It is fair to say that pressure on company directors and officers has increased considerably in recent years. Greater scrutiny in the wake of corporate scandals, including Carillion, Patisserie Valerie, and BHS, has led to tighter company regulations around the world and a demand for improved corporate governance by investors and shareholders; all of which has made being a company director more onerous and personally risky. While duties and obligations have always been imposed on company directors and officers due to their seniority, they are facing an escalating amount of litigation. Facing such action, even if not warranted or there is no actual liability, is time-consuming, potentially reputation harming, and extremely costly when it comes to mounting a legal defence. Directors and officers can, in some cases, seek indemnification from the company for any financial losses or use directors’ and officers’ (D&O) liability insurance to protect them from such costs.
What is directors’ and officers’ (D&O) liability insurance?
D&O liability insurance is typically taken out by a company on behalf of its directors and officers to provide protection from any potential costs which arise while performing their duties. In the event of any claim made by a third-party against a director or officer, the D&O insurance will cover the losses which result. Putting in place, this type of cover is permitted under the Companies Act 2006 (CA 2006) section 233, which states:
“Provision of insurance: Section 232(2) (voidness of provisions for indemnifying directors) does not prevent a company from purchasing and maintaining for a director of the company, or of an associated company, insurance against any such liability as is mentioned in that subsection”.
Specifically, the CA 2006 allows a company to take out insurance to cover any liability relating to negligence, default, breach of duty or breach of trust by the director or officer in relation to the company by which they are employed.
There is no legal obligation to take out D&O insurance, according to the CA 2006.
Claimants may include the company itself, shareholders, regulators, government bodies, competitors, and liquidators.
Who is covered by a D&O liability insurance policy?
D&O policies cover directors and officers who are no longer with the company if a claim is brought that relates to wrong-doing when they were employed by the company, and all new directors and officers are automatically added once the policy is active. In addition to insuring directors including executive directors, non-executive directors, shadow directors, prospective directors and de facto directors, and officers including company secretaries, in-house lawyers, risk managers and other senior managers, D&O policies can be used to insure others, including employees in a management role, lawful spouses, estates, and liquidators.
What type of claims are covered by a D&O liability insurance policy?
Breaches of directors’ duties under CA 2006
As defined in the CA 2006, directors have a number of duties, any of which can give rise to a claim; these include the duty to:
- act in accordance with the company’s constitution
- only exercise powers for the purposes for which they are conferred
- promote the success of the company, taking into consideration the long term impacts of decisions made, including for employees and community and the environment
- exercise independent judgement.
- exercise reasonable care, skill and diligence
- avoid conflicts of interest
- not accept benefits from third parties
- declare an interest in proposed transactions or arrangements of the company
In addition to potential wrong-doing in the day to day operation of a company, directors and officers commonly face claims relating to offerings of securities, acquisitions, and disposals.
Breaches of accounting duties under the Finance Act 2009
Another potential area of claim covered by D&O insurance policies relates to actions by senior accounting officers (SAOs). Under the Finance Act 2009, those with the ultimate responsibility for the financial arrangements of large companies (with a turnover of £200m+ or with gross assets of £2bn+) are legally required to put in place and observe the proper implementation of appropriate tax accounting arrangements.
Other types of breach which may give rise to a claim
In addition to the above, D&O policies cover ‘derivative claims’, which are brought internally by shareholders on behalf of the company against a director or officer. Section 260 of the CA 2006 states that a derivative claim “may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company”. This cover is important because of the wide-ranging scope of a derivative claim which may be brought in relation to alleged breaches, even if this was before the director or officer was even hired by the company.
D&O insurance can also provide protection against class action claims.
Given the growing potential for litigation and the exposure to risks faced by directors and officers, D&O insurance cover is now taken out by an ever-increasing proportion of companies, not just by large multinational organisations, but small, medium, and large entities, private, public, and charitable.
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