Example directors and officers (D&O) insurance claimants - directors face compensation claims, regulatory investigations and fines

Example directors and officers (D&O) insurance claimants

Authored by Simon Taylor (ACII)

 

Claims involving directors and officers are often political, commercially sensitive, and complicated.

Below we take a closer look at the potentially different types of claimaint D&O insurance covers:


Example directors and officers insurance claimants

 

> Shareholders

Traditionally, shareholders are seen as the party most likely to sue directors for the mismanagement of a company. For instance, claims may result from mergers and acquisitions, misleading statements, poor business decisions or other mismanagement. Shareholders (usually alleging loss of share value) may claim that a director made a negligent decision. Another common claim is misrepresentation: shareholders claim that the directors did not give them complete and accurate information about the company.

 

> Creditors, receivers, liquidators and administrators

A company’s creditors, receivers, liquidators, and administrators may bring an action regarding insolvency such as wrongful trading under the Insolvency Act 1986, which could involve trading when the directors knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation or administration. Subsequent case law has made the directors personally liable for the additional debts the company incurred during the period they traded while insolvent. Creditors can sue directors personally if they have been found guilty of wrongful trading.

 

> Regulatory bodies

In the UK, regulators for example include the Department for Business Innovation and Skills (BIS), the Financial Conduct Authority (FCA), the Prudential Regulation Authority (PRA), the Office of Fair Trading (OFT), HM Revenue and Customs (HMRC), and the Environment Agency. These bodies may allege a breach of regulations, such as health and safety, competition law, export regulations, wrongful trading, or failure to disclose information Directors can incur defence and representation costs if they are prosecuted or investigated by a regulator. A D&O policy will typically pay defence costs, but not any criminal fines. Additionally, policies may pay civil fines, but only where the law permits.

 

> Crown Prosecution Service 

Certain regulatory breaches are criminal offences and the investigation and any subsequent prosecution will involve the police and the Crown Prosecution Service (CPS). Bribery and manslaughter are just two examples. Fraudulent, dishonest or criminal conduct, in addition to gaining an illegal profit, is not insurable. Under most policies, insurers will require a final adjudication from a court of law, or an admission of guilt. This means the insurer will defend the individual on the basis they are innocent until proven guilty.

 

> Derivative shareholder actions

The Companies Act 2006 increased the scope for shareholder derivative actions in the UK. A derivative action can be brought against a director by a member of a company on behalf of the company itself. A derivative action can be brought for: (1) an actual or proposed act or omission involving negligence, default, breach of duty, or breach of trust by a director of the company; (2) a director putting themselves in a position where their personal interests conflict with the company.

 

> Employees

Employees – either past or present – may allege breach of employment conditions or legislation. The cover will typically provide for wrongful or unfair dismissal, sexual or workplace harassment, discrimination, refusal to promote, wrongful demotion, negligent reference, negligent evaluation, invasion of privacy, retaliation against an employee, false imprisonment, and wrongful infliction of emotional distress.

 

> Customers

Some customers have also sought to sue directors individually, rather than the company, in certain contractual disputes. Although the directors may successfully defend such claims by hiding behind the corporate veil – i.e. by demonstrating that they had no special personal relationship with the claimant (although the company did) – if they are found to bee personally liable, then their liability is unlimited (unlike the company’s). The policy does defend directors from spurious claims, which can be as expensive to defend as legitimate claims.

 

> The company itself

The company itself may claim that a director has breached their duty of care to the company. For example, it may allege that the director has not disclosed a conflict of interest or acted without authority. The alleged breach of duties might occur while the director is on gardening leave waiting to join a competitor. This was the allegation behind legal proceedings between an insurance consolidator and a former director of one of its subsidiary companies. The dispute was related to a client that had moved from the consolidator to the director’s future employers while the director was on gardening leave.

 

> Suppliers and other contractual parties

For example, the Court of Appeal upheld an award for damages against a company director who made false representations about her company’s ability to pay for a cargo of sunflower oil. In the original case the claimant sued the defendant and her co-director, seeking damages in deceit on the basis that the representations she had made were false, and the claimant had entered into the contract on reliance upon them. The High Court dismissed the claim against the co-director but found the defendant liable in damages for deceit and awarded a sum equal to the market value of the cargo (approximately GBP 900,000).

 

> Competitors

A company’s competitors may allege unfair practices, e.g. distorting the market or gaining unfair competitive advantage. They may also bring legal action for the following: libel, slander, and/or product disparagement, or infringement of intellectual property.


Examples of claims against directors and officers

 

> Mergers and acquisitions

A company was taken over by a French entity. The new owners sued the former chairman and managing director, alleging that during negotiations leading up to the sale, the former directors had made false representations regarding the financial condition of the company. They also claimed that the former chairman and managing director had also provided misleading profit forecasts in order to induce the claimants to purchase a majority shareholding in the company at an inflated price. Damages of over £22 million were sought.

 

> Insolvency

Here are two examples of claims arising from insolvency situations: A director was held responsible for another director’s illegal company loan account when the company went into liquidation, costing the ‘innocent’ director £1.43 million plus legal costs. A boat builder went into liquidation with losses of £1.5 million. Existing directors believed the company was making a profit. Liquidators sued the directors for negligence after finding that no accurate financial records had been kept.

 

> Health and safety

An employee was killed falling into a plastic-shredding machine. The Health and Safety Executive (HSE) investigated the accident and concluded that two directors were responsible and should be cautioned personally for not providing the employee with a safe system of work, particularly as they had been instructed that the machine was not to be used. The incident was also reported to the police and the Crown Prosecution Service, who brought a charge of manslaughter. One of the directors lost his £250,000 home as a result of the incident. Most D&O policies would pay defence costs of individual directors who are prosecuted by the HSE, but not any criminal fine.

 

> Breach of duty

The Companies Act 2006 imposes certain duties on directors of UK limited companies. If a director breaches their duties, they could face civil action and in some cases, criminal sanctions. D&O insurance policies are designed to protect against breaches of duties, or breaches of law. As a director you have a: (1) duty to act within powers; (2) duty to promote the success of the company; (3) duty to exercise independent judgement; (4) duty to exercise reasonable care, skill and diligence; (5) duty to avoid conflicts of interests; (6) duty not to accept benefits from third parties; and (7) duty to declare an interest in proposed transactions.


D&O claim considerations

Claims involving directors and officers are often highly political, commercially sensitive, and complicated. Considerable expertise is required to negotiate and settle such cases. Early notification against potential litigation is the best way to mitigate the loss and ensure policy cover. There is often some doubt as to whether potential litigation is covered under the D&O insurance, and it is always safest to notify potential claims as soon as possible. Your attention should be drawn to the claims conditions in the policy wording confirming that notice of any claim must be made as soon as practically possible and within the policy or discovery period. Insurers have the right, but are not obliged, to take over the control of the defence of any claim. It's worth noting that insurers can avail themselves of subrogation rights.

 



About the author

Simon Taylor is a respected senior industry professional and a Chartered Insurance Broker with over 20 years’ of experience in the commercial insurance sector as an underwriter, broker and director.