Samantha Holland
Partner
Commercial Litigation UK Team Leader and UK Head of Insurance/W&I
Article
22
Claims against directors and officers (D&O claims) are on the rise, both domestically and across the globe. Directors and officers, and others in key management roles within public and private companies, are increasingly becoming targets for civil litigation, government investigations and enforcement actions.
Whilst the company itself is usually first in the firing line, individual directors and officers are often named as defendants, and regulatory bodies are increasingly willing to take enforcement action against individuals in positions of authority. Now, more than ever, directors and officers are aware that their own reputation and personal assets may be at risk.
This is where Directors' and Officers' Insurance (D&O insurance) can provide some protection – and some very welcome peace of mind. D&O insurance can, in many instances, provide individual directors and officers with the funding that they need to be able to defend themselves against civil claims and regulatory investigations, as well as with an indemnity in relation to any damages payable to third parties. However, D&O insurance is not always the panacea that it appears and individual directors may need advice to help them understand what cover is available to them as well as assistance with any coverage issues raised by D&O insurers.
Directors and officers need to consider the impact of their decisions on a wide range of stakeholders – shareholders, customers and creditors to name but a few – as claims can come from all angles whether alleging serious mismanagement or simply as a result of one poor decision by a director as part of their everyday role. There are also new threats on the horizon. Mounting cyber security incidents have already contributed to an increase in D&O claims and with investors and companies being ever more concerned with climate change, reducing their carbon footprint and ensuring board diversity, the growth in D&O claims in support of the Environmental, Social and Governance (ESG) agenda is only expected to continue.
We consider two particular growth areas for potential claims against directors and officers below.
In October 2022, the Supreme Court handed down its decision in the case of BTI 2014 LLC v Sequana. See our alert on this judgment for more details – Creditor Duty FAQs: what directors need to know. The judgment confirmed that the duty to prioritise the interests of creditors is part of a director's fiduciary duty to act in good faith in the interests of the company. There is no separate duty owed to creditors, instead directors are required to consider creditor interests as well as shareholder interests. The weight to be given to the interests of creditors (as opposed to shareholders) will increase as a company's financial difficulties become more serious. In effect, there is a balancing exercise that needs to be undertaken with the interests of creditors becoming more important and ultimately becoming paramount at the point of imminent insolvency.
This highlights important issues for company directors and officers where a company is in financial distress and they have to determine where the balance of competing interests should lie. Given this uncertainty and the present economic climate, the current trend of bringing claims against directors is set to continue in the wake of Sequana giving courts the opportunity to flesh out exactly how the new creditor duty will be applied in practice.
In recent years, there has been a significant rise in ESG litigation, but we are only at the start of a wave of litigation that will sweep across the UK legal landscape in years to come. Directors and other officers are increasingly being scrutinised to ensure they are taking the steps necessary to address and mitigate environmental and climate risks, as well as a multitude of emerging other risks and topics on the ESG agenda. Accountability in respect of such risks rests with the board, and there are already early warning signs that directors and officers will be targeted in a personal capacity (rather than merely as the mouthpiece of their companies).
An article published by Zurich Insurance in August 2022 – ESG to drive a new wave of D&O liability | Zurich Insurance – highlighted the prominence of ESG claims and warned businesses to prepare now for a surge in ESG related liability. The article also referenced the London School of Economics and Political Science's (LSE) Grantham Research Institution, whose research had confirmed the clear upward trajectory in climate litigation and the fact that the number of climate change related cases has more than doubled globally since 2015.
Failure by a board of directors to consider and mitigate (or take advantage of) the impact of climate change on their business could lead to claims against the directors for breach of duty, particularly given the rise of activity in this area by activist investors, special interest claimant law firms and the support of litigation funders. Any failure to follow the increasing number of ESG related laws, regulations and guidance – requiring transparent disclosure – could make it simpler to establish such a breach. Although, having a well drafted and robust ESG Policy in place could help directors defend claims that may be brought against them.
Greenwashing is another source for claims against directors, officers and their companies. Where companies are misrepresenting their climate credentials, making false representations about the eco status of their products or failing to take action in accordance with their stated goals, litigation and regulatory enforcement could very well follow – as well as significant reputational damage. While the focus is currently on climate related issues, it is likely there will also be an increase in claims relating to nature and social impact, pay equity, consumer rights (and many more areas). There is also going to be increasing scrutiny of boards who are not diversifying or who are making misleading claims around Diversity and Inclusion (D&I) issues. This in turn may lead to greater use of employment practices liability (EPL) insurance – usually added as an extension to D&O cover, to provide cover for allegations of wrongdoing in relation to employment related issues.
Increasing claims against directors could also lead to an increase in policy coverage disputes. In compiling the Mactavish Claim Insurance Litigation Index – Claim Litigation - Mactavish (mactavishgroup.com), issued in October 2022, Mactavish analysed commercial insurance claims litigation and insurance trends and practices. The report confirmed the rate at which commercial policyholders sue their insurers has more than tripled in the last 10 years.
The Mactavish data suggests that legal challenges to insurance claims are only likely to increase. Insurers are getting tougher and are looking to shore up their balance sheet in the face of tougher market conditions.
It is therefore really important that any claims are promptly and properly made. D&O claims must be appropriately managed and legal advice taken when required.
It is always very important to read your D&O policy carefully to understand the precise scope of cover, but in headline terms, a D&O policy will provide cover for losses that may arise if a director or officer makes a mistake in discharging their duties. It will generally cover the legal costs that will be incurred and the costs involved in compensating third parties.
There are usually two core elements of cover available:
Some policies also have Side C or entity cover, which provides cover for the company, usually in relation to liabilities incurred in trading securities on the stock exchange. If a policy also provides entity cover, it will be important for the directors and officers to be aware that the policy limit might be eroded by claims against the company, meaning that there could be less cover available for the directors. It is important that directors are comfortable that the policy limit takes this into account.
Generally there will be no excess payable for Side A cover, but a large excess will usually be payable by a company under Side B cover (including for defence costs).
Some policies include a definition of "indemnifiable loss"; normally defined as a loss for which a director could be indemnified by the company, save for insolvency or as a matter of law. Claims for indemnifiable loss would then be treated by insurers as falling under the Side B cover whether or not the company has opted to indemnify its director. Previously, this led to individual directors being responsible for the policy excess including the initial chunk of defence costs, even if they were not being indemnified in respect of those costs by the company. Most modern policies now provide that in those circumstances, insurers will forward fund the director within the policy excess, and then look to recover the excess from the company. This means that the director is not out of pocket.
As stated above, a D&O policy will usually cover damages and compensation payable to third parties, as well as reasonable defence costs provided they are incurred with the prior written consent of insurers. Ordinarily, a D&O Policy will allow for individual directors to be separately represented where there is a potential conflict of interest between them, or between them and the company.
However, a D&O policy cannot cover everything and it is worth remembering that the following losses are unlikely to be covered:
When looking at the structure of a D&O policy, it is important to be aware that defence costs are paid on a first come first served basis. It is therefore important for directors claiming under a D&O policy to act quickly before the limit for defence claims is exhausted by other directors using the D&O policy to fund their own defence, or by the company making its own claim under the D&O policy if the policy provides Side C cover.
Sometimes, there is a separate ring-fenced limit available for non-executive directors (NEDs) where the policy limit has been exhausted. A company will usually provide a NED with cover, as long as the personal liability that the NED may be subject to has not arisen as a result of dishonesty. Prior to an appointment, NEDs should check whether their actions while performing their director duties will be covered by an adequate D&O policy taken out by the company, as this cannot be guaranteed.
The latest article from Mactavish published on 21 March 2023 – D&O cover - the calm before the storm? – predicts that D&O cover will become more restrictive and more expensive. For that reason, directors are best advised to review their D&O cover now and stress test how it would respond to claims, liaising with their brokers to improve the cover if commercially available and appropriate. If a claim arises, it is important that directors and officers take legal advice on how best to manage the relationship with their D&O insurers as soon as possible.
To discuss any of the points raised in this article further, please get in touch with Samantha Holland, Jatinder Sahota or Teresa Edwards.
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