D&O insurance: how does it work and what are the pitfalls?
Directors and Officers liability insurance (or “D&O insurance”) plays a vital role in protecting directors, officers and other managerial employees from a wide range of claims that may be made against them for helping to manage the company. It is important that companies make sure that adequate D&O insurance coverage is maintained, and that claims or potential claims are notified under the policy as soon as possible. In this article, we look at how D&O insurance works, and how to avoid some of the pitfalls that can arise.
Indemnification from the company
It is only right that the individuals involved in running a company should have some protection from the kinds of claims that may be made against them. The claims that might be made against a director of a company include defamation claims, claims from employees, shareholders, liquidators or creditors, or even prosecution by a regulatory authority, amongst many other possibilities. Even if an individual has done nothing wrong, he or she may have to incur substantial costs defending a claim, and so having access to funds to compensate the individual concerned for their defence costs, as well as any damages award, is essential.
For a company’s directors, D&O insurance often sits alongside promises made by the company to hold the director harmless from losses arising from certain claims. Such indemnities from the company are usually contained in the company’s articles of association, or a deed of indemnity put in place when the director took up his or her appointment.
Advantages of D&O insurance
D&O insurance is designed to supplement the protection provided to directors by the company. D&O insurance thereby plays a key role in ensuring that the best talent continues to be attracted to boardrooms and other managerial posts in UK companies. The protection provided by D&O insurance is significantly broader than the indemnities that may be provided by the company, in a number of respects.
Companies are precluded by the Companies Act 2006 from indemnifying their directors for claims which might be brought against them by the company itself. Unfortunately, this includes some of the most likely claimants, such as liquidators or other insolvency officer holders acting on behalf of the company in the event of the company’s insolvency, or derivative actions brought by shareholders in the name of the company. D&O insurance does not have this limitation and is able to cover insureds for claims that may be made against them by the company, as well as by third parties.
D&O insurance also has the advantage that it provides insureds with access to a separate pot of money in the event that the company becomes insolvent (something which is often the trigger for claims being made against the directors of the company). In that case, the insolvent company will no longer have the money to fund the cost of defending a claim against its directors, or meeting any damages award that might be made. In the event of the company’s insolvency the right of the individuals insured by the policy to claim under a D&O insurance policy could prove invaluable.
Finally, a D&O insurance policy typically protects a wider range of persons than will benefit from any indemnity provided by the company. The insureds under a D&O insurance policy will normally include not just the company’s directors, but the company secretary, and (typically) any employee who exercises a managerial or supervisory function. The individuals protected by a D&O policy will also normally include the former, as well as the current directors and officers, in respect of any claims made against them in relation to their acts while they were a director or officer of the company.
Side A and Side B coverage
D&O insurance provides two kinds of coverage:
- Under “Side A”, the insurer promises to indemnify the individuals insured by the policy (the directors, officers and other employees) against losses (defence costs or damages) they incur as a result of claims that may be made against them for “wrongful acts” committed by them in their insured capacities. The term “wrongful act” is typically defined very broadly to include essentially any breach of legal duty, meaning that all claims will be covered, subject to any specific exclusion in the policy.
- Under “Side B”, the insurer promises to indemnify the company for any loss that the company has incurred compensating an individual insured by the policy for defence costs or damages, pursuant to any indemnity that the company has provided to that individual.
Like all insurance, D&O policies include terms, conditions, exclusions and other limitations, which will need to be complied with in order to avoid the risk of prejudicing any claim that may be made under the policy. Some policies are easier to follow than others, but you may find it helpful to get assistance to understand what is covered by the policy and what is not. The good news is that D&O policies are not typically written on “standard forms” and there will often be scope for negotiating changes to the terms before the policy is issued or renewed.
Special care needs to be taken whenever you become aware of a claim or potential claim that may be covered by the policy. The policy will usually contain a term requiring claims, or circumstances that may give rise to claims, to be notified in accordance with a deadline prescribed by the policy, and for the notification to contain prescribed details relating to the claim. Failure to adhere to these notification clauses can be costly so it is worth paying close attention to their requirements. In the case of circumstances which have not yet crystallised into claims, it can be particularly important that the circumstance is properly notified to the insurer in accordance with the policy terms, so as to ensure that any claim that subsequently emerges is covered by the policy.
If you would like to discuss any of the points mentioned above in more detail please let us know.