ICSA Guidance on Protection against Directors and Officers Liabilities Indemnities and Insurance

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1 ICSA Guidance on Protection against Directors and Officers Liabilities Indemnities and Insurance Contents If using online, click on the headings below to go to the related sections. 1. Introduction 2. Companies Act 2006 (CA) provisions 3. Scope of directors indemnities 4. Loans to directors to fund defence costs 5. Authorisation and disclosure 6. Directors and officers insurance 7. Scope of protection available 8. Considerations when granting indemnities 9. Principles of directors and officers insurance 10. Further guidance 1 of 6

2 1. Introduction This guidance note summarises the protections that can be made available to directors in discharging their responsibilities following changes introduced in the Companies Act 2006 and highlights the main issues companies should consider when deciding what protections they should put in place. 2. Companies Act 2006 (CA) provisions Section 232 of the CA states that any provision (whether in the company s articles, a contract with the company or otherwise) which seeks to exempt a director from any liability for negligence, default, breach of duty or trust will be void and ineffective subject to the following exceptions: 1. the company may purchase and maintain insurance cover for directors against such liabilities (s233 CA); 2. the company may give an indemnity to directors against any liability incurred to a third party, i.e. to any person other than the company or an associated company (s234 CA). As discussed below, however, there are limits to the extent of the indemnity that may be given; 3. a pension trustee company, or an associated company, may indemnify a director of the trustee company against any liability incurred in connection with the trustee company s activities (e.g. investment strategy and decisions) (s235 CA). 3. Scope of directors indemnities The third party indemnity mentioned above is, in practice, of limited value in the UK since directors common law and statutory duties under Part 10 of the CA are all owed to the company. This indemnity is aimed more at third party civil actions in other jurisdictions, e.g. a shareholder class action against the directors of an English company with a US listing. In addition, the third party indemnity must exclude: criminal and regulatory fines payable by the director; defence costs in criminal proceedings in which the director is convicted; defence costs in civil proceedings brought by the company where judgement is given against the director; and costs incurred in connection with an application by the director for certain reliefs where the court refuses to grant such reliefs. The pension trustee indemnity can extend to liabilities owed to the pension trustee company for breach of duty It would, however, exclude criminal and regulatory fines and defence costs in criminal proceedings in which the director is convicted. 4. Loans to directors to fund defence costs Section 206 and s207 of the CA allow a company to provide a loan to a director to: defend himself in any civil or criminal proceedings in connection with any alleged negligence, breach of duty or breach of trust by him in relation to the company; and defend himself in any investigation or proposed action brought by a regulatory authority in connection with any alleged negligence, default or breach of duty by him in relation to the company 2 of 6

3 provided that the loan is repayable immediately if such defence becomes unsuccessful. These provisions mitigate the prohibition on a company indemnifying a director against defence costs in relation to an action brought by or on behalf of the company by allowing the company to fund those costs on an as incurred basis and claim immediate repayment if the defence is unsuccessful. 5. Authorisation and disclosure Companies may wish to include in their articles the power to grant indemnities to directors to the extent provided by the CA. The fact that the articles give the company this power does not, however, oblige it to exercise it. Legal advice should be sought on the content and format of any indemnity the company wishes to give. At the time of Board authorisation, the directors will need to comply with the provisions in the articles regarding their declaration of interest in and right to vote on the indemnity proposed. Section 236 of the CA requires details of any third party or pension trustee indemnity provision in force at any time during the financial year or at the date of approval of the financial statements to be disclosed in the directors report for that year. A copy of any indemnity provision or a written note of its terms must be held available for inspection at the company s registered office and kept for at least one year after expiry of the indemnity. (s237 CA) 6. Directors and officers insurance In view of the increasing liabilities to which directors are subject, it is now very common for companies to take out insurance policies protecting both directors and senior officers against such liabilities. The Combined Code includes a provision requiring listed companies to arrange appropriate cover in respect of legal action against their directors. New directors joining a company will wish to understand how the Directors and Officers Liability (D and O) insurance policy operates and should ensure that they are covered by it. It is good practice for summary details of the policy to be given to non-executive directors on their appointment. 7. Scope of protection available There is significant overlap between the scope of D and O cover and the protection that can be made available to a director under a third party indemnity given by the company. D and O cover is, however, broader than is legally possible under a company indemnity. The main differences between the protections offered and issues for consideration are summarised below. 1. Both indemnities and D and O insurance can cover defence costs. However, defence costs funded as incurred under a company indemnity must be repaid if the defence is unsuccessful. Defence costs paid under D and O may not be repayable. 2. Both indemnities and D and O insurance can protect against civil liabilities (damages) owed to third parties but only insurance can cover damages awarded against a director in favour of the company itself although even then it would be a rare occurrence. 3. D and O insurance provides an external source of funding independent of the company. Its provision and cost will, however, be subject to market conditions and to limits and exclusions. 3 of 6

4 4. An indemnity, dependent on what a company decides to put in place, may have fewer exclusions and can potentially be uncapped. 5. Where both a company indemnity and D and O insurance cover the same risk, directors will have the option of claiming protection under either although the indemnity may be expressed to be inapplicable where a claim is accepted by D & O insurance. (Bear in mind also the insurer s rights of subrogation). 8. Considerations when granting indemnities Individual companies need to make their own decision on the level of insurance cover and the extent of any indemnity they wish to make available to their directors. D and O cover will normally be the primary protection made available. Indemnification may be considered to provide an additional layer of comfort for directors in the event that a claim arises which falls within the narrower protection afforded by an indemnity and which for some reason cannot be met under the D and O policy (for example if the level of cover has already been exhausted by other claims or if an insurer asserts that one of the policy exemptions applies). Some listed companies grant indemnities, as well as purchasing insurance, on this basis, i.e. to provide maximum benefit for and so attract and retain high quality board members. However, third party indemnity provision may in some circumstances be adversely perceived by investors. Companies may be seen as offering to use shareholder funds to protect directors against their own wrongdoing. It is prudent, therefore, when considering the grant of indemnities, to have regard to shareholder perceptions and any pertinent corporate circumstances or developments prevailing at the time. 9. Principles of directors and officers insurance Who is covered 1. The policy will normally cover the directors and any nominated officers of the parent company and its subsidiaries. Directors and officers of associated companies may or may not be included. Policies will normally automatically cover wholly owned subsidiaries but if subsidiaries which are less than 100% owned are to be covered, especially those in joint ventures or those less than 50% owned, this may require special arrangements. It seems to be standard practice in the UK for the parent company itself and/or its subsidiaries to be covered to the extent that they in turn have indemnified their directors and officers against the insured risks. 2. Although it may be usual practice, standard policies may not automatically cover directors and officers who, at the request of the company, sit on boards outside the insured group. Outside directors cover may be required for these individuals. Period of cover Cover will normally start from the date of directors and officers appointment and the insurer should be advised of such appointments within the time limit specified in the policy. There will be an obligation to update and confirm the list of directors and officers covered at the annual renewal. Historically, cover would frequently cease when the appointment came to an end unless the policy is extended, on payment of an additional premium, to include run-off cover. Run-off cover will generally protect the individual against any claim made subsequent to the termination of his appointment which related to actions or inactions occurring during the period of his appointment. More recently it seems that this retired directors cover is becoming more standard but even so there would normally be an exception where retirement happens as a result of a transaction putting the policy into run-off. 4 of 6

5 The period of run-off cover normally offered may vary from six months to six years. The longer period is recommended, however, it is important to be clear as to the actual cover purchased. As an example if a claim is issued just before the expiry of say a six year (72 month) run-off period, it does not have to be served on the defendant for up to four months from the date of issue by which time the six year run-off period will have expired. To obtain a clear six year run-off cover it is recommended that a run-off period of 84 months is actually negotiated. Duty of disclosure Directors and officers are required to disclose to the insurer any claims or circumstances which may give rise to a claim. It is important to check the policy to see when disclosure is required. It may be immediately the event or circumstance occurs or at least as soon as it is recognised that it may give rise to a claim. In any event it will be required at the time of the Director or officer joining the policy and at each renewal. Extent of cover Care should be taken to understand what is covered by the policy and what areas of risk remain. Common inclusions are: damages against an insured person, out-of-court settlements, costs and expenses arising from the investigation, defence or settlement of a claim if arising out of wrongful acts; libel and slander; wrongful acts (e.g. error, misleading statement, omission, neglect of duty) committed by the individual in their capacity as a director or officer of the company. Usual exclusions and restrictions are: fines, penalties and punitive damages levied by regulators or criminal courts; appeal costs in the event of a conviction; loss of earnings or expenses incurred; liabilities covered elsewhere (e.g. claims for property damage or personal injury which may be met by employer or public liability policies are almost always excluded); fraudulent, dishonest or illegal acts; legal jurisdiction restrictions specific geographical areas (e.g. the US) may be excluded or subject to limited cover; pension trustee liabilities; loss or liability arising from existing conditions; insured v insured claims actions between parties covered by the same policy is a fairly standard exclusion. Close attention should be given to the wording to establish whether directors would be covered against claims from the company itself or from another director covered by the same policy. Amount of cover Policies are normally written with specific monetary limits. There may be limits per claim or incident and an overall limit per year. It may be possible to negotiate the automatic reinstatement of sums insured. Deductibles will also be subject to negotiation and different deductibles may apply to different sections of a policy. The excess on a policy can be an important consideration. It may, for example, make sense for the company to buy cover with no excess for liabilities of directors which cannot be covered by indemnities whilst choosing cover for the company itself to cover indemnity payments (in whole or in part) above a certain amount which amount is then self insured. 5 of 6

6 Conditions All D and O policies will have conditions attached covering issues such as the notification of appointments, the notification of potential or actual claims, admission of liability and the obligation of an individual to make themselves available to defend a claim. Managing the cost of insurance Some insurers may invite companies to give a presentation on their governance, internal control and risk management processes in order to give the insurers some comfort on the risks they are underwriting. This can be a useful way of managing the cost of D and O insurance, help establish a long term relationship of confidence and trust and keep premium increases to a minimum. 10. Further guidance This guidance note is intended to alert companies and their directors to the main issues involved in D and O insurance: it is not a comprehensive guide. The extent and restrictions on cover available are changing all the time and up-to-date professional advice should be sought by any company or individual considering taking out this kind of insurance. November 2008 ICSA would like to thank all those individuals and organisations that contributed to the formulation of this Guidance Note. The information given in this guidance note is provided in good faith with the intention of furthering the understanding of the subject matter. Whilst we believe the information to be accurate at the time of publication, ICSA and its staff cannot, however, accept any liability for any loss or damage occasioned by any person or organisation acting or refraining from action as a result of any views expressed therein. If the reader has any specific doubts or concerns about the subject matter they are advised to seek legal advice based on the circumstances of their own situation. Institute of Chartered Secretaries & Administrators 16 Park Crescent London W1B 1AH Phone: Fax: Web: 6 of 6

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