D&O insurance: Some valuable peace of mind for directors worried about insolvency

Fortunately, large numbers of UK businesses have purchased Directors’ & Officers’ liability insurance (sometimes described as “management liability” insurance). Such policies can help provide peace of mind for the individuals in charge of managing the company, including directors who may be concerned about their personal exposure if the business enters an insolvency procedure.

It would be prudent, however, for directors to seek specialist advice on the terms of any D&O insurance policies currently in place, and to take the other practical steps listed below to help minimise the risk of being left with any personal exposure for allowing a company to continue trading.

Personal exposure of directors

Many UK businesses, small and large, are currently having to balance keeping their businesses afloat with their obligations to ensure that suppliers and other creditors continue to be paid. Directors of companies will want the best outcome possible for the businesses they manage, but clearly will not want to find themselves personally exposed if the business does fail.

If a company is insolvent then the directors can be personally liable for failing to act in the best interest of creditors (known as misfeasance).

If a company carries on business operations with the intent of purposefully deceiving and defrauding its creditors, then the directors can become liable for fraudulent trading. Whilst the burden of proof for establishing fraudulent trading is high, if it is proven the directors of the company can be made liable to make such contributions to the company's assets as the court thinks proper.

In normal circumstances, directors can also become liable for wrongful trading, if they continue trading beyond the time when they knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation and did not take every possible step to minimise the potential loss to the company’s creditors.

As part of its efforts to protect businesses in the light of the current Covid-19 crisis, the government has suspended the wrongful trading provisions. However, this suspension does not water down the basic duties owed by a director to ensure he or she has regard to the interest of suppliers and creditors at a time when the company is, or may become, insolvent.

Accordingly, our advice to directors of companies in financial distress is that you must continue to act in the best interests of all creditors and have a reasonable belief that the company can avoid an insolvency process, or risk personal liability.

What protection is available for directors?

Notwithstanding this advice, some directors will no doubt be concerned that their business judgements may be second guessed later, particularly if the business does fail and the company is forced to enter into an insolvency procedure. Liquidators and administrators, for example, have duties to investigate the conduct of directors leading up to a company’s insolvency, and may face pressure from creditors to take action against the company’s directors.

Many directors will be indemnified against certain categories of personal liabilities by the company itself, either pursuant to the company’s articles of association or a separate agreement or deed entered into with the company. However, company indemnities are unlikely to provide comfort to directors concerned about their personal exposure in these circumstances. The company by definition will not be solvent and cannot therefore be relied upon to have the funds required to protect its director. In any event, company law prevents companies from indemnifying their directors against liabilities they incur to the company itself (as opposed to third parties). As a director’s duty to act in the best interests of the creditors is a duty that is owed to the company, a breach of that duty cannot legally be indemnified by the company.  

Companies law, however, is clear that companies can purchase insurance for their directors against liabilities to the company (see section 233 Companies Act 2006). Increasing numbers of companies have chosen to do so by purchasing D&O insurance.  

Coverage under D&O policies

D&O insurance is a complicated product written on complex standard forms. In order to understand the scope of the cover it provides it is necessary to consider the individual policy wording in full.

However, generally speaking, policies include coverage for damages, and defence costs, that directors incur in respect of claims alleging “wrongful acts” committed by them in their capacities as directors.   The term “wrongful act” is typically defined broadly to include essentially any breach of a legal duty by the director, including breaches of duties that apply to take account of the interests of creditors (although this may not be specifically mentioned in the wrongful act definition).

The cover provided by D&O policies will therefore usually be broad enough to cover liability that a director may incur for misfeasance, or wrongful trading. Exclusions and other terms and conditions will however apply to the insurance coverage and these would need to be checked in order to confirm the scope of the cover provided by an individual policy. 

Typically, exclusions for fraud or dishonest conduct will apply, as well as exclusions for liability resulting from acts or omissions that were deliberate or intentional on the part of the director. The effect of these exclusion clauses is likely to be that no cover will apply for any liability the director incurs as a result of fraudulent trading.

However, there may well be cover for legal expenses incurred defending a fraudulent trading claim, provided that the defence is successful (ie that there is no final adjudication of fraud). The cover for such legal expenses may itself be very valuable to a director who might otherwise be faced with a large bill for defending a fraudulent trading claim made against him or her.

It would be prudent also to check the “insured versus insured” exclusion in the policy. This clause can exclude claims brought by the company against individual insureds (including potentially claims brought by a liquidator, on behalf of the company, against a director). However, in many policies this exclusion clause will apply only to claims brought in the United States or made under US law. Many policies will also include carve outs from this exclusion clause to specifically ensure that claims brought by liquidators are still covered by the policy.

Practical steps

D&O insurance can provide a valuable safeguard for directors who, in the current environment, are increasingly being asked to make difficult decisions about whether to continue trading. Whilst insurance is no substitute for taking appropriate precautions to avoid liability in the first place, it can provide directors with a valuable additional degree of peace of mind. This kind of insurance also serves a useful wider purpose in that it can help directors to focus on making appropriate business judgements, without becoming unduly concerned about their personal exposure (or too risk averse as a consequence).

Given the current crisis it would be prudent for any directors concerned about their personal exposure to:

• Get specialist advice on the coverage provided by their D&O policy for any personal liabilities they could incur as a result of the company continuing to trade.
• Consider closely the policy’s terms for notifying claims or circumstances which may give rise to claims in the future, and assessing whether a notification of a claim / circumstances should be made to the insurers. D&O policies typically operate on a “claims made and reported” basis, meaning that the policy will only respond to claims that are: (a) made against the director and reported to the insurers during the period of the policy, or (b) which are made against the director after the policy has expired but which arise from circumstances that were reported to the insurer during the policy period.  It can be vitally important therefore to notify claims or circumstances to the insurers as soon as possible.
• Pay close attention to the renewal terms of the D&O policy in order to ensure that there is continuity of cover going forwards for any claims or circumstances which may come to light in the future as a result of any decisions that have already been made, including in any future scenario where the director may have ceased to be a director and may therefore lose visibility on the company’s D&O insurance arrangements.
• Otherwise take practical precautions to minimise the risk of a claim being made against any of the directors in their personal capacity, including by seeking legal and, possibly, accountancy advice, continually assessing the company’s financial position and keeping accurate financial records, aiming not to increase liabilities, and meeting regularly and keeping written records of decisions made.