Mitigating Executive Risk: The Role of D&O Insurance and Company Indemnities

A Directors & Officers (“D&O”) policy is a fundamental part of a company’s insurance programme.  It provides protection to directors and other senior individuals[1] who may face personal liability for matters related to their role.  Individuals may also have protection via indemnities from the company.  How do the indemnities and D&O coverage interact?

Who makes a claim under a D&O policy – directors or company?

The short answer is that it can be either, or both.  A D&O policy is designed principally to cover the personal liability of directors and officers, which liability may arise (or be alleged to arise) whilst they are acting in their capacity as directors and officers of a company.  Where there is no company indemnification of a director (e.g. where the company does not cover a director’s legal costs in defending a claim), a D&O policy will cover that personal liability directly.  This is known as Side A or cover for non-indemnifiable loss, and so it is the director making the claim on the policy directly.

Most D&O policies also provide cover where the company does indemnify their directors.  Here, it is the company that is actually (and legally) suffering the financial loss, since the company is paying defence costs and other losses.  This is known as Side B or cover for indemnifiable loss, meaning that it is the company making the claim on the policy.

Does it matter if a claim is Side A/non-indemnifiable or Side B/indemnifiable?

Practically speaking, the main difference between Side A and Side B is that Side A will always have a nil retention[2].  Therefore, if a claim is Side A, insurers pay from the first penny.  Side B often does have a retention, meaning that the company will pay the first portion of the loss, before the insurers start paying above that.  There may also be some additional coverages, or layers of coverage, that are Side A only.

Does the policy protect a director if a company does not pay the retention? 

There are provisions that help, although each policy must be checked individually.  For example, policies may include a term that states that if the company refuses to indemnify the insured person, when it is legally able to indemnify, insurers will pay the policy retention.  Insurers will then be entitled to pursue the company for reimbursement of the retention.

Do these provisions mean a director has nothing to worry about?

There are still practical risks if a company does not indemnify, even if insurance policy provisions provide protection from the first penny. In particular, insurers may hold back payment whilst they investigate coverage for the director’s claim, which can take time, especially if the claim is complex. 

To help move the process along it is important that the director provides the insurer with reasonably requested information as soon as possible. Your broker can assist with this process by helping to identify with you early what information insurers will require.

Once coverage is resolved, is that the end of the practical issues for a director?

There can be risks associated with ongoing claims conduct, such as agreement of lawyer rates, legal budgets for certain work, and failure to seek consent for settlement.  Failure to seek consent causes a clear issue (as the insurer may then refuse to pay at all) but even if consent is sought, an insurer may not provide that consent (and may be entitled to refuse to provide it) if it considers the request is unreasonable.

We now have lawyers’ fees agreed and have obtained consent as required by the policy.  Can a director finally stop worrying about insurance?

There can still be delays in payment whilst insurers review invoices and satisfy themselves that time has been properly spent, and that narratives are appropriately detailed.  If a lawyer is acting for multiple defendants (e.g. both the company and the insured person) or on insured and uninsured matters, it is important that the narrative and bill are broken down, so the insurer can clearly identify what portion of the bill it needs to pay.

Payment delays may need to be managed with the director’s lawyers, who may be asked to provide further information to support their work.  In some cases, insurers will refuse to pay certain elements of an invoice if it goes outside of an agreed approach (for example, if there is repetition of work by multiple fee earners).  It is important to agree at the outset that lawyers will produce narratives of sufficient detail to allow insurers to audit the work done.

What are the concerns for the company regarding interaction between the D&O policy and company indemnification?

A D&O policy usually provides a direct right for a director to bring a claim for cover.  If a director (or other individual) falls within the scope of cover, he or she will be entitled to a copy of the policy and to bring a claim – it is a severable policy.  That is seen as a key protection for directors.  A company will not be able to restrict access to the policy after the event (for example, if it has fallen out with the director).

A D&O policy may require the company to pay the retention even if the company is under no obligation to indemnify the director.  A typical clause will, effectively, require indemnification if legally permitted (i.e. so long as there is no legal bar on indemnification, the D&O policy will assume indemnification has taken place).  The reason for that is so that a company does not simply choose not to indemnify, and thereby avoid the retention associated with a Side B/Indemnifiable Loss claim. 

I am a Company Director, and I’ve read your article – what should I do now?

A D&O policy does many things to protect directors, including if a company is unable or unwilling to indemnify.  Many directors have claims paid each year, and the points identified in this article should not be overstated – it is a crucial cover and your broker will help you through the complexities we have identified.  However, it is clear that there can be practical difficulties with recovering under an insurance policy, even in relatively straightforward claims, and that the risks of payment delays will fall to the director if it is they rather than the company making the claim. 

Directors should, therefore, consider carefully their indemnification position with the company, to ensure there are no surprises if a claim does arise.  For example, directors should review the protection they have under articles of association, consider contractual indemnities in place (and ensure that these provisions operate clearly in the event of claim), and review arrangements periodically to check that they remain fit for purpose.

Finally, remember that, whilst the aim is to provide enough cover in a worst case scenario, there is no guarantee that D&O limits will be sufficient to cover all claims.  If there is no cover remaining, company indemnities will, once again, be the principal protection for directors.