ClientEarth's recent derivative action against Shell's board of directors has drawn attention towards the potential liability of directors and other key decision-makers of UK companies. Directors and officers have significant duties and responsibilities placed on them under the Companies Act 2006. This coupled alongside the modern shift towards a "blame culture" has increased the appetite for holding directors and officers accountable for companies' decisions by means of litigation. As a result, shareholders and third parties are now provided with far greater forms of remedy against directors and officers personally. To protect these individuals and to ensure the stability of their companies, Directors & Officers (D&O) insurance has emerged as a critical risk management tool.
What is D&O Insurance?
D&O Insurance is a type of liability insurance which offers liability coverage for company directors and officers from claims made directly against them as a result of their decisions and actions taken within the scope of their duties owed to the company. This can be extended to include spouses, estates and liquidators, non-executive directors and other key employees in managerial positions. The financial protection provided by D&O insurance is designed to help cover the costs (including legal costs) associated with investigating and defending claims, reaching settlements, and paying out damages.
Who is covered?
The Companies Act 2006 permits companies to purchase and maintain D&O insurance to cover its directors and officers (including directors and officers of a company in the same group) against liability for such individuals' actual or alleged negligence, default, breach of duty or breach of trust in connection with the company of which they are a director or officer of. Claims of this nature can be raised by various parties, including the company's shareholders or investors, creditors, employees, third parties or regulators.
What is not covered?
D&O Insurance does not cover claims made against a company as a whole; only those made against individual directors or officers. D&O insurance cannot cover losses suffered by directors and officers which arise from fraudulent or dishonest acts by those directors and officers.
There are also various other exclusions which may apply and the extent of cover available will ultimately depend on the wording of the policy. Property damage, pollution, serious bodily harm and death are all common exclusions.
Key Benefits of D&O Insurance
Whilst D&O insurance is not compulsory, it is considered good practice for companies to maintain D&O insurance for the following reasons:-
Enhancing Corporate Governance
For a company to succeed it will often be challenged with the difficult task of navigating risks and seizing opportunities. In the absence of D&O insurance, directors may be discouraged from taking those risks required to promote the success of the company, in the fear of being reprimanded. As such, D&O insurance supports effective corporate governance by providing directors and officers with the confidence to make informed decisions when taking the appropriate level of risk in the best interests of the company.
Attracting and Retaining Talent
Qualified individuals and specialists may be reluctant to accept a position as a director or officer of a company if personal assets, such as their homes, are at risk in the event of a claim being made against them. D&O insurance can therefore be used as a crucial recruitment tool to attract and retain top level talent in leadership roles.
Litigation Costs
Any allegation of wrongdoing will need to be investigated and defended, if appropriate and associated legal costs can add up to thousands of pounds. Without adequate D&O insurance, directors and officers may be unable to properly defend themselves against (often lengthy) legal proceedings, including prosecution and/or disqualification.
Company Indemnity Prohibition
The Companies Act prohibits a UK company from indemnifying a director against his liability for negligence, default, breach of duty, or breach of trust in relation to the company or associated company (a claim) Any provision in the company's articles of association or in any other agreement with the company which appears to exempt its directors or the directors of its associated companies from such liability will be invalid. An associated company includes a company's UK holding company, UK subsidiaries or UK subsidiaries of the same UK holding company.
There are two limited exceptions to this general rule:-
• a company is permitted to indemnity its directors against liability incurred in connection with a claim by third parties other than the company or ay associated company.
• a company can indemnify a director or officer against liability incurred in connection with the company's position as a trustee of an occupational pension scheme.
Where the above exceptions do not apply, D&O insurance can be a useful safety net.
Evolving Legal and Regulatory Environments
Directors' and officers' duties and responsibilities are constantly evolving as legislation and case law develops. With directors being expected to comply with such changes, the risk of litigation is increased. For example, the rise of cyber security incidents has led to various data protection and security regulations that directors and officers must be aware of. Additionally, with companies and investors being even more concerned with climate change, reducing their carbon footprint and ensuring board diversity, the growth in claims in support of the Environmental, Social and Governance (ESG) agenda is only expected to continue.
Key Takeaways
D&O insurance serves as a valuable risk management tool. It allows companies to protect their directors and officers from the financial risks associated with claims being made against them. It also enhances corporate governance and helps attract and retain talent in leadership roles.
If you require further advice on any of the issues raised in this article, please get in touch with your usual Brodies contact or one of the contacts listed below who will be happy to assist.
Contributor
Trainee Solicitor - Corporate Funds
