I N CRISIS Sarah Turpin and Frank Thompson of K&L Gates look at - - PDF document
Conference preview 26 FINANCIAL SERVICES: D&O EXPOSURE D I R E C T O R S I N CRISIS Sarah Turpin and Frank Thompson of K&L Gates look at how D&O insurance and corporate indemnification can be combined to offer comprehensive
Conference preview
FINANCIAL SERVICES: D&O EXPOSURE
Sarah Turpin and Frank Thompson of K&L Gates look at how D&O insurance and corporate indemnification can be combined to offer comprehensive protection for directors to mitigate the financial consequences of claims and investigations in which directors are implicated
www.cdr-news.com
Commercial Dispute Resolution NOVEMBER-DECEMBER 2012
n today’s highly regulated and litigious climate, directors and offjcers are subject to heightened scrutiny and fjnd themselves increasingly exposed to civil, criminal and regulatory
governance and more shareholder activity all result in greater external
activity resulting from the recent economic downturn, combined with the growing interaction between criminal and regulatory bodies on a global scale, all add to the risks faced by directors and offjcers in a wide variety of business sectors. Most companies recognise the benefjts of directors & offjcers’ liability (D&O) insurance cover in providing protection to directors in respect of the risks and liabilities they face. However, the extent of cover available and the interaction between D&O insurance and corporate indemnifjcation is not always fully understood. Tiere are real benefjts both to directors and to the company in understanding how these protections operate and can be used to maximum efgect.
D&O insurance – how does it
Tie D&O policy will typically be taken
and will be structured around the indemnifjcation provided by the
liabilities of directors and offjcers in respect of claims made against them where no indemnifjcation is provided by the company. Side B (ofuen referred to as corporate indemnifjcation coverage) covers the same liabilities but where the company has or is legally permitted to provide indemnifjcation. Side B cover efgectively provides balance sheet protection to the company, but in respect
the directors. Most D&O policies impose a policy retention or excess in relation to the Side B cover which is payable by the
presumptive indemnifjcation language whereby it is presumed that the company will indemnify to the maximum extent permitted by law. Tie aim of this is to ensure that the company is liable for the retention even if the company decides, for whatever reason, that it is not willing to indemnify the director in question. It is important to check that the policy wording will not impose the retention on the directors where their only recourse is against D&O insurers as the company has failed to indemnify them. Some companies also purchase Side C (also referred to as entity cover) which covers the liabilities of the company itself usually for claims arising out of depreciation in value of the company’s
cover from the directors’ point of view is that the directors are efgectively sharing the policy limit with the company. Securities claims against the company can be very expensive even just in terms
UK companies purchase only Side A and Side B cover so as not to dilute the cover available to the directors. Most D&O policies provide cover for civil, criminal and regulatory proceedings including the cost of defending those
extended to also provide cover for criminal and regulatory investigations but the extent of coverage for investigations varies enormously and some policies have not kept apace with the ways in which criminal and regulatory bodies conduct the investigation process. Tiere are also restrictions in any D&O policy regarding the availability of cover for criminal and regulatory fjnes and penalties since, under English law, fjnes and penalties resulting from deliberate wrongdoing cannot be insured against as a matter
Authority has also banned insurance coverage over any fjnes it imposes, although it remains permissible to purchase insurance to protect directors against the costs of formal proceedings and other investigations conducted by the
penalties to be expressly excluded from D&O coverage. Tiat said, some D&O policies covering D&O risk in multiple territories will provide cover for fjnes and penalties to the extent insurable in the relevant jurisdiction. D&O policies will normally provide cover for criminal proceedings including the costs of defending such proceedings. Tiis is becoming one aspect of the policy where it is important to get the wording right as criminal proceedings can now arise from a variety of sources – such as competition law, health & safety legislation and environmental protection measures – which ought to be covered. However, fraud and dishonesty cannot be insured as a matter of public policy and most policies will include express exclusions for claims arising from fraudulent or dishonest conduct. Tie language of the exclusion can be critical and it is important that the exclusion only applies to the individual against whom there is a fjnding of fraud and dishonesty.
It is particularly important to ensure that cover is available in the event of insolvency (and that coverage does not lapse due to an insolvency event) as it is in these circumstances that directors are often most at risk
Conference preview
FINANCIAL SERVICES: D&O EXPOSURE
Also, given the scope for fraud or dishonesty to be alleged but not ultimately proven, it is important to ensure the exclusion does not apply in the absence of any admission or fjnal adjudication so as to ensure defence cost cover is available. D&O policies should provide cover for most civil proceedings including claims by third parties and claims by the company. However, D&O policies will typically impose “insured v insured” exclusions which seek to exclude certain types of claim brought by other directors or by the company, the aim being to exclude collusive claims designed to access the proceeds
requires careful attention to avoid directors fjnding themselves without cover particularly for claims brought by shareholders
receiver or administrator. It is particularly important to ensure that cover is available in the event of insolvency (and that coverage does not lapse due to an insolvency event) as it is in these circumstances that directors are ofuen most at risk.
Company indemnification – how does it operate and what does it cover?
Tie extent to which the company is able to indemnify its directors is usually dependent on the country of incorporation. For UK companies, changes were introduced by the Companies Act 2006 which signifjcantly broadened the extent to which companies are permitted (but not obliged) to indemnify
in the Articles of Association which enable the company to indemnify directors to the extent permitted by the Companies
not be enforceable by the director against the company in the absence of a separate indemnifjcation agreement. It is therefore in the best interests of the director to have the benefjt of an express indemnifjcation agreement with the company. Tiis can take a number of forms such as a deed or deed poll benefjting all directors or separate contractual arrangements with individual directors. Tie Companies Act 2006 does impose certain restrictions in relation to liabilities and defence costs which the company
cannot indemnify against. In particular, the company cannot indemnify against damages payable by a director to the company in the event that any claim brought by the company against the director is successful. Similarly, the company cannot indemnify defence costs in such circumstances or defence costs relating to criminal proceedings where the director is convicted of a criminal
indemnifjed by a UK company. Tie inevitable consequence is that, even if the director has the benefjt of both D&O cover and corporate indemnifjcation, there is likely to be no coverage available to the director in the event of a fjnding of fraud or dishonesty nor for criminal fjnes
to check the wording of the D&O policy and any express indemnifjcation agreement to avoid any additional gaps in cover. Tie provisions of the Companies Act with regard to indemnity are permissive, not obligatory, and it is perfectly possible for an indemnifjcation agreement to impose broader exclusions than those imposed by the legislation. Similarly, the wording of D&O policies does vary and there may well be scope to negotiate broader cover than that provided by the existing policy wording.
D&O insurance v corporate indemnification – do you really need both?
In practice, a director is likely to get the broadest protection by having both D&O insurance and a corporate indemnifjcation agreement in place. Most D&O policies operate on a “claims made” basis which means that it is the policy in force at the time that the claim is made against the director (and notifjed to insurers) that responds. Tie limit of indemnity under a D&O policy typically applies on an aggregate basis which means that the limit applies to all claims made and notifjed to the insurers during the policy period. Tie cover efgectively operates on a “fjrst past the post” basis such that, depending on the number of claims made during the policy year, directors making later claims may fjnd there is no cover available as the limit has already been exhausted by earlier claims. In contrast, unless the company decides to impose a monetary cap, corporate indemnifjcation is not typically subject to any monetary limit and will not be shared with the other directors of the
available subject of course to the company’s ability to pay. If the company is insolvent then any corporate indemnifjcation agreement may not be worth the paper it’s written on. Tiis is
ensuring that the insurance coverage remains intact afuer an insolvency event. Tie other reason that D&O cover may fail to respond is where insurers deny cover for reasons intrinsic to the policy cover (such as the application of a policy exclusion) or for reasons extrinsic to the insurance (such as the non-compliance with policy terms
the inception of the policy). Even if there are good reasons to dispute the denial of cover, the inevitable delay which results from cover being disputed makes the availability of corporate indemnifjcation invaluable. Directors that don’t have the benefjt
having to put their hands in their pockets to fund their own defence costs. D&O insurance and corporate indemnifjcation are not mutually exclusive. A common misconception is that a director must choose between having the benefjt of D&O insurance or an indemnity from the company. On the contrary, both can be combined to provide an efgective package of protections for directors. If the company purchases Side B cover this also provides balance sheet protection for the company allowing the company to recover any indemnifjcation payments, subject to any applicable policy retention. However, the extent of the D&O cover provided does vary and it is important to take steps to ensure the cover is as broad as possible. It is worth investing time and money up front with a view to maximising the cover available and eradicating or minimising onerous terms and conditions which insurers may rely upon to deny or limit the cover available. Tie “devil is in the detail” when it comes to insurance contracts and this is particularly so in relation to D&O cover.
at the CDR Conference on 26-27 November.
www.cdr-news.com
Commercial Dispute Resolution NOVEMBER-DECEMBER 2012 About the authors
Frank Thompson is a senior associate in K&L Gates’s London office and member of the Litigation & Dispute Resolution and Insurance Coverage practice groups. His practice is focused
Sarah Turpin is a partner within K&L Gates’s Sarah Litigation and Dispute Resolution and Insurance Coverage practice groups. She advises policyholders in relation to disputed claims and assists policyholders in seeking to maximise recoveries. www.klgates.com
n