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Directors’ and Officers’ Liability Insurance – the Need of the Hour
Rupanjana De, ACS, Director, Nandi Resources Generation Technology Pvt. Ltd., Kolkata.
Directors’ and officers’ liability insurance is relatively a new concept in India though it has its existence for long in the western countries. While emphasizing the importance of such insurances the article goes in to further explain its scope, coverage, formalities, etc.

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Risk management is an important component of corporate governance practices and efficient management of the risk that key persons in a company are exposed to is therefore vital for every company. Insurance is the best tool for risk management. The recent years have seen a lot of developments in the insurance market in terms of products and services. Directors’ and Officers’ (D&O) liability insurance is one such product which has now become an important part of management liability insurance. Globally, in most of the countries in Europe and America, majority of the large corporations maintain D&O liability insurance today. In general, the D&O liability insurance claims are more from larger companies, whether listed or unlisted, but for that matter it is erroneous to conclude that private or smaller companies and their directors are immune to such an insurance product. Even in the latter type of companies litigation possibilities are not completely ruled out and there are numerous instances of litigation between members of the family or once-upon-atime friends who mutually agreed to start a company. These apart, companies, big or small, listed or not always stand open to the risk of litigations from creditors, customers, employees, banks, vendors, competitors and other public institutions.

Some insurance companies have even come up with the Independent Director Liability Insurance (IDLI) policy which is a welcome development. It goes a step further and protects the Independent directors’ personal assets as conventional D&O policy might not suffice for their total protection. It is slowly gaining popularity in the US. The importance of such a policy to protect the independent directors of companies was felt consequent upon the major recent corporate scandals of Enron, WorldCom, HealthSouth etc. all of which came to light with the dawn of the new millennium. Another new product in this market is the Employment Practices Liability Insurance (EPLI) which provides coverage in respect of certain claims relating to employment made by employees.

Directors’ and Officers’ Liability Insurance, often referred to as just D&O Insurance, is one type of liability insurance whose beneficiaries are the directors and key officers of a company or the company itself. The payment of this liability insurance is made in order to cover various costs of a lawsuit like damages, defense costs, lawyers’ fees, consequent losses etc. resulting from the wrongful acts and deeds of directors and officers of a company in their capacity as such. Such wrongful acts might be omissions, errors, misstatements, misleading statements, neglect or breach of duty by such directors or officers. Suits can be brought for various reasons by various stakeholders like the shareholders for insider trading, or shareholder derivative suits, by the creditors for

Directors’ and Officers’ (D&O) liability insurance might be a relatively new concept in the Indian market but the western countries have seen its presence across the last several decades.

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Directors’ and Officers’ Liability Insurance – the Need of the Hour

misrepresentation of financial health of the company, by competitors for unfair trade practices, by consumers for defect or deficiency of product and services and by public organizations for various issues like pollution and other health hazards. Lawsuits covered may range from both civil and criminal suits to regulatory investigations and trials. The Directors of a company are bound by their fiduciary duty towards the company and the shareholders. There is a principalagent relation between the shareholders and the directors, and the directors, as agents are bound to act in the best interest of the shareholders. In this age of corporate governance, the scope of directors’ duties have been enhanced so much so that in most cases 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 for breach of contract or breach of duty, non-disclosure of interest, negligence, mismanagement of assets etc. to all stakeholders. This substantially enhances their risk. In countries like the United States, corporate law makes it mandatory for companies to indemnify their directors and key officers against risk of personal liability arising by virtue of their position in the company. The idea behind is to encourage qualified and capable people to take up these important positions in the companies and for the companies to be able to retain them. However, there are numerous situations in which the companies are not allowed to indemnify its directors or officers in which cases the D&O insurance comes in handy. Following is a brief note on the possible ways to relieve directors from liability: Ratification by shareholders: Certain breach of duty by directors can be ratified by an honest disclosure of the same in a shareholders meeting and the latter deciding to ratify the directors by passing the required resolution. Indemnification by company: While the company cannot enter into contract with directors to exempt them from any liability arising out of negligence, fraud etc. towards company, the company can definitely indemnify directors against 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 suit is brought against the directors and none of the above is applicable. This is the essence of section 633 of the Companies Act, 1956. D&O liability insurance: When all the above fails then comes the D&O insurance cover for protecting directors.

insurance and pays the insurance premiums although the sole beneficiary 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 paid by the company while the remaining part is borne by the directors and officers themselves.

Traditionally D&O policies had three insuring clauses viz., SideA or Insuring Clause 1 provided insurance coverage to individual directors and key officers of a company when because of the legal provisions or financial constraints of the company, the indemnity against any losses are not or cannot be provided by the company, examples are in case of the company being bankrupt (financially incapable) or for derivative suits brought against such insiders by shareholders on behalf of the company (legally incapable); Side-B or Insuring Clause 2 provided insurance coverage not to individuals but to companies when the latter indemnified its directors and key officers and thereby incurred cost or losses and in this way it protected the company’s balance sheet; and Side-C or Insuring Clause 3 which provided coverage to the companies for losses incurred by it, e.g. when any claims are made against the company itself.

For many decades, there existed only side-A and side-B policies with hardly a thin line of differentiation with the result that much depended upon interpretation of clauses when actual claims were to be made. To resolve this ambiguity the ‘presumptive indemnification’ clauses were introduced much later in the mid 1980s and then permanently built into the policies thereafter. It started with a Philadelphia based NYSE listed company that had taken a Side-B policy of $5 million and that was the maximum they could take at that point of time. A class action suit followed shortly after naming all directors as defendants and the cost was much higher than the policy retention. The policy was ambiguous on when the Side B would apply and when side A would be applicable. It followed that the lawyers creatively deduced that if the company simply refused to indemnify its directors, the Side-A would be applied and the company would be saved of the high cost. Since the wording was vague on this issue, the courts upheld the interpretation and this was how simply because of inappropriate and exclusive language of the policies, the company could shift a Side-B claim to a Side-A claim and managed to get a $5000 million in place of a mere $5 million as originally taken in the policy. Taking this case as a precedent, the ‘presumptive indemnification’ clauses were introduced and all future policies were endorsed with the same. This clause stated that Side A would apply only

It is conventionally the company that purchases the D&O

Directors’ and Officers’ Liability Insurance – the Need of the Hour

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when an insured company is legally or financially incapable of indemnifying its directors and officers and that the company has no right to simply refuse to indemnify and thereby change a Side-B claim into a Side-A one. It was not until mid 1990s that Side-C insuring clauses came into being. Historically the concept of D&O insurance has primarily been individual protection and so whenever the company was named as a co-defendant in suits along with the directors and officers, there invariably was a great difficulty in making a fair allocation of defense and other costs between the companies and individuals and those by far led to further disputes. This dilemma was finally resolved in the case of Nordstrom v. Chubb in 1995. Post this decision, the insurers were made to add a new Side-C insuring clause thus putting an end to the entire confusion. Though introduction of Side-C policy, solved one problem, it gave rise to some new problems. One such problem related to the fact that consequent upon the increase in exposure, the insurance companies could not do much about increase in premium pricing. Almost for the same premiums the insurers were now insuring both individuals and companies. Consequently the risk to the underwriters increased many folds. Another problem related to the limit of liability purchased by companies. After addition of companies in the insured list, the insurance policy limit were not consequentially increased implying that the directors’ and officers’ individual protection got substantially reduced as they now shared it with their employer companies as co-insured. This is one of the reasons that have led to a renewed interest in Side-A only policies, the others being factors like increased cases of companies’ financial bad health, increased number of litigation and higher defense and other related costs. The companies tend to prefer not to indemnify its directors and officers and get an insurance coverage instead.

For the purpose of claims things that are typically covered by the definition of loss are damages, settlement cost and defense cost. Punitive and exemplary damages may be included only if specifically mentioned in the policy taken. Losses from wrongs that are legally uninsurable are not covered. Also not covered are penalties, fines and taxes. There are certain exclusion clauses that might be there in the D&O insurance policy taken. These are: (a) Exclusion of coverage of dishonesty or intentional wrong by a director or officer (b) Exclusion of coverage of an insured person against another insured person (e.g. a company cannot claim against a director in a case when both are insured) (c) Exclusion of coverage of liability arising from professional services (e.g. doctors) (d) Exclusion of claims arising out of acts committed on a date prior to a specified date (ideally the date of taking the policy). (e) Exclusion of claims already pending at the date the policy is taken (f) Exclusion of claims resulting from insider trading (g) Exclusion of claims relating to bodily injury, mental distress, sickness, death etc.

The basic principle that governs the D&O insurance regime is the economic concept of risk aversion and its effects. Risk aversion implies the unwillingness of a person to accept a proposition which has an uncertain result and instead opt for another proposition that guarantees a certain result even if it be lower than the highest expected result in the first case. This concept of economics would apply to a highly knowledgeable individual who might be unwilling to take up the position of a director simply because he is afraid of ending up with personal liability. D&O insurance provides a shield in these cases. Such insurance can make a director or an officer risk-neutral if not risk-loving, both of which will benefit the company ultimately. By being risk neutral they can take important decisions for the company based upon all necessary information available at hand at the time of taking decision and in this manner they can give their 100% to the company. In addition to the above, purchase of a D&O insurance policy by a company will also give it the signaling strength by which it can claim to be a good employer in the job market. It can have an edge over its competitors. A liability arising from their position in the company might not only cause financial

It would be erroneous to deduce that D&O insurance makes directors or officers negligent to their duties and that it encourages them to undertake unauthorized activities intentionally. While unintentional wrongs are covered by most D&O liability insurance, intentional, unlawful and unauthorized acts by directors and officers of companies howsoever high positions they hold are not covered by D&O insurance policies. In order to be so covered, the wrongful act should come under the definition of “wrongful acts” in the concerned policy, and ideally it includes those acts, omissions, commissions or mis-statements made by such directors or officers in good faith in their capacity as such director or officer of the company. This does not imply that D&O insurance would cover fraud, illegal and unlawful activities.

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Directors’ and Officers’ Liability Insurance – the Need of the Hour

losses to directors and officers, but at the same time their personal goodwill might also get tarnished. There is no denying the fact that they have a large specific investment involved. So, with the right D&O coverage in place, a company will be able to attract the most efficient and able candidates on board and key positions. In the long run, the shareholders will be benefitted in the form of getting better returns and the society at large will also be better off in the sense that there will be increased productivity and increased job security. For companies, therefore, it is a costbenefit analysis. The better you pay for insurance, the more qualified people you get.

policies in place. It gave this product a strong foothold that was to stay for many decades to come.

D&O policies from various insurance companies do have the similar structure and may appear to be the same, but they do have different composition, terms and conditions as well as benefits and language and clauses differ from insurer to insurer. A company interested in taking coverage needs to closely scrutinize exactly what kind of coverage it is looking for and who would be the best insurer. In the absence of proper care before taking the policy, companies are likely to end up in trouble. In purchasing the right policy, an attempt should be made to get the most favorable terms and conditions and for that the underwriter has to have a proper idea of the insured company’s nature of activities, its financial position, its shareholders, mergers and acquisitions in the past or probable in the near future, any changes in business activity, kind of risks that it is exposed to etc. For this the important documents to be consulted are the company’s audited balance sheet and profit and loss statement and income tax returns for the last few years, current quarterly or half yearly unaudited results as applicable, the prospectus or information memorandum if there has been a share issue, details of loans, list of shareholders, creditor information, details of shareholder grievances over the past few years and a basic understanding of the competitors and any likely suits from their side.

D&O liability insurance policies promote the concept of Business Judgment Rule which states that law presumes that directors of companies have bona fide regard for the interest of stakeholders of a company in running the management of the company and in taking important decisions. Under this rule, in plain language, it is to be presumed that in taking any decision about the company management, the directors pay utmost regard to the interest of all the stakeholders. The intent of legislation is to encourage just and well informed decisions by the company management without fear of personal liability and thereby to help the business to progress and to ensure that the shareholders’ wealth is multiplied. D&O insurance is just another assurance of putting into practice the business judgment rule and protecting the directors who work in the best interest of the company. In running a business, if a gap is created due to lack of express legal provisions, D&O insurance would fill the gap. The ultimate objective is to have the best business decisions.

The history of D&O insurance dates back to the 1930s when the first policy was introduced by the British insurance and reinsurance provider Lloyd’s of London. They foresaw the need of such a product in the face of the great economic depression of 1930 that upset the economies of the United States and many other countries in a major way. However, despite the vast consequences, the product did not sell well with the directors and officers of corporations and the D&O insurance policy failed to gain the required popularity. The law did not empower companies to indemnify their directors at that time. A decade later, the popularity of this new product in the insurance market began to gain and laws were passed in the US that empowered companies to indemnify their directors and officers. During the 1960s there were several mergers and acquisitions that led to litigations against companies and their directors and officers exposing their personal liability which only reconfirmed the need for companies to have D&O insurance

The Companies Act, 1956 makes directors and company secretary the officer in default. The Act specifies several provisions that, if contravened, can lead the liability and expose them to heavy penalty or even land them in jail. There are other enactments also that make the directors liable for contravention by the company and the directors may be prosecuted under those acts like the environmental laws, tax laws, labour laws, anti-trust laws, securities laws etc. Apart from statutory duties, there are also many common law duties of directors that have not been codified by any statute but are conventionally considered as binding on them. India being a common law country, these duties find special importance. Such duties are duty to take care and exercise diligence, duty not to be negligent, duty of loyalty to the company, duty to put the interest of the company first, duty to avoid conflict of interest, duty to act in good faith, duty not to make any secret profit, duty to make proper disclosure, duty to abide by the company’s articles and memorandum of association, duty not to delegate (delegatus non potest delegare) and so on. If the director fails to take care of his duties, depending

Directors’ and Officers’ Liability Insurance – the Need of the Hour

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upon the breach, he may incur liability for breach of fiduciary duties, for ultra vires act, for wrongs committed by co-directors, for breach of contract, for wrongful act or acts mala fide, for negligence or statutory negligence. He may incur both civil and criminal liability. While for non-statutory liabilities the courts might apply business judgment rule to protect the directors, statutory liabilities will be dealt with according to statutory provisions. Statutory penal provisions provide for fines, penalties or even imprisonment depending upon the gravity of the offence or contravention and the director may also incur unlimited personal liability under certain provisions under the Companies Act, 1956. In countries like US, directors and officers are very much conscious of the D&O insurance programme of the employer company. This serves as an important consideration before joining the board. In India, barely one-tenth of companies listed on the Bombay Stock Exchange seem to have proper D&O liability insurance in place. The coverage limit is also much narrower and the insurance claims for directors and officers can generally be made for liability arising from misleading financial statements and mismanagement of funds only. Companies are indemnified against cost of litigation that it bears on behalf of its directors and officers. Considering the benefits and necessity, of late the Securities and Exchange Board of India has been considering making it compulsory for all listed companies to have proper D&O liability insurance cover to protect their directors and officers from exposure to personal risk arising from corporate frauds and scandals. While mutual funds and insurance brokers in India are compulsorily required to take liability insurance cover, there is no such mandate for companies as of now.

Bhopal gas tragedy a non-executive chairman was sentenced to two years’ imprisonment. While many have opined that the sentence is very less compared to the magnitude of the effects of the tragedy, others do also show concern about the law being so strict on a non-executive director. In the wake of huge emphasis on corporate governance in Indian companies now where even non-executive directors can be brought to trial, D&O insurance seems all the more imperative for Indian companies at present. This would not only come handy for directors and officers not willing to take risk, but at the same time would also imply new business of vast magnitude for general insurance companies. While for most top ranked companies abroad, D&O insurance is either mandatory or suggestive, in India, it was never so popular. However, consequent upon the Satyam scam, highly capable directors are now pressing upon companies to take D&O insurance cover before they join the board. The Companies Bill, 2009 if enacted, will bring enhanced risk to directors as it provides for class action law suits by shareholders against companies and the management. Such litigation might be very expensive and in the absence of D&O insurance cover to protect the directors, companies would have a tough time convincing qualified people to join the boards. What follows from the above discussion is that D&O insurance is the need of the hour in Indian companies. In India, the D&O insurance policy is provided by National Insurance Company Ltd. (NIC) The Oriental Insurance Company Ltd. (OIC) United India Insurance Company Ltd. (UIIC) The New India Assurance Company Ltd. (NIAC) Some other private parties

In the wake of the Satyam scandal that shook the Indian corporate sector, D&O insurance policies need all the more attention. It was initially stated to be a Rs. 7000 Cr. scandal and now the fresh estimates by CBI show that the scandal is to be valued much higher at Rs. 24000 Cr. We all know that for many years the senior management of Satyam under the leadership of its founder Chairman had been cooking the books of the company under close attention of unsuspecting directors and executives many of whom were men of great reputation and goodwill. The scam almost terrorized many directors across companies and a few hundreds of such directors across the country on boards of elite companies decided to step down due to fear of possible consequences in case there were any frauds in companies they were serving. This sudden wave of risk averseness amongst the corporate elite was fueled by this ground breaking corporate scam. In recent verdict on the

Government regulations for running the companies are becoming tougher and stricter day by day with the result that the risk of directors’ and officers’ personal liability is extending. This makes the D&O liability insurance coverage the need of the hour for corporate houses in order to enable them to attract and retain big brains and talents in their boards and important positions to steer them to success. At the same time, corporate scandals are on the rise, so are shareholder derivative lawsuits. This has resulted in premiums soaring higher and higher over the years. There is a dire need to strike a balance. Also the D&O insurance products by different insurance providers in India have much narrower scope than their western counterparts. The products need to be made more mature by inclusion of more clauses and bringing more ‘losses’ under the scope of claimable losses. Last but not the least the general understanding of the various new products in the insurance market needs to be enhanced in order to take more benefit out of them.

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