How Does D&O Insurance Work?
What is D&O Insurance?
Directors and Officers Insurance covers a company’s executive from personal liability. Whilst a company is a separate legal entity that can be sued, there are instances where a director will be personally liable, including:
- Company losses caused by directors breach of duties;
- Debts incurred whilst insolvent trading;
- Director acting as a guarantor using personal assets;
- Unpaid tax obligations;
- Fraud and phoenix activities;
- Breach of director duties or obligations.
When a director has breached any duties mentioned above, an action against a director or directors may be brought by:
- The company itself;
- Shareholders and employees
- Government regulators, including ASIC or APRA;
- Creditor and liquidators;
- Customers and competitors, or even;
- Other directors.
As such, directors are exposed to personal liability, including having to pay:
- A fine or penalty;
- Legal costs and interest.
It is important to note that these liabilities extend past resignation or when the company becomes deregistered.
Why it is important
D&O insurance is vital to both the director and the company. Being the ‘mind’ of the corporation comes with significant responsibilities, including strategic decisions of the company and ensuring that the company meets its statutory obligations. As such, the increased pressure of personal liability may detract from a directors ability to make crucial decisions, therefore hampering the company’s growth. D&O insurance is also essential to the individual directors, as they can make decisions without the pressure of personal liability, especially if they are serving on multiple boards.
D&O insurance usually covers liability to the extent that the law permits it. A Deed of Indemnity is good at reducing risks incurred; insurance will transfer the liabilities onto the insurer. Insurers will generally cover personal liabilities and associated costs arising from a breach of duty or failure to meet an obligation mentioned above. However, it is essential to take into consideration the following:
- Whether the insurer will cover individual claims, if the company takes the D&O insurance;
- Exhaustion of indemnity by other insured parties;
- Time for the claim to be paid out, and
- Other financial gaps that might arise include reputation and fines for criminal offences.
Exclusions will vary from insurer to insurer. However, general exclusions include:
- Fraud / dishonest acts;
- Wilful violations;
- Statutory exclusions;
- Majority shareholder exclusion for claims brought a party with interest in the company (around 10-20%); and
- ‘Insured v insured’ cases where a party covered by the same insurance brings an action against another party covered by the insurer.
Consequences of failing to obtain comprehensive D&O insurance
Failing to get D&O insurance has several implications, as mentioned above. For the company, failure to provide comprehensive D&O insurance will have two primary consequences.
Firstly, if a company fails to provide a comprehensive D&O insurance policy, it may not attract high-quality talent to their board or other management positions. Secondly, existing board members may have a low-risk appetite, therefore electing not to pursue commercially more profitable endeavours due to their liabilities.
Secondly, failure to obtain adequate D&O insurance may result in the individual being personally liable for any of their actions.
Although appealed on unrelated grounds, Hall v Poolmann provides an example of the risks of being an uninsured director. Liquidators brought proceedings against Mr Irving, a director, who was accused of trading whilst insolvent. The judge, in this instance, stated that the court would not concern itself with whether the director was insured. As a result, the director would have been personally liable for the damages sought by the liquidators.