All companies have 'appointed' directors whose positions should be fairly obvious to both those within the company and to those who do business with it. Essentially, directors are people described as such in the Company documents. However Section 741(1) of the Companies Act provides a non-exhaustive definition of director, namely: in this Act, 'director' includes any person occupying the position of director by whatever name called.
This could include:
Executive, Non-Executive, Shadow, Associate, Nominee and Alternate Directors
An 'officer' of a company is a little more difficult to identify. All companies have at least one 'appointed' officer (the company secretary). They are likely to have other employees with significant executive responsibilities who, if they are managers, will also be 'officers'. But then, any employee or company representative might be deemed to be an officer.
How does liability arise?
Director's liabilities can be summarised simplistically under four distinct headings:
Personal liability to third parties for acts of the company. A director can have a personal liability if he acts as the 'mind and will' of the company, i.e. where he is a sole or majority shareholder or a sole director.
Companies can commit crimes and civil wrongs with the active participation of the directors, who can expect to be joined in any resultant proceedings.
Regulatory/disciplinary proceedings and investigations. E.g. investigations carried out by the Financial Services Authority or proceedings brought by the DTI under the Company Director Disqualification Act 1986 (especially following a period of 'wrongful trading').
Civil liability to the Company at common law. The fundamental duties imposed upon a director at common law are a fiduciary duty and those of skill and care.
Statutory liability. The failure to act in accordance with statute law, i.e. an Act of Parliament e.g. the Companies Act 1985, Insolvency Act 1986, Health and Safety at Work Act 1974 and the Environmental Protection Act 1990.
Indemnity by the company
Whilst all directors should take care in limiting their own and their companies' exposure to liability, there are practical limits if caution is not to stifle the business.
Indemnity may be given by the company to the director in practice, if the company approves it and can afford it. But if indemnity is promised in advance, it is only enforceable to the extent of the meagre provisions of section 310 of the Companies Act 1985. The effect of this legislation is to make void any provision (whether in the Articles of Association, a service contract or otherwise) which purports to:
- Limit or extinguish liability
- Provide indemnity against liability,
other than that 'incurred in defending any proceedings (whether civil or criminal) in which judgement is given in favour or there is acquittal'
The effect of this is to make the director personally liable. The director's assets are on the line and without adequate protection they can be at serious risk.
Who can claim against directors?
Shareholders. In the UK, only in exceptional circumstances do minority shareholders have personal remedies against directors. In the US, such claims (referred to as 'derivative' actions) represent a substantial exposure to directors. There are some exceptions to the current position, principally where minority shareholders feel they have been prejudiced in some way by the majority shareholders or the directors and bring a claim under Section 459 Companies Act 1985. Things are about to change, though. In 1998 the DTI issued a consultative document called 'Shareholders Remedies'. It seeks to make it easier for shareholder actions to be brought and it may result in a new Companies Act in 2002/3.
The DTI. The Department of Trade and Industry or the appointed liquidator has the power to investigate the affairs of the company and institute criminal proceedings. There are hundreds of provisions in copious legislation that could give rise to both civil and criminal exposures.
The Official Receiver. In all types of winding up the official receiver and liquidator can refer discrepancies to the DTI. The official receiver can also apply for permission to examine the conduct of directors and officers, both present and past. This may lead to action taken against directors for wrongful trading.
The Company. A company may have rights of action against a director for breach of the fiduciary duty owed by the director to the company.
Regulatory bodies. Many firms provide professional services and the directors are members of or controlled by professional bodies. For example, Architects are RIBA members, Surveyors RICS members, IFAs controlled by the FSA, etc. Cover is often provided for representation costs in respect of official investigations or other action taken against directors.
EU commissioners. As EU directives continue to come into operation commissioner's powers will continue to increase.
Customers/others. Claims can arise where customers or suppliers have relied upon a director's representation which turns out to be wrong. If the director is the 'mind and will' of the company, he may be liable to such third parties. Ordinarily the director does not owe a duty to creditors unless he is the 'mind and will' of the company. However, creditors interests are represented by the Liquidator of the company who can bring a claim for 'wrongful trading' in the name of the company. In any event he would be at risk of a claim which would require a defence.
What do Insurers look for?
Insurers will want a proposal form but will usually indicate terms on the basis of the latest published report and accounts. You should attach details of any public offerings and any interim statements. Business activity, location and financial status are major underwriting criteria, whilst turnover and the number of directors and officers are relatively unimportant factors. Here are some of the issues:
Generally, companies in high hazard industries tend to represent the greatest risks. For example, manufacturing, bi-tech, hi-tec companies and financial institutions.
Activity
Companies in high hazard industries tend to represent the greatest risks - not intended as a truism but meaning business areas that either represent racy investment propositions (e.g. e-commerce or bio-technology) or where disasters are prone to happen, such as environmental businesses.
Location
Obviously, activity in North America and Australia attracts attention.
Date established
Many new companies fail during their first two or three years, often because the business is too speculative, directors too inexperienced or newer businesses are more affected by market conditions.
Listed
Public companies normally have many shareholders -so more potential claimants, more people to consider, greater reporting standards.
Who owns the shares
In a small private company, where the shares may be owned by family, insurers may wish to exclude shareholder claims in order to avoid being drawn into family disputes, for example, shareholders who are also directors, may bring an action against the company and directors under Section 459 Companies Act, where they have been dismissed as a director. In a larger private company or a public company, there may be a few people with a large shareholding who may have effective control of the company.
Changes to share capital
Acquisitive companies and those that raise money are clearly more exposed as investors'unfulfilled expectations can lead to litigation - e.g. directors' warranties, indemnities, etc. Insurers will want to see the offer document before agreeing to cover.
Unexplained board changes
A sign of trouble.
Gearing / leverage
Highly geared or leveraged companies (where there is a large amount of debt in relation to the equity) can indicate instability.
Liquidity
The ratio of current assets to current liabilities which can indicate instability.
Share price
A measure of what the market thinks about the company.
Contingent liabilities
Unstable companies have been known to hide impending disaster in the small print of the contingent liabilities section of the annual report and accounts.
Unstable companies have been known to hide impending disaster in the small print of the contingent liabilities section of the annual report and accounts.
Example of Claims
Although it is unlikely that the UK will become as litigious as the USA, it is nevertheless the case that actions involving director's liability are more readily and more frequently brought than was so only a few years ago. Some corporate crises have received widespread publicity but many other instances arise that result in claims against directors being settled out of court receiving little or no attention. Recent trends include the growing interest of consumer bodies and others in finding a scapegoat and the increasing willingness of the courts to hold directors personally liable.
Director procured his company to infringe patent rights and became personally liable.
- Managing director misrepresented (on behalf of his company) a product specification to a customer and was found personally guilty of fraud, liable for deceit and a breach of the duty of care.
- Director signed a company cheque whilst company in receivership; cheque dishonoured, director personally liable to payee.
Two directors of company in insolvent liquidation held jointly liable for £75,000 damages (plus interest and costs) arising from their wrongful trading worsening the insolvency.
Two directors of company in insolvent liquidation held jointly liable for £420,000 damages - the total amount paid to one of the directors in preference to the creditors. Both directors in breach of their fiduciary duties as well as liable for wrongful trading; directors also disqualified for three years.
Directors made financial representations to identified bidders for their company, aware that any bidders would rely on these, as they did. Court of Appeal held that if the representations were proven negligent, the directors would be liable for this breach of their duty of care. Liability was never established due to out of court settlement.
Main Bodies
As discussed earlier in this paper directors are constrained by various Acts of Parliment including the Companies Act 1985. As a result directors and their companies are policed by the Department of Trade and Industry the Health and Safety Executive and other Government bodies. There are no specific professional bodies that regulate individual directors but many are members of the Institute of Directors who represent their interests. Directors of companies that offer professional services may be regulated by a body relevant to the professional sector but only in their capacity as a professional not as a director and a professional indemnity policy will be required. (See PI Demystified)
What Should You look For?
Taxation
There is sometimes confusion regarding the taxation implications of D&O. The whole premium for a D&O policy is, and always has been, an allowable expense of the company for corporation tax purposes as the insurance can be demonstrated to be 'wholly and exclusively' for the purposes of the business.
So far as the director is concerned, there is a benefit in kind by virtue of the insurance providing personal protection. The premium paid by the company on behalf of the directors is likely to be assessed for income tax. Directors cannot expect to claim the premium as a deductible expense if taxed under Schedule E (PAYE), unless it can be shown that the insurance premium was incurred wholly, exclusively and necessarily in the performance of those duties" attaching to the directors' office or employment. The director will rarely succeed in proving this to be the case. It is usually the nature of the duties alone that necessitate the expenditure, not a requirement by the company that a director effect insurance.
The future
D&O insurance is approaching its adolescence in the UK. So, there will be spots and growing pains. Growth in the sector is rapid and closely linked to more sophisticated corporate law and an increase in awareness of consumer rights. The proposed new Company Act in 2002/3 will lead to directors facing new responsibilities and a time may well come when no prudent director will agree to act without D&O insurance.
GlossaryExecutive directors.
The executive director is the most common type of director. Normally an employee, an executive director will carry out management and board roles. They are appointed by the company's Articles of Association. These articles, or rules, generally include provisions governing future appointments.
There are two definitions of executive directors, they include:
- De jure directors
- There may be some qualification within the Articles of Association which must be satisfied before a person may act as a director, for example, a share qualification. A director who is validly appointed having satisfied all provisions is a 'de jure' director.
- De facto directors
- Executive directors can also include what are known as 'constructive' or 'de facto' directors. These are directors who have not been appointed by the Articles of Association but they still act in the capacity of director. They carry out functions of a director without formal appointment.
Non-executive directors.
Non-executive directors are not employees and will usually only serve on a part-time basis but they have the same powers as the executive directors on the board.
Shadow directors.
These are outsiders under whose directions or instructions the directors are accustomed to act. An example of a shadow director is a significant shareholder who, whilst not a director, intervenes in the management of the company, for example a 'venture capitalist' (in this regard a parent company and its directors canbe 'Shadow' directors).
Associate directors.
An associate director does not have a seat on the board and is not a director as defined by the Companies Act. He may have certain powers which might be provided for in the articles of association. He may however be covered as an 'officer'.
Permanent directors.
These are directors who do not require re-election.
Nominee directors.
Directors who sit on the board to represent a specific interested party, for example bankers or shareholders.
Alternate directors.
Directors nominated by a director during a period of absence.
N.B. The above expressions are not mutually exclusive, for example a nominee director is normally a non-executive director but may also be an executive director. A shadow director could be an executive director or a non-executive director. In any event, all of the above owe the same duties to the company and other potential claimants.
Fiduciary duties.
These are concerned with the director's relationship with the company and its shareholders. A company has no physical existence although it does have a legal entity. It owns property and enters into contracts. It is the directors who manage the assets and control the day-to-day business. They act as trustees of the company's assets and because they control the activities of the company, they must ensure that their actions are bona fide and for the benefit of the company. A director must act towards or on behalf of the company honestly and in good faith, without allowing personal interests to conflict with those of the company.
Directors owe fiduciary duties to the company.
Skill and care.
Directors owe a company a duty to act with reasonable care, skill and diligence. But to what standard?
Under Section 214 Insolvency Act, a director must carry out the functional tasks with reasonable care and using such skills as are possessed. The case of Re D'Jan 1995 established that the Section 214 definition was applicable to directors' duties as follows:
The duty of care owed by a director to the company is that of a reasonably diligent person having both:
the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director, and
the general knowledge, skill and experience that the director has.
Statutory Liability Examples.
The Companies Act 1985, contains many pitfalls for the director. It includes over 200 provisions whereby a director can incur fines or penalties for failing to carry out the prescribed duties or for allowing the company to be in default.
The Insolvency Act 1986 and
the Company Directors' Disqualification Act 1986 have, between them, significantly increased the exposure of directors, particularly when a company goes into insolvent liquidation following a period of 'wrongful trading'. This can now lead to a director being obliged to contribute personally to the deficiency of assets and also to the director being disqualified from holding office.
The instances of director disqualification under the Company Directors' Disqualification Act 1986 has increased sharply: in 1986/87 there were 72 disqualification orders, rising to 1,219 in 1996/97 and then to 1,540 in 1999/2000.
Many other modern statutes which regulate business activity in general contain provisions which can impose personal liability upon a director when the company is in default. A typical example is section 37(1) of the Health and Safety at Work Act 1974. Under this Act an offence is committed by a company with the consent or connivance of a director, or is attributable to the director's neglect. That director is guilty of the same offence and can be punished accordingly. Therefore the Act imposes personal duties on both the company and individual directors.
The Environmental Protection Act 1990 and the Environment Act 1995 expose directors to numerous offences. For example, a director may be liable for disposing of waste without a licence. In serious cases of environmental damage a director could receive an unlimited fine and up to five years' imprisonment. The Environmental Agency has stated that it will pursue individual company directors where appropriate. Furthermore, under certain statutes, such as the Clean Air Act 1993 and the Radioactive Substances Act 1993, liability is strict (automatic).
The Consumer Protection Act 1987 and the Food Safety Act 1990 expose directors to criminal and personal liability where 'unsafe' products are placed on the market. Recent food scares have brought this potential exposure into focus.
The Social Security Act 1998. A director is not usually personally liable for his company's debts, but this new law changes the position, in particular in relation to unpaid National Insurance Contributions (NIC). If the failure of the company to pay NIC is due to the 'fraud or neglect' of a director or officer, a notice may be served on the director or officer requiring him to pay the outstanding sum. In effect, the corporate veil is being lifted.
Personal Liability.
It is only by means of its human management that a company can formulate its policy and carry it out. Companies can commit crimes (e.g. fraud and manslaughter) and torts (civil wrongs such as negligence or defamation) with the active participation of directors, who can thereby expect to be joined in the resultant civil or criminal proceedings against the company.
Health and safety legislation contains many pitfalls. Public interest in this area emanates from disasters such as the sinking of the Herald of Free Enterprise ferry at Zeebrugge, Piper Alpha, the King's Cross fire and the Paddington rail crash. Public enquiries have found companies such as P&O seriously at fault for the disasters.
It is often easier for successful actions to be brought against the directors of smaller companies, where directors are not many tiers of management removed from execution of policy. In other words such directors are effectively 'the company' A good example is the action known as the Lyme Regis canoeing tragedy. Here the managing director was found to be the 'controlling mind' of the company and therefore linked to the deaths of four teenagers, which arose because of inadequate safety precautions. The director was found liable for corporate manslaughter andsentenced to two years in prison.
New offences proposed by the government include reckless killing and death by gross carelessness.
Please see below: 'The usual cover'
Usual Cover
What is covered by a D&O policy?
Board basis.
Conventionally D&O insurance is underwritten on a 'board basis' to protect directors and officers of a given company or group of companies. It can usually be extended to embrace associated companies and appointments held by directors or employees in outside companies, e.g. those in which the insured company has an investment or other commercial interest.
Blanket basis.
Cover commonly available on a 'blanket basis', embracing all past, present and future directors and officers.
Wrongful acts.
Indemnity is provided to the director for legal liability arising from a 'wrongful act' committed whilst acting as a director. This may be for damages and might include the costs of representation or defence in civil or criminal proceedings or in official investigations into the affairs of the company. 'Wrongful act' is usually defined as "any actual or alleged breach of trust, breach of duty, neglect, error, mis-statement, misleading statement, omission, breach of warranty, of authority or other act wrongfully committed or attempted." Wrongful trading is included.
Company reimbursement.
D&O policies are often split into two sections - the D&O section and the company reimbursement section. It is the company reimbursement section that will respond if, in law, the director is able to look to his company for indemnity.
Legal costs.
Legal costs can be substantial and are normally covered by D&O policies, subject to the insurer's prior consent. They cover the costs of investigation, defence and settlement of claims. These costs might embrace lawyers for investigation and defence, experts and court costs. The costs are normally included within the limit of indemnity (in which case they erode the cover for damages) and if there is an excess (in soft market conditions there is usually no excess) then it may apply to the costs.
If the excess applies to legal costs there can be policy disputes where an insured disagrees with the expenses being incurred by an insurer, particularly in the event of a successful defence of a spurious claim. Claimant's legal costs normally form part of the claim against the insured director.
'Claims made' policy form.
Like professional indemnity, medical malpractice and libel insurance, D&O Insurance is underwritten on a 'claims made' basis. This provides cover for claims made (and reported to the insurer) during the period of insurance only. In contrast, other liability covers normally provide indemnity for 'losses occurring' during the policy period. A claim is generally notifiable under a D&O policy when the insured first becomes aware of circumstances that could lead to a claim - this could be anything from an event happening (such as an administrative receivership), to a verbal criticism to receipt of a statement of claim. The interpretation of when this situation occurs can be the source of policy disputes between the insurer and insured.
Notable features on a claims made policy are:
- A claim might be made against a policy written now but the wrongful act might have occurred many years previously.
- It protects the insured against the erosion of the value of cover by inflation.
- It protects the insurer against the effects of legislative changes, inflationary awards and claims made with new knowledge.
- It allows the insurer to 'get off' a risk completely by simply refusing to renew. This is fine for an insurer that discovers a sub-standard insured or where an insurer wants to leave a particular market sector but it leaves the quality insured very exposed to market ups and downs and the possibility of no cover just as it is about to be an issue. Moreover, it allows an insurer to reduce an insured's cover where future problems might be anticipated.
- If the policy lapses for any reason, there is normally no cover thereafter for any claims that might arise, regardless of when the alleged neglect might have occurred.
Retroactive date.
Many "claims made" policies incorporate a retroactive date, either as part of the wording or by endorsement. This effectively excludes claims arising from things done or that ought to have been done before the retroactive date, or often claims arising out of contracts entered into before the retroactive date. If there is no retroactive date then cover is fully retroactive for all work since commencement of the business. You should be clear that the insured understands the extent of retroactive cover.
It is normal for an insurer to apply a retroactive date of inception of the policy if there has been no prior cover. If retroactive cover is required then most insurers will offer it for a one-off additional premium.
Limit of indemnity.
The limit of indemnity is normally an aggregate limit, so it can be exhausted piecemeal by one or a series of claims made during the period of insurance.
Geographical limits.
The situation of a wrongful act is normally irrelevant and cover can be arranged to provide indemnity even where a legal action is brought or commenced in an overseas jurisdiction. Exposure (activity or assets) in the USA or Canada does require careful consideration but these jurisdictions can usually be included subject to appropriate policy conditions and premium and often the imposition of an increased excess.
Public policy.
Considerations of public policy preclude indemnity for fines or penalties, for punitive or exemplary damages (other than exemplary damages awarded in an action for libel and slander, where covered) or for any matter involving proven fraud, dishonesty or malicious conduct.
Employment.
Where a director is in dispute with the company regarding termination of office or employment, indemnity for the costs of the pursuit or defence of legal proceedings may be covered. Similar cover is given in respect of disputes regarding UK taxation or social security contributions relating to the employment. The benefit to the director is that, when out of work as a result of redundancy or dismissal, he may well not have the means to pursue the company or to defend any allegation of past misconduct.
Investigations.
Directors operate in an increasingly regulated business environment. Whether the company or a trading partner is being investigated by an official body, the directors may need to be legally represented. These costs of legal representation may be substantial but are usually covered under a D&O policy, whether or not a claim for damages might subsequently arise.
The Usual Exclusions
- Professional duty - This affects directors who undertake professional work for the company's clients. The company should get adequate professional indemnity insurance (PI). The exposures from consultancy activities are distinct from those of a director. Often a director will face both. For example a management consultant or company doctor, who may assume the mantle of non-executive director as an extension of his pure consultancy activities. Alternatively a professional firm who act in the form of a limited company rather that as a sole trader or partnership.
- Prior & pending litigation - All D&O policies will exclude existing claims, prior or pending proceedings against the company or its directors and officers. Similarly the policy will exclude any prior existing circumstances which should have been notified or were not disclosed.
- Major shareholders/closely held - D&O policies are designed to cover claims made by shareholders. However insurers often endorse the policy to exclude claims made by 'major' shareholders, sometimes referred to as a 'closely held' clause. This is because they may have a controlling influence over the board.
- Wrongful profit - where a profit or advantage is gained from a wrongful act.
- Other common exclusions include - bodily injury and radioactive contamination.
- Claims made by the company or a current director - Unless at 'arms length', i.e. that the claim is brought without any connivance on the part of the directors.
- Important conditions. Insurers need to be advised of any mergers, acquisitions, share offers etc, if full cover is to continue.
Prompt notice of circumstances that might lead to a claim is vital, as in the case of any 'claims made' policy.
The Usual Extensions
Outside directorships.
Directors can get extra cover for other directorships held by them. Often referred to as an 'outside board' extension, it is designed for directors that may be appointed to the board of a client company.
Spouse extension.
Cover can be bought which covers a spouse of a director if there is some risk of liability; this is most relevant in family-run companies.
Environment.
Additional cover can be purchased for environmental exposure. Usually the cover extends only to defence costs.
EPL extension.
Cover for EPL (Employment Practice Liability) can be provided either as an extension to a D&O policy or as separate cover. New employment law has enhanced the employment rights of all in the workplace against the company, rather than the individual directors. The company could be exposed to litigation involving sexual and racial discrimination, unfair dismissal and harassment.
A Proposal form is available in Adobe Acrobat format by clicking the links below.
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