D&O Liability and Insurance – Part 2: Obtaining adequate Insurance Coverage

Authors: Dr Daniel Jenny / Dr Clemens von Zedtwitz

Introduction

The maxim that "Anything that can go wrong will go wrong" is especially true of business where mistakes can never be fully avoided, and board members (Directors) and managers (Officers) always run the risk of being held liable when mistakes are made. Such risks can result in claims for substantial damages. In the aftermath of the financial crisis and the woes experienced by large companies, D&O liability has become the focus of greater public attention. In Part One of this series, we explained the basis for liability and how liability can be avoided.

This article, Part Two, shows how D&O liability is personally aimed against the members of managing bodies who – due to the corresponding restrictions in coverage – may not expect coverage under the company's professional liability insurance or privately subscribed liability insurance. Because sufficient insurance coverage is a must for Directors and Officers, this second article shows how adequate insurance coverage can be obtained.

Coverage at a glance

D&O insurance provides protection for members of managing bodies whenever they are sued for damages based on a breach of duty in their capacity as a Director or Officer of a company. This insurance protects their private assets (insurance against financial losses) by paying for justified claims of damages (liability coverage) or by reimbursing their costs for defence (coverage for defence costs). In addition to these typical fields of coverage, most D&O insurance policies now provide limited coverage related to mounting a legal defence in criminal or regulatory proceedings.

The D&O insurance contract is concluded by the company for its directors and officers

D&O insurance coverage is purchased by a company (as a policyholder) on behalf of members of the managing bodies (as insured persons). The insured individuals are usually not just current members of the managing bodies, but include all former and future members.

Members of managing bodies should be informed about their insurance coverage and may request this information from the company. It is recommended to do this in due time since relations with the company could deteriorate if liability claims are brought against a Director or Officer.

While the members of the managing bodies did not conclude the insurance contract with the insurance company, they are entitled to the claims arising from the insurance contract. In case a company – to the extent legally admissible – holds members of the managing bodies harmless if a liability claim is brought against them, the company may then lodge its own claim against the insurance company (company reimbursement).

It is also possible that D&Os may enter into a contract with an insurance company themselves (e.g. to cover specific director mandates), but this rarely happens in practice because of limited coverage, low limits and expensive premiums.

Specialised brokers and D&O cover

Because parties are, in principle, free to determine the cover provided in an insurance contract, D&O coverage has developed into complex and specialised products, particularly internationally. Given the broad variety of terms and conditions to be found on the market, specialised brokers should be used for concluding a D&O insurance contract. Brokers will often issue an invitation to tender for insurers where offers can be compared, negotiated and improved.

Mistakes in the application process may jeopardise cover

The company obtaining the D&O insurance cover must provide truthful answers to questions asked by the insurance company in the course of the application process. Otherwise, a violation of pre-contractual duty of disclosure can put coverage at risk and create the possibility of cancellation and release.

Insurance contracts often contain regulations where the information provided in the application process by one insured person cannot be held against another insured person (severability). Such regulations, however, are often restricted, but some attributed knowledge is possible within a limited group of insured persons (limited severability), such as the CEO, CFO, COO or General Counsel. If such limited attribution of knowledge is possible, the examination and verification of proper insurance coverage must also include a review of the insurance application and its contents.

Retroactive date and extended reporting period

In D&O insurance, the insured event can technically be split between a primary event and a secondary event. The primary event is the breach of duty by a member of the managing body. The secondary event is the need for legal protection (cover for defence costs) or the liability of the member of the managing body that is established in a judgment (cover for liability).

This technical distinction is relevant in practice for various reasons. Many years may pass between the breach of duty that sets the relevant basis for a liability of the D&Os and the need for legal protection or establishment of the liability. D&O insurance policies often provide a policy period of one year. Assuming the policy is renewed for a number of years (possibly with changes to the insured limits), the question arises: what is the relevant policy period? Typically, the relevant trigger is when a claim is made against the D&Os (claims-made-principle).

As a consequence, a D&O insurance contract based on the claims-made principle can provide cover for breaches committed before the inception of the insurance contract unless such breaches were excluded from the coverage by the insurance company in the pre-contractual risk assessment or by fixing a maximum retroactive date. It is also possible, however, that a breach of duty committed before or during the insurance period leads to a claim against the D&Os only after the expiry of the insurance contract. This risk can be addressed by agreeing on an extended reporting period since, otherwise, the managing bodies would be left without sufficient insurance coverage.

Insured sum, deductible and aggregation

Under D&O insurance, the maximum amount paid by the insurance is limited in contrast to the generally unlimited liability of a managing body. The insured sum must be determined carefully at the moment of the conclusion of the insurance contract based on the potential damages.

In the context of determining an adequate insured sum, there are two additional factors that must be considered, which are used by the insurance companies to (further) limit their liability: the deductible and the aggregation of several insured events into so-called serial damage. For example, if the D&O insurance policy provides for a high deductible, a narrowly stipulated aggregation clause could lead to a situation where many claims brought against the D&Os are not aggregated into a serial damage and the deductible is applied several times, possibly to each and every single claim. On the other hand, a broadly worded aggregation clause may be disadvantageous to insured individuals if the policy provides for a low insured limit (per claim) which, as a result, would be available only once for the (aggregated) claims.

Duties in an insured event

If an insured event takes place, policyholder and insured individuals must perform certain duties. They must inform the insurance company (i.e. make a notification of claim) and cooperate to establish the factual background of the claim. These obligations arise from the Swiss Insurance Contract Act (VVG) and are often changed and amended in the insurance contract. D&O insurance contracts thus contain deadlines (e.g., of 45, 60 or 90 days) and formal requirements regarding the notice of claim (e.g. notice by e-mail followed by a registered letter). Failure to comply with these obligations may lead to loss of coverage.

Even though many D&O insurance contracts contain provisions where the company in its capacity as policyholder is entitled and possibly obliged to fulfil these duties, the members of the managing bodies in their capacity as insured persons and persons entitled to make an insurance claim are ultimately responsible to comply with all requirements. Experience has shown that it makes sense at an early stage to obtain the advice of a specialised legal counsel who can then help an insured person within the proper handling of the insured event.

Typical pitfalls

From the conclusion of the insurance contract to obtaining indemnity upon the insured event, there are various pitfalls for an insured person. These pitfalls result from the complexity of the VVG (which is better understood when taking the corresponding case law into account), and the many foreign concepts and terms (in particular from the Lloyds market), which do not always fit neatly into Swiss D&O insurance contracts. Some typical pitfalls include:

Conclusion: protect yourself, know the pitfalls

• D&O insurance contracts protect the members of managing bodies (and their personal assets) in the event of liability. This coverage is a must and not a luxury. The members of the managing bodies should, in their own personal interest, make sure that sufficient D&O insurance coverage exists by purchasing appropriate coverage or by reviewing and checking their existing insurance solution.
• From the conclusion of a D&O insurance contract to obtaining an indemnification from the insurer after an insured event, there are various pitfalls for insured persons. A simple mistake can lead to the total loss of coverage. Know these pitfalls and take appropriate precautions.

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