India: D&O Diary

BACKGROUND

In a fast-moving competitive environment, the Directors and Officers of an organization are required to take bold and crucial business decisions from time to time. Any wrong decisions can possibly trigger legal actions (both civil and criminal in nature) against them. As a consequence of such actions, there is a potential exposure of loss of reputation and financial liabilities for them.

A few instances of liabilities against Directors and Officers are a breach of duties, shareholder and stakeholder claims, sexual harassment allegations, violations of corporate governance regimes, enquires and investigations initiated by the governmental authorities, money laundering offenses, tax liability (in certain instances where the company has defaulted but a director is held personally liable) and liabilities under various statues.

While the liability of the company is limited, the liability of the Directors and Officers is unlimited. Considering the potential risks associated with their profession, the Directors and Officers liability insurance policy, popularly known as D&O Policy, is one of the key insurances policies for any organization to cover losse

UNDERSTANDING D&O POLICY

The risk scenarios essentially covered under the policy include prospectus financial liability, damages, and defence costs (including related and ancillary cost) for the legal actions initiated by or against them. Typically, defence costs comprising attorney fee, cost of filing legal paperwork, investigation cost and cost of expert witnesses make up a large sum of the total claim amount. In specific cases, the cover also gets extended to include the company itself. However, insurance providers will have to be told that both coverages are required.

An alternate avenue or a supplementary measure to protect the director is to earmark funds annually or periodically, for making good the loss. Some big corporations do have the funds allotted specifically to indemnify their Directors and Officers. A well-drawn policy and a separate committee will be key for its implementation.

MISCONCEPTIONS ABOUT D&O POLICY

While there is no mandatory requirement to have the D&O Policy, the common misconception is that it is mostly required for a public company or may not be required for smaller companies. Infact, big organizations have more deep pockets than smaller set-ups to indemnity and have alternate plans in place for their Directors and Officers. Hence, the nature and size of an organization cannot be a barometer to decide whether or not the cover is required. Although it could be the determining factor to decide the extent of coverage required by an organization.

Another misconception is that the potential liabilities of directors or companies will be covered under other policies like general insurance liability, errors and omissions policy, and professional liability policy. However, D&O Policy is specifically designed to protect the Directors and Officers from their actual or alleged wrongful actions, which protection may not be granted in other policies.

In certain cases, a company may not want to consider D&O Policy because it may have separately agreed to indemnify its Directors and Officers. However, the Directors may have issues recovering the losses if they are no longer directors of the company or the company itself becomes insolvent or it has no funds to indemnify its Directors, or in cases, where the company itself is the claimant. Taking a D&O Policy can cover such eventualities to protect them.

EXCLUSIONS

Every insurance policy specifies what it will cover and what it will not cover. Similar is the case for the D&O Policy.

A D&O policy does not cover instances where the Directors and Officers have acted in a dishonest or fraudulent manner or when directors and officers fail to comply with the signed contract. In certain cases, one insured director may bring a claim against another insured director or where a company may have several insurance covers and a particular claim may fall within the scope of another insurance policy. Even in such cases, D&O cover cannot be invoked.

Some of the other exclusions could be pollution claims, workmen compensation, criminal activity, instances of theft, and claims normally covered under other or prior insurance.

While one may assume they are covered under the policy, it may so happen that exclusions may apply. As such, the most important aspect to be considered at the time of taking a D&O Policy is to carefully analyze and understand the exclusions. Although a time-consuming exercise, it is crucial to devote time, focus on and fiercely negotiate the exclusions, since it may affect the coverage of potential claims.

CONCLUSION

With the evolving business environment, there are many potential sources of claims for the directors and officers. Add to it, the broadened scope under the statutes (like the Companies Act, Factories Act) which put certain specific and stringent compliance obligations on the Directors and Officers; besides imposing stricter civil and criminal penalties on them. Many investors in private equity and M&A transactions also insist on having a D&O cover for their nominee directors on the Board of Directors. Hence, it is worthwhile for the company to consider D&O liability insurance. To conclude, however, before going for a D&O Cover, it will be important to consider the following questions (i) What does the typical D&O policy look like? (ii) What is covered, how much is covered and who is covered (iii) What is not covered? (very important) (iv) How can risk management protect the Directors and Officers from different claim scenarios? and (v) What do different insurance providers have to offer based on the requirements of an organization?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.