Directors and Officers Liability Insurance- Part 2

In our previous article, we got to see that directors and officers of a company can be held legally liable for any wrongful acts they commit while performing their duties on behalf of the company. A director or officer of a company has a fiduciary responsibility to the shareholders, employees, and any other stakeholders in the company. In discharging their duties, one or two things may go wrong which would put the director or officer in conflict with the stakeholder. A standard D&O cover will offer protection for them through the Side A insuring clause of the D&O cover. For Instances where the company meets the costs of a legal suit on behalf of the directors or officers, then, it is reimbursed through Side B Cover- “Company Reimbursement). The other common term used to refer to Side A and Side B coverage is called Management Liability. The key underlying principle to note in this case is that the director or officer is named as a party to the litigation.

An interesting example you can read about a  D&O policy could step in to cover the legal costs of a director of a company is the stockholder derivative suit against Elon Musk for the 2016 acquisition of Solar City by Tesla Inc. Fortunately, the case was decided in favor of Elon Musk. Tesla CEO Elon Musk Wins $13 Billion Delaware Chancery Suit Over Tesla’s SolarCity Deal | Cravath, Swaine & Moore LLP

What happens then when a company or organization is named in a legal suit alongside its directors and officers? can it be protected from the defense costs and awards/judgments leveled against it? The Stakeholders in a company can not only bring legal action against the company’s officers but against the company itself as well. An example of this is the lawsuit against Alleghany corporation (Stein v Alleghany Corp et al, U.S. District Court, Southern District of New York, No. 22-03057). Stein, a shareholder sought legal action against Alleghany Corporation for its proposed acquisition by Berkshire Hathaway. Alleghany shareholder sues to block $11.6 bln Berkshire buyout over lack of disclosures | Reuters

The costs of such litigations do have a financial impact on businesses, both corporations and SMEs alike. With costs potentially even leading up to bankruptcy (especially where a case involves a class action lawsuit). To protect the company assets, the D&O policy can be extended for Side C cover (Also referred to as Entity Cover or Corporate Legal Liability- CLL).

What is Entity Cover?

Just as the name suggests, entity cover is insurance for the entity itself. In the past, (even today) owners of the most private business were in most cases sole shareholders and directors in that business. So a loss to the company would also mean a loss to the owner-director/shareholder. As such if a director were sued, then the company itself would stand to suffer the loss. Because of this, Entity cover has evolved and developed alongside the standard Directors & officers cover. As a section under the D&O Policy, it protects the company from the costs of a legal action in which the company is named as a defendant concerning a wrongful act committed by its officers or directors while acting within the scope of their managerial or fiduciary duties. The beneficiary under the D&O policy where Side C cover is granted is the entity or Company.  

Where a publicly listed company is insured, the coverage under Side C Cover is limited to Securities related claims. A securities claim is brought about by a breach of a fiduciary duty or wrongful conduct that results in a loss of the market value of a company’s shares.  While for SME’s and nonprofit organizations, the coverage would be broader. The extent of the wording will often vary from carrier to carrier.

Where SME’s and, Private Companies and Non-Profit organizations are involved, more often than not, most claims for entity cover often relate to Employment and Human Resource related issues such as wrongful termination, sexual harassment, etc.

Example: “Atuhura  Arajab Vs Kinyara Sugars Works  Civil Suit No.7 of 2011. The plaintiff was awarded special and general damages for wrongful dismal as well as the cost of the suits for unlawful termination from employment”

Coverage provided under a D&O Policy is usually on a claim-made basis.

What this means is that the policy will only pick up claims that are made while the policy is active or within the extended reporting period. In addition, the policy will have a retroactive period so that claims for wrongful acts that happened before the policy’s inception but were reported during the current period of the policy are covered.

 

The policy limit is usually an annual aggregate limit. So all claims that happen within the period of cover will be covered within that single limit. The Cover is more often than not written on a costs-inclusive basis, so legal costs and any awards in respect of a lawsuit will be covered within the limit of indemnity agreed to.  If company X has a limit of cover of $10M and they lose consisting of 3M as settlement award and 2M defense costs, the available limit of cover for any future loss will be $5M.  The Limit of cover purchased by a company is also dependent on the company’s annual revenue. For Example, a company with an annual revenue of $100M could purchase cover for a limit of $2M.  It wouldn’t make sense for an organization with an annual revenue of $10M to purchase D&O cover with a limit of US$50M for example.

 

Main Policy Exclusions.

The exclusions under a D&O policy will vary from underwriter to underwriter. Some of the standard exclusions include.

  • Dishonesty or Fraud
  • Liability for Bodily Injury and sickness
  • Loss or damage to Property Damage-
  • Professional Liability- Breach of professional duty will be covered under a Professional Indemnity cover
  • Copy right infringement
  • Liability for product defects

 

Examples of D&O Cases

Most claims under D&O relate to wrongful termination, discrimination, misrepresentation,  misreporting financial matters, and wrongful trading. The people most likely to bring a claim under D&O include former employees, government agencies, shareholders, and competitors.

For Some of the claims examples under D&O check out the following website:- Crime D&O Claim Examples | A.J. Wayne & Associates (ajwayne.com)

 

Reference;

  1. Atuhura v Kinyara Sugar Works Ltd (Civil Suit 7 of 2011) [2020] UGHC 37 (10 March 2020); | Ulii
  2. Cravath, Swaine & Moore LLP. (02, May 2022). Tesla CEO Elon Musk Wins $13 Billion Delaware Chancery Suit Over Tesla’s SolarCity Deal. Retrieved from https://www.cravath.com/news/tesla-ceo-elon-musk-wins-dollar13-billion-delaware-chancery-suit-over-teslas-solarcity-deal.html

Prepared by: Josepg Iranya
Senior Reinsurance Broker.

 

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