Cover for directors against personal liability: have you got it?

With greater scrutiny of corporate governance, and expansion in the role of the FSA as financial markets regulator, claims against directors personally are on the increase. As the Equitable Life proceedings show, claims are not only targeted at main board directors - non-executive directors may also find themselves in the firing line.

In this climate, directors and officers liability insurance which, only a decade ago, might have been considered an optional extra to be purchased by a prudent company, must now be considered essential. Section 310 of the Companies Act 1985, while preventing companies from indemnifying their directors against allegations of wrongdoing in many instances, permits companies to purchase insurance on behalf of their directors and to pay the premiums for this. But it is not mandatory for companies to do so.

Since the publication in July 2003 of the new combined Code on Corporate Governance, however, listed companies have been recommended to "arrange appropriate insurance cover in respect of legal action against [their] directors". Directors of listed companies can therefore reasonably expect to be protected by insurance. Directors of non-listed companies would be well-advised to ensure that their company voluntarily follows the Combined Code in this respect.

One immediate problem, though, is that often D & O insurance will be arranged by the Company, and directors may not even be aware of its terms. A survey conducted last year by this firm in conjunction with the Institute of Directors revealed that most directors were broadly happy with the cover obtained on their behalf by their company but had no clear idea of its terms.

The following are just some of the things a director may wish to know about the insurance bought for his protection:

Who is usually covered?

• Current directors and officers of the named insured company and its subsidiaries, acting in their capacity as such. As well as main board directors, this will usually include: (i) non-executive directors and employees acting in a managerial capacity; (ii) alternate directors who take decisions at board level on behalf of their appointor; and (iii) shadow directors.
• Past directors, and directors who are appointed midway through a policy year.
• Outside directors (ie. directors who are asked to sit on the board of a company outside the insured group) may be covered but should check the terms of any cover.
• Directors of companies that are acquired by another group should check their insurance position with the new owners.

Against what risks?

Cover is normally provided for claims made during the policy period against directors and officers in respect of losses arising from wrongful acts or omissions or similar. Under a 'claims made' policy it is (with various limited exceptions) immaterial when the event itself occurred which gave rise to the claim; the important issue is when the claim was made against the director or officer.

The liabilities which are covered will be defined in the policy itself and will usually include breach of duty, negligence, misrepresentation and negligent misstatement by the person in his capacity as a director or officer. Certain policies may cover breach of statutory duty, employment claims, misfeasance, disqualification proceedings, criminal proceedings, and proceedings and inquiries by regulatory authorities such as the FSA.

Will I have to fund legal costs to defend myself?

There is usually cover to meet defence costs as they fall due; in fact, most claims made on D&O policies are for defence costs. Most policies contain a provision that if a director is found guilty of fraud or dishonesty these costs must be repaid to the insurer.

If judgment is given in favour of a director, he should also be entitled, under provisions normally included in company articles of association, to be reimbursed by the company for costs he incurred in defending proceedings.

Might I have to bear a deductible myself?

There is usually no deductible payable by a director.

How much cover do I need?

This is a difficult question to which no general answer can be provided. Amongst other things, it will depend on:

• the level of cover available in the market
• cost of premiums
• likelihood of claims, and their potential size
• whether directors can call upon other group resources to indemnify them or to fund defence costs in advance
• the perception that claimants may be encouraged to pursue directors who are known to have substantial insurance
• the amount it may cost a director to defend himself. If a director is involved in a complex dispute, cover could even be exhausted before the case reaches full trial
• any limit on the aggregate amount that can be claimed under the policy in one year. A director could find that cover has been exhausted by claims made earlier in the year against other directors.

A single director may have little opportunity to influence the level of cover purchased; but if there is a general concern amongst the board that cover is inadequate, the level or extent of cover could be increased or alternative arrangements considered.

What is usually excluded?

• Dishonesty and fraud that is admitted or where judgment is obtained against the director
• Fines may not be covered, depending on the type of policy and the nature of the fine
• Pollution and environmental liability
• Damage to property
• Losses which should be covered by a professional indemnity policy (in order to avoid overlap between insurances)
• Claims made by one insured against another insured – e.g. one director against a fellow director, or the company against a director. However, in the event of insolvency, claims being made by a liquidator against a director for misfeasance, wrongful trading etc. will frequently be covered
• Because of its litigious climate, claims brought in the USA are commonly excluded

What happens when I cease to be a director?

The policy will generally provide cover for the acts and omissions of former directors. However, since the policy responds on a 'claims made' basis - i.e. to claims which are made in the relevant policy year - the director will need to satisfy himself that there will be a policy in place which provides cover for him at the time when a claim is made. 'Run-off' cover, which provides protection for a departing director for a set number of years, may be provided automatically under the policy. If this cover is inadequate, perhaps because the period covered is too short, it may be necessary for the director to purchase his own run-off cover.

What if my company becomes insolvent?

The risk of claims is likely to increase where a company becomes insolvent. In particular, claims for wrongful trading, wrongful preference and misfeasance may be brought against directors by the liquidator or, potentially, by the DTI.

Unless the policy contains an exclusion where there is an insolvency, there should be cover for such claims. However, a liquidator or administrator is unlikely to renew the policy and the director should consider his potential exposure urgently at the point of liquidation or administration. If appropriate, advice should be taken specifically in relation to this issue.

Where can I find out more?

In 2003 the Institute of Chartered Secretaries and Administrators issued a seven-page Guidance Note on Directors and Officers' Insurance in conjunction with the City of London Law Society, the Association of British Insurers and the British Insurance Brokers Association. It provides a checklist of some of the major issues relating to D&O insurance that should be considered by prospective executive and non-executive directors, and also acts as an aide memoire for existing directors and for organisations considering their own requirements for cover. The note can be found at http://www.icsa.org.uk/news/guidance.php.

For further information, please contact Maxine Cupitt at [email protected] or on +44 (0) 20 7367 2885.