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Conference preview
FINANCIAL SERVICES: D&O EXPOSURE
D irectors
in
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
protection for directors to mitigate the financial consequences of
claims and investigations in which directors are implicated
Commercial Dispute Resolution
NOVEMBER-DECEMBER 2012
I
n today’s highly regulated and
litigious climate, directors and officers
are subject to heightened scrutiny and
find themselves increasingly exposed
to civil, criminal and regulatory
proceedings. New legislation, stricter
governance and more shareholder
activity all result in greater external
pressures. The increase in regulatory
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 officers in a wide variety of
business sectors.
Most companies recognise the
benefits of directors & officers’ 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 indemnification is not
always fully understood. There are real
benefits both to directors and to the
company in understanding how these
protections operate and can be used to
maximum effect.
D&O insurance – how does it
operate and what does it cover?
The D&O policy will typically be taken
out by the company as policyholder
and will be structured around the
indemnification provided by the
company. Side A insurance covers the
liabilities of directors and officers in
respect of claims made against them
where no indemnification is provided by
the company. Side B (often referred to
as corporate indemnification coverage)
covers the same liabilities but where
the company has or is legally permitted
to provide indemnification. Side B
cover effectively provides balance sheet
protection to the company, but in respect
of losses incurred by or on behalf of
the directors.
Most D&O policies impose a policy
retention or excess in relation to the
Side B cover which is payable by the
company. The policy will typically include
presumptive indemnification language
whereby it is presumed that the company
will indemnify to the maximum extent
permitted by law.
The 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
securities. The disadvantage of Side C
cover from the directors’ point of view is
that the directors are effectively sharing
the policy limit with the company.
Securities claims against the company
can be very expensive even just in terms
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of defence costs. For this reason many
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
proceedings. Some D&O policies are
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. There are also
restrictions in any D&O policy regarding
the availability of cover for criminal
and regulatory fines and penalties since,
under English law, fines and penalties
resulting from deliberate wrongdoing
cannot be insured against as a matter
of public policy. The Financial Services
Authority has also banned insurance
coverage over any fines it imposes,
although it remains permissible to
purchase insurance to protect directors
against the costs of formal proceedings
and other investigations conducted by the
FSA. It is not uncommon for all fines and
penalties to be expressly excluded from
D&O coverage. That said, some D&O
policies covering D&O risk in multiple
territories will provide cover for fines 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.
This 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. The
language of the exclusion can be critical
and it is important that the exclusion only
applies to the individual against whom
there is a finding of fraud and dishonesty. 
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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 final
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
of the D&O policy. Again, the wording of these exclusions
requires careful attention to avoid directors finding themselves
without cover particularly for claims brought by shareholders
or the company at arms length and claims made by a liquidator,
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 often most at risk.
Company indemnification – how does
it operate and what does it cover?
The 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 significantly broadened the extent to which
companies are permitted (but not obliged) to indemnify
directors. Some companies include indemnification provisions
in the Articles of Association which enable the company to
indemnify directors to the extent permitted by the Companies
Act. However, provisions in the Articles of Association may
not be enforceable by the director against the company in the
absence of a separate indemnification agreement. It is therefore
in the best interests of the director to have the benefit of an
express indemnification agreement with the company. This
can take a number of forms such as a deed or deed poll
benefiting all directors or separate contractual arrangements
with individual directors.
The Companies Act 2006 does impose certain restrictions
in relation to liabilities and defence costs which the company
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
Commercial Dispute Resolution
NOVEMBER-DECEMBER 2012
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
offence. Criminal fines and regulatory penalties cannot be
indemnified by a UK company.
The inevitable consequence is that, even if the director has
the benefit of both D&O cover and corporate indemnification,
there is likely to be no coverage available to the director in the
event of a finding of fraud or dishonesty nor for criminal fines
or regulatory penalties. This is not surprising but it is important
to check the wording of the D&O policy and any express
indemnification agreement to avoid any additional gaps in cover.
The provisions of the Companies Act with regard to indemnity
are permissive, not obligatory, and it is perfectly possible for an
indemnification 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 indemnification
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 notified to insurers) that responds.
The 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 notified to the insurers during the policy period. The
cover effectively operates on a “first past the post” basis such that,
depending on the number of claims made during the policy year,
directors making later claims may find 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 indemnification is not typically subject to any monetary
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limit and will not be shared with the other directors of the
company. There is a potentially unlimited amount of indemnity
available subject of course to the company’s ability to pay. If
the company is insolvent then any corporate indemnification
agreement may not be worth the paper it’s written on. This is
one of the particular benefits of having D&O cover in place and
ensuring that the insurance coverage remains intact after an
insolvency event.
The 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
or conditions or the non-disclosure of material facts prior to
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
indemnification invaluable. Directors that don’t have the benefit
of an express indemnification agreement may find themselves
having to put their hands in their pockets to fund their own
defence costs.
D&O insurance and corporate indemnification are not
mutually exclusive. A common misconception is that a director
must choose between having the benefit of D&O insurance or
an indemnity from the company. On the contrary, both can
be combined to provide an effective 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 indemnification 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. The
“devil is in the detail” when it comes to insurance contracts and
this is particularly so in relation to D&O cover. n
- Frank Thompson will be discussing D&O liability issues
at the CDR Conference on 26-27 November.
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
on assisting policyholders in accessing the proceeds of their insurance policies.
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
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