D&O issues and insolvency

Published on
7 min read

This article considers some of the issues which can arise when a D&O policy is in place and whether it would respond to claims which arise in insolvency situations.

Claims against directors

A company can pursue a claim against its directors for breach of duty. Their primary duties are codified in the Companies Act 2006 - and a director must exercise those duties with “reasonable care, skill and diligence”. Claims against directors tend, in practice, to be pursued once they have left office or when the company is in administration or liquidation.

The most obvious practical reason why claims arise in insolvency situations is that the beneficiary of the claim (the company) may not know of the wrongdoing until the board is replaced or an administrator or liquidator identifies the issue.

Once a company is insolvent, claims can be pursued by the administrator or liquidator under the Insolvency Act 1986. Section 212 does not create a cause of action but allows claims to be pursued in the office holders` name in the insolvency under a streamlined procedure. It is routinely pleaded in conjunction with other claims. It applies to claims against:

  • Current and former officers
  • Former liquidators and administrative receivers
  • Any person who is or has been concerned, or has taken part in, the promotion, formation or management of the company

where any of the above has:

“misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company”.

The claim may be brought long after the act complained of and may not be limited to acts taking place in the past six years. The Court of Appeal in Burnden Group (UK) Holdings Limited v Fielding (and another) (2016) recently confirmed the primary limitation period was six years but, in the appropriate case, there may be no effective limitation period at all if the claim is to recover trust property or its proceeds in the possession of a trustee director.

The office holder may bring claims for wrongful and fraudulent trading, or relating to transactions at an undervalue and preference claims under the Insolvency Act 1986.

D&O cover

The company tends to take out D&O insurance, rather than individual directors, so the liquidator is in a good position to consider whether the potential target is covered when he takes control of its books and records.

A common misconception is that cover ceases on a company`s liquidation. D&O insurance is written on a “claims made” basis, which means that the policy responds to claims made against directors and officers, and notified to insurers, during the policy period (subject to any extended reporting period which allows claims to be notified for a subsequent period). Insolvency situations often lead to claims against former, even retired, directors who remain “in the frame” long after the wrongful act was committed. Continuing directors are obviously unlikely to recommend that a claim be brought against themselves and are more likely to bring a claim against their predecessors. This enables them to demonstrate to shareholders that problems have been inherited and not created by those serving on the present board.

So long as the D&O policy has continuity of cover for the directors concerned, and claims are notified in accordance with policy terms and conditions, past or retired directors should be covered.

What might it cover?

In considering whether a D&O policy will cover claims made under the Insolvency Act (s. 212 to 215) the first question is whether the directors or officers carried out the alleged wrongful acts while acting as a director or officer, rather than in some other professional, or personal, capacity.

If they acted in a professional capacity (eg, as an accountant or a receiver), they may be covered by a professional indemnity (PI) insurance policy. That policy is much more likely to respond in those circumstances although notifications are sometimes made to both D&O and PI policies to cover all bases.

Assuming there are no issues surrounding capacity, and that the alleged conduct did not fall within a “professional services” exclusion, the next question is whether the wrongful act caused a loss defined in and covered by the policy. Since s. 212 Insolvency Act 1986 covers a multitude of acts, whether or not a policy responds will depend on the type of claim being pursued and the conduct alleged.

If the director has benefitted from his conduct, the D&O cover is very unlikely to indemnify him. Specific policy exclusions normally cover circumstances where the director has benefitted personally and the courts would not allow unjust enrichment of an office holder in any event. It will only respond in circumstances where it can be established that a loss has been suffered which the policy covers.

Fines/compensation orders

Most D&O policies exclude civil, criminal or punitive fines or penalties, liabilities uninsurable under UK law, as well as losses arising from an insured`s “wilful misconduct”. The Company Directors Disqualification Act 1986 has recently been amended to allow the court to make compensation orders in disqualification proceedings. Although it is still not clear, it is unlikely such compensation orders would be covered by a D&O policy. That could lead to inconsistencies especially because a liquidator might pursue exactly the same loss by a misfeasance claim under s. 212 Insolvency Act 1986 (which may well be covered).

When PLC’s or multinationals with US subsidiaries take out D&O cover, it is commonly extended to “punitive and exemplary damages for securities claims” as well as fines and penalties insurable under local law. Although the position in relation to fines and penalties is not entirely clear and may depend upon local laws, it is clear that directors and officers with D&O cover will be entitled to be indemnified for the cost of defending themselves when confronted with claims under the Insolvency Act.

Investigation and defence costs

D&O insurers are obliged to advance defence costs when a valid notification is made, assuming the director pleads his innocence of any alleged dishonest or fraudulent conduct, unless and until those allegations are proven in court or other tribunal by way of a final adjudication. It should be noted that directors are insured separately under D&O policies, on a joint and several basis, such that the knowledge and potential liability of one will not be imputed to another. This will also have an impact on which director(s) is entitled to claim indemnity for costs, where allegations are made against a number of directors.

The cover provided by D&O policies usually extends to “Investigation”, “Pre-investigation” and “Regulatory Crisis” costs, which may apply to certain notifications arising from insolvencies. If an investigation were commenced as a precursor to Disqualification proceedings, or a Trading Standards Investigation, for example, with the director(s) required to attend, the cost of legal representation required by the director may qualify as “Investigation” or “Pre-investigation” costs. The director would be required to obtain insurers` consent before incurring such costs and insurers may refuse to pay if the director attends an investigation voluntarily, rather than being required to attend. A director who chooses, or is advised, to attend an investigation of his own volition will often argue that such action is in insurers` best interests as well, and an attempt to mitigate or avoid potential allegations. Such situations provide fertile ground for disputes between insurers and insured directors as regards the extent of the costs which insurers are obliged to meet.

Insurers are even obliged to fund the costs of an appeal so that issues of fraud or dishonesty are finally resolved. Only if such conduct is proved, or admitted, may insurers attempt to reclaim those costs from the directors concerned. However, by that stage, they may be so substantial that insurers can recover only a small proportion, if anything, from the directors concerned.

That may mean that a respondent with D&O insurance may have the means to defend himself but there may still be uncertainty as to whether the director will be indemnified in relation to the claim until the allegations of dishonesty or fraud have been resolved.

Summary

Given the specialist nature of D&O cover, the variety of wordings on the market, and the fact that it is mainly taken out by larger companies - although it is now taken out by SMEs more than ever before - we expect it to become increasingly relevant in insolvency situations. The prospect of it being in place should inform insolvency practitioners` decisions about whether potential targets are worth pursuing and insurers may see an increase in notifications to D&O covers. It is to be hoped that some of the gloomier forecasts as regards the UK economy`s future, as the UK extricates itself from the EU, are not borne out. If they are, we can expect to see a sharp rise in insolvencies in the next few years.

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