One of the truths that goes with insurance policy very well and for everyone is, “Do something today that your future self will thank you for”.
Directors and officers (D&O) liability insurance is an insurance coverage, which seeks to protect individuals who are serving as directors or an officer of a for-profit/ non-profit business or other type of organization, from their personal losses in case they are sued. This sort of insurance comes under business insurance which can also help reimburse a business or non-profit for the legal fees or other costs incurred in supporting such individuals against lawsuits. In other words, companies can indemnify their executives against covered claims, further, turning to their D&O policy for reimbursement. D&O is akin to corporate governance, corporate law, and the fiduciary obligation owed to stakeholders, such as shareholders and beneficiaries.
D&O liability insurance not only protects the personal assets of corporate directors and officers, but also their spouses in the events where they are personally sued for any act done in managing a company. This insurance policy functions as ‘management errors and omissions liability insurance’’ which means that it covers all the claims which are the result of managerial decisions that result in adverse financial consequences.
Since directors can be sued for numerous reasons, therefore, various kinds of claims that are covered by this insurance like an individual’s decision and actions in his/her capacity as a leader of a company, mismanagement, securities violations, breach of fiduciary duty, unfair trade practices, improper money transactions, theft of IPR, illegal acts or profits.
Laws in India
The Companies Act of 2013 recognizes the right of companies to purchase D&O insurance, but one also needs to know that D&O liability insurance policy is not mandatory in India. With the immense changes in the business over the time period its complexities and demands have also increased which have made D&O insurance very common now. Stakes and responsibilities of directors and officers of the company are comparatively high which also results in the unlimited personal liability.
Section 197 (13)
Where any insurance is taken by a company on behalf of its managing director, whole-time director, manager, Chief Executive Officer, Chief Financial Officer or Company Secretary for indemnifying any of them against any liability in respect of any negligence, default, misfeasance, breach of duty or breach of trust for which they may be guilty in relation to the company, the premium paid on such insurance shall not be treated as part of the remuneration payable to any such personnel:
Provided that if such a person is guilty, the premium paid on such insurance shall be treated as part of the remuneration.
Although D&O liability insurance is not mandatory even then it is a vital part of corporate governance, as it protects the directors and officers against their personal liabilities.
Why do you need D&O insurance?
What people don’t realize while buying D&O is that it has more utility than any other item on your to-do list. So, while buying such a policy one needs to look into various accounts along with the coverage their insurance policy is provided. It becomes very important to understand the necessity of the same. The VC of any company wants you to have this policy in place because of two reasons mainly:
- They want to make sure their employee is protected from legal liability
- If a dispute/tension develops between you and them, the VC wants to make sure that you have the capital that is required to bear the legal costs without staking the future of the entire company.
Basically, the insurance will pay for the defense against certain lawsuits as well as any settlement claim that is brought against an insured.
What is covered in D&O insurance?
Side A: This solely protects directors of the company by paying all the defense cost and settlement which is the result of lawsuits levied on directors. It will only pay the individual directors when the entity is insolvent or legally not permitted to do. Side A coverage is the most important matter for corporations.
Side B: this one indemnifies the entity after the entities have paid the individuals cited in the suits
Side C: this coverage protects the balance sheet of the company and will also reimburse and costs/settlements incurred.
It is to note that policies of D&O can be composed to assure a diversity of perils, but they generally rule out illegal profits, fraud, and reprehensible activity.
types of losses paid
- Public relation expenses
- Defense expenses
- Extradition expenses
- Emergency expense advancement
Director & officer
Although a director and officer share a similar set of duties still there lies a difference between two of them when it comes to few things.
- A director is the person who takes part in managing business affairs, while officers check up on daily working and management of the business.
- The director is appointed by a company owner/s or shareholders, and it’s usually a part of the board of directors. While an officer can be: CFO, CEO, President, Vice President and Treasurer.
- The director is personally liable for lawful acts taken on behalf of the corporation while corporate officers are generally not liable for the same.
- The officer has the authority to legally bind the corporation which is certainly not with the director.
Excess D&O insurance
Excess D&O insurance policies are really significant, yet they go on to be the overlooked part of D&O insurance. These policies run by the epithet of ‘follow the form ’coverage. Irrespective of its name, few excess D&O policies literally follow the terms and conditions of the original D&O insurance policy. Aside from that, many excess policies will put various terms and conditions that have the potential to impact the overall protection that is provided by insurance. But insureds often lose out on the coverage that is included in the policy because they fail to give proper time that is required to analyze, review and negotiate an excess policy. Few of the provisions mentioned below create a lot of fuss if not reviewed and negotiated properly
- The attachment/exhaustion provision -provision determining the beginning of the excess policy coverage
- Arbitration provision
- Appeals provision
Directors and officers liability – claims examples
- Sexual harassment, discrimination and other human resource issues
- Trading while insolvent; disqualification
- Corporate manslaughter
- Misleading information
- Health and safety
- Insufficient control as a Director
Difference between management liability and director & officers
Although with evolving business trends and shift in the, D&O insurance has become closely linked with broader management liability insurance, which covers liabilities of the corporation as well as the personal liabilities for the directors and officers of the corporation, yet there lies the difference between both of them.
- Management liability protects the company as well as its directors and officers against all sorts of liabilities and statutory obligations while D&O happens to be product specifically designed to protect the personal assets of individuals acting as directors and officers of the company in the event they get sued because of any course of their action.
- Management liability creates a blanket cover not just for directors and officers, but it can also cover employees among other things which is not in the case of Directors and Officers insurance.
- Management liability is designed for SME business and it provides cover for those accused of failing in their responsibilities as managers, whereas D & O is designed for larger companies and provides protection to those accused of failing in their duties as directors and officers but it’s for their benefit only.
Who needs D&O’s insurance?
About business insurance it is often said, “Nobody wants it yet everybody wants it!”
- Businesses with large financial obligations
- Public and Private businesses with a B.O.D. – As general liability and umbrella insurance don’t cover liabilities of the board of directors of the company.
- Non-profit Organizations – to attract quality board members
The size of insurance coverage in Indian banking sector varies between public and private sector. There has been a lot of effect put to raise up the limits under the existing D&O insurance policy by up to 50% since the beginning of 2019. When it comes to the corporate sector, demands are increasing steeply too.
US companies have seen a consistent increase in 2019 along with the increasing rates. There have been various factors responsible for the same, one being the most popular the #metoo movement along with the others, notably cyber security, privacy and data protection exposures etc.
The D&O market in the UK saw a drastic change in the last couple of years across all industries. The D&O landscape has turned to 180 degrees by increased class actions and changing legal and regulatory environments globally.
European countries have seen increased regulatory activity which is directly proportional to D&O claims. The European D&O market only began to come up around 12 months after the London market. The European insurers have now become a viable option for clients who had their whole program placed with London insurers. We can say that the D&O market will see more increase in upcoming years.
The terms of D&O policies usually vary depending upon the nature of the organization and the risks it faces. Coverage of the insurance totally depends upon the financial status and business prospects of the company. So, it becomes really, really important to take a good amount of time to get the right policy and also in order for an experienced insurance company to have a great backup if things go south for you as a director or officer of the company. D&O insurance is indeed not a cheap one, but one just can’t ignore the fact why it is costing too much and its value along with it. The situation in India with respect to directors and officers only changed with the advent of the New Company Act and regulations like Insolvency and Bankruptcy Code 2016.
With the outbreak of COVID-19, it is affecting the risk of litigation against Directors and Officers. The rates for D&O insurance rose 19% globally as found in the survey done by March. Further, Lloyd’s of London has estimated the non-life insurers globally will pay $100 billion in COVID-19-related claims this year. Further, there is also a threat of potential securities class actions arising upon the companies listed in the US. One needs to beware of the coverage limits potentially being applied in unexpected ways. There is no denial to the fact that the COVID-19 situation the market conditions are challenging right now and it is recommended to the companies to check upon the coverage and begin their renewal protocols related to the policies at their earliest without thinking too much about the expense as the risk is way too high in the given circumstances.
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