A r t i c l e s A r t i c l e s A r t i c l e s A r t i c l e s A r t i c l e s
misrepresentation of financial health of the company, bycompetitors for unfair trade practices, by consumers for defector deficiency of product and services and by publicorganizations for various issues like pollution and other healthhazards. Lawsuits covered may range from both civil andcriminal suits to regulatory investigations and trials.The Directors of a company are bound by their fiduciary dutytowards the company and the shareholders. There is a principal-agent relation between the shareholders and the directors, and thedirectors, as agents are bound to act in the best interest of theshareholders. In this age of corporate governance, the scope of directors’ duties have been enhanced so much so that in mostcases the term ‘shareholder’ is replaced by the term ‘stakeholders’and it is believed that the directors are bound by their duty of care not only to shareholders but also to creditors, employees,suppliers, customers and so on. They can therefore be liable forbreach of contract or breach of duty, non-disclosure of interest,negligence, mismanagement of assets etc. to all stakeholders. Thissubstantially enhances their risk. In countries like the United States,corporate law makes it mandatory for companies to indemnifytheir directors and key officers against risk of personal liabilityarising by virtue of their position in the company. The idea behindis to encourage qualified and capable people to take up theseimportant positions in the companies and for the companies to beable to retain them. However, there are numerous situations inwhich the companies are not allowed to indemnify its directorsor officers in which cases the D&O insurance comes in handy.Following is a brief note on the possible ways to relievedirectors from liability:
Ratification by shareholders
: Certain breach of duty bydirectors can be ratified by an honest disclosure of thesame in a shareholders meeting and the latter decidingto ratify the directors by passing the required resolution.
Indemnification by company
: While the company cannotenter into contract with directors to exempt them fromany liability arising out of negligence, fraud etc. towardscompany, the company can definitely indemnify directorsagainst liability arising out of their dealings on behalf of the company with third parties.
Business Judgement Rule
: Next comes the business judgment rule which the courts might apply when a suitis brought against the directors and none of the above isapplicable. This is the essence of section 633 of theCompanies Act, 1956.
D&O liability insurance
: When all the above fails thencomes the D&O insurance cover for protecting directors.
PURCHASING THE INSURANCE
It is conventionally the company that purchases the D&Oinsurance and pays the insurance premiums although the solebeneficiary may be the directors and officers in most cases.However, sometimes in order to avoid problems like that of income tax etc. the premium is split up and a portion is paidby the company while the remaining part is borne by thedirectors and officers themselves.
THE INSURING CLAUSES
Traditionally D&O policies had three insuring clauses viz., Side-A or Insuring Clause 1 provided insurance coverage to individualdirectors and key officers of a company when because of thelegal provisions or financial constraints of the company, theindemnity against any losses are not or cannot be provided bythe company, examples are in case of the company being bankrupt(financially incapable) or for derivative suits brought againstsuch insiders by shareholders on behalf of the company (legallyincapable); Side-B or Insuring Clause 2 provided insurancecoverage not to individuals but to companies when the latterindemnified its directors and key officers and thereby incurredcost or losses and in this way it protected the company’s balancesheet; and Side-C or Insuring Clause 3 which provided coverageto the companies for losses incurred by it, e.g. when any claimsare made against the company itself.
EVOLUTION OF THE INSURING CLAUSES OVERTIME
For many decades, there existed only side-A and side-B policieswith hardly a thin line of differentiation with the result thatmuch depended upon interpretation of clauses when actual claimswere to be made. To resolve this ambiguity the ‘presumptiveindemnification’ clauses were introduced much later in the mid1980s and then permanently built into the policies thereafter. Itstarted with a Philadelphia based NYSE listed company thathad taken a Side-B policy of $5 million and that was themaximum they could take at that point of time. A class actionsuit followed shortly after naming all directors as defendantsand the cost was much higher than the policy retention. Thepolicy was ambiguous on when the Side B would apply andwhen side A would be applicable. It followed that the lawyerscreatively deduced that if the company simply refused toindemnify its directors, the Side-A would be applied and thecompany would be saved of the high cost. Since the wordingwas vague on this issue, the courts upheld the interpretation andthis was how simply because of inappropriate and exclusivelanguage of the policies, the company could shift a Side-B claimto a Side-A claim and managed to get a $5000 million in placeof a mere $5 million as originally taken in the policy. Takingthis case as a precedent, the ‘presumptive indemnification’clauses were introduced and all future policies were endorsedwith the same. This clause stated that Side A would apply only
Directors’ and Officers’ Liability Insurance – the Need of the Hour