19 Dec 2008
Risky business: Directors' and officers' liability and insurance - are you covered?
by Mark Waller, Paul Miller
Companies should be reconsidering their Directors’ and Officers’ insurance now.
In recent years we have seen a broadening of D&O insurance cover, illustrated by the gradual dilution of once virtually absolute broad exclusions.
However, we are entering the stage of the D&O insurance cycle where the pendulum may start to swing back towards a hardening of the market for both price and the breadth of cover. There is certainly anecdotal evidence to suggest that the rash of shareholder actions and other litigation arising from the economic crisis has lead to a hardening of terms and price for D&O cover. While there is currently capacity in the market, there are clear signs of a tightening arising from recent renewals. On current indications the 2009/2010 renewal process may start to see a reversal of the current trend of broadening policy terms to a more restrictive approach to policy wording negotiations.
These indications aside, a number of leading D&O insurers have shown a willingness to negotiate more favourable terms for D&O cover. Now is a good time for organisations and individuals to review and lock in their D&O insurance cover before a hard market gets into full swing.
It is important however to take the time to properly review the policy terms and the cover provided to ensure you are getting maximum protection - and the best deal. The following are some of the areas that are the subject of intense negotiation between D&O insurers and insurance purchasers.
Cover for claims by the company
A clear example of the broadening of D&O insurance cover in recent years has been the shift by many insurers away from the "insured v insured" exclusion to a "consensual claims" approach. Until recently, D&O policies typically contained the former, which provided that the policy did not cover claims brought by the company against its own directors/officers or by one insured against another insured. The rationale behind this was to prevent the situation where a director might concoct an action by the company against themselves in an attempt to recover losses the company had incurred by reason of the director’s mismanagement.
In recent times, a number of D&O insurers have effectively removed the insured v insured exclusion. Rather than excluding any claim by the company against its directors or officers, insurers now limit the exclusion to consensual claims brought with the solicited or voluntary (rather than legally required) assistance or active participation of the director/officer against whom it is brought. Other insurers have done away with the insured v insured exclusion altogether and at least one insurer no longer automatically applies the consensual claims limitation.
Major shareholder claims
Insurers’ treatment of the "major shareholder" exclusion is another example of the broadening of D&O cover in recent years.
The exclusion applies to any claim against a director/officer by a party who had or has control of over 10 percent or more of the voting shares of the company. This exclusion is regularly the subject of intense negotiation between purchasers of D&O insurance and insurers with the purchasers making some headway in negotiating out some of the more severe limitations imposed by the broader versions of this exclusion.
As D&O insurance typically extends cover to directors and officers for claims against them by shareholders, it is difficult to see the rationale for the major shareholder exclusion. The broader versions of the exclusion apply regardless of the type of claim, whether it relates to the shareholder’s interest in the company, the control exercised by the major shareholder, the involvement of the major shareholder in the decision-making process that led to the claim, or whether the majority shareholder was in fact a shareholder at the time of the circumstances which gave rise to the claim.
Further, the effect of this exclusion on a target company in the context of a takeover would be to exclude cover to the target board for any claim by the acquiring company arising out of the transaction. This would be a real concern to directors of a target company in a hostile takeover who may then be the subject of scrutiny and potentially litigation by the new board if the acquiring company is successful.
A number of insurers limit the major shareholder exclusion to where the major shareholder has board representation at the time of the wrongful act. We consider that the exclusion ought to be removed altogether or restricted to "consensual claims" in the same way as the consensual claims exclusion for claims by the company against directors and officers. Alternatively, the exclusion should at least be limited to claims against the major shareholder’s representative director and should not apply to claims against the other directors and officers.
Cover for innocent directors
One area where most D&O insurance policies are wanting is that they do not provide clear and unambiguous protection for innocent directors/officers in relation to the effects of fraud or dishonesty or misconduct of other directors/officers.
While D&O insurers often attempt to deal with the issue by agreeing not to impute the knowledge of the director/officer engaging in the misconduct to the innocent directors/officers, these provisions typically are limited to the contents of pre-contractual submissions or proposal forms. This generally does not address the risk that pre-contractual non-disclosure by one director/officer will avoid, or prejudice, the cover of the innocent directors/officers. Most D&O policies do not make it clear that the innocent directors/officers remain covered by the policy and that the post-contractual misconduct conduct of one director/officer will not affect coverage of the innocent directors/officers.
There is a real risk that the knowledge or conduct of one insured could give rise to rights by an insurer to avoid the policy or otherwise prejudice the cover provided to all insureds under the D&O policy. Further, an insurer may be entitled to cancel ongoing cover under the policy. These and other issues need to be considered carefully when reviewing D&O insurance policies.
It is essential that companies and individuals take the time to review their D&O insurance to ensure they have the right cover - and the broadest possible cover. Not all policies are the same and terms vary from policy to policy. A number of leading D&O insurers have shown a willingness to negotiate favourable terms and now may be the opportunity to review and lock in your D&O insurance terms before the hard market gets into full swing.