been caused following a heavy rainstorm and reported to the Management Company, however repair work had not been commenced several months later when a subsequent rainstorm caused further damage.
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