the d and o umbrella

  • Date:01 Oct 2005
  • Type:CompanyDirectorMagazine

The D&O umbrella often has holes

You think you may be covered but when the litigation rain begins, your D&O umbrella may have holes in it.
Ali Cromie* reports

Directors and officers liability insurance is “extremely complex” says insurance specialist, Andrew Strain, tapping into the emotions of directors who despair at the bewildering task of securing foolproof personal asset protection.
To alert directors to key elements of directors and officers (D&O) liability insurance, the AICD recently brought together experts at a Directors’ Briefing in Sydney.
Strain put the insurers view: He is a specialities underwriting manager at Zurich Australian Insurance. Anne Horvath, a senior associate at legal firm Phillips Fox, described key trends in the D&O landscape and she gave some tips on how directors could help themselves if a claim was made against them.

Laying the foundations
Directors need to understand the precise nature of D&O insurance. “There can been confusion”, says Strain.
Directors and officers liability insurance is designed to indemnity directors from personal liability from decisions made while overseeing a corporation.
D&O insurance covers directors and officers for “wrongful acts,” says Strain. It does not indemnity the likes of lawyers, engineers, consultants for breach of a professional duty.
Horvath says there are several key trends in the director insurance environment:
• legal claims against directors that were once against the company, for example by disgruntled senior employees against the board;
• an escalating number of claims against individual directors and officers of smaller listed companies, for examples for breaches of continuous disclosure (Sons of Gwalia is an example);
• more claims against D&O policies because directors are being required to spend more time in inquiries, not just the big royal commissions like HIH but at ASIC and ACCC inquiries; and
• a growth in litigation funding with an accompanying increase in class actions against directors, lead to increasing claims against D&O insurers.
“What this means is basically that you [directors] have a greater risk of being dragged into litigation,” says Horvath.
The principal groups covered by D&O insurance from personal liability for “wrongful acts” are:
• directors, company secretaries, executive officers and senior managers;
• employees acting under specific direction or at the request of management; and
• natural persons deemed by legislation, for example the Corporations Act 2001 past, present and future natural persons.
The policies tend to be quite broad, says Strain, varying as to who they cover. For example, some policies cover employees acting “under the direction of management”, while other policies limit the cover to “natural persons deemed by legislation. “
The main thing D&O picks up is “wrongful acts”, says Strain. They include:
• errors;
• mis-statement;
• misleading statement;
• misleading conduct;
• omission;
• neglect; and
• breach of duty.
“It really means anything you do as a director or officer can fall under the interpretation of wrongful act,” explains Strain. However, D&O excludes:
• bodily injury/property damage;
• dishonesty;
• insured versus insured, with write-back for;
  (i) employment practices claims, and,
  (ii) claims brought in the name of the company by ASIC or as part of a shareholder derivative action;
• personal profit advantage; and
• professional liability.
The main exclusions are bodily injury and property damage, says Strain. These are covered by public liability insurance.
Another exclusion is for “insured versus insured” cover which precludes claims brought by, say an employee against the company. However most employment practices liability insurance policies write back cover for employee claims against a director or officer, says Strain.
Under the dishonesty exclusion, Strain told the Directors’ Briefing that “some insurers” advance directors and officers their legal costs to defend allegations of fraud and dishonesty. Other insurers only pay out claims “after” final adjudication.
D&O insurance policies typically exclude claims involving improper use of sensitive information, such as a director making personal profits – as in the recent case involving Steve Vizard, the former Telstra director.
Other important aspects of D&O cover include:
• advance payment of defence costs;
• allocation of costs;
• confidentiality;
• severability and non-imputation; and
• territorial/jurisdictional limits.
Advance payment of defence costs for directors is an important aspect of D&O, involving several cases in recent times. Strain reiterates that directors need to look at whether defence costs are paid before or after adjudication.
Allocation of costs is another issue requiring director understanding. Strain says because D&O policy cover only extends to claims against directors and officers where there are claims are against directors and the corporate entity, there needs to be agreed allocation of legal expenses.
The issue of confidentiality of terms of D&O policies comes up often. “We are asked, ‘What should go in the annual report?’ As underwriters we prefer no disclosures. If people start talking about there being, for example, a $10 million liability limit, that’s flying a red flag to people,” says Strain.
Severability and non-imputation clauses in D&O policies relate to situations where say, two of the company’s eight board directors sign the D&O policy which contains misrepresentations. The severability clause means dishonesty by the two signatories does not affect the “innocent” directors. As Strain says, D&O cover is “extremely complex”.
What can directors do to help themselves?
Horvath says there are things you can do to ensure you are covered for cost orders against you and to preserve your policy limit if a claim is made against you in your capacity as a director, notwithstanding that all policies are different.
1. Notify your insurer of claim
The first action a director subject to a possible claim should take is to notify their D&O insurer. “Frankly if you make those notifications, it is much less likely you’ll get into allegations of non disclosure as your insurer will know something about you when it comes to your matter,” says Horvath.
2. Seek insurers consent before incurring costs
Most policies provide for advance payment of defence costs and provisions for you to get your costs as they are incurred – not down the track after judgment, she says.
“There is less likelihood of you ending up in a debate or dispute over the costs if you keep your insurer informed about the costs and seek their consent.”
Most of the debates between directors and their insurers relate to late notification: solicitors are already engaged and there is a gap between insurers charge-out rates and commercial rates. Also an insurer will sit there and say: “I wouldn’t have considered this and that.”
Most of your insurers have litigation guidelines, so “look at them so you know what they consider reasonable”, advises Horvath.
3. Who chooses directors legal advisers?
Different policies have different provisions about how an insurer will defend a director. Will the director, their organisation or the insurer defend you? Horvath recommends directors and officers carefully example whether they are lumped in under umbrella representation or able to insist on separate legal counsel.
“There are a number of reasons directors want separate interests from their organisation and between executive and non-executive directors as each can have separate interests.”
Insurers typically prefer to retain their own solicitors to defend directors and officers against claims whereas directors and companies may wish to retain their corporate solicitors – the firm that probably gave the original advice on the matter giving rise to the claim.
There are inherent conflicts in this and your insurer has a real interest – which is aligned to yours (directors) – in eliminating that risk, says Horvath.
When the insurer has the right of deciding who is to conduct your defence, they will usually appoint a lawyer from their legal panel. If it is a director’s right to chose their defence team, then the insurer will generally have the right to “associate” with your defence, and will still (if indemnity is extended) have considerable say in your defence.
4. Consult your insurer before any settlement agreement
Horvath warns directors to ensure that any settlement has the agreement of their D&O insurer. Once again, the interests of a director and their organisation may diverge under the pressure of litigation.
She says a company feeling pressured by ASIC to settle a claim involving small investors came to an agreement with the litigants.
The company was driven by a concern about the impact of the claim on its licence. However the insurer, left out of the loop, refused the claim on the grounds it was not a “loss” as defined under its insurance policy.
“Directors can be left high and dry in such situations.’’
What do D&O underwriters look for in renewing insurance or taking on new business? According to Andrew Strain:
• a completed, signed and dated proposal form – signed by two representatives; chairman or managing director (directors) executive officer/senior manager (officers);
•  latest audited financial statements and notes to accounts; and
•  interim financials – if available.
Strain says that if the underwriters have a good feel for the operation of the insured, they are more likely to provide more competitive terms. “It’s not just about us being “bloody-minded” but providing a comfort so we give the most competitive terms.”
There are signs the D&O rates are once again on the move – this time down. Horvath told the Directors’ Briefing that the period of a “hardened’” insurance market – is “rapidly changing”.

* Ali Cromie is a learning facilitator for AICD Education Programs and principal of Rigour Group, specialising in employment screening of senior people to reduce organisation risk.