Discover D&O in 16 Lessons

A D&O policy’s insuring agreements, along with its coverage extensions, make up the total protection available to a policyholder. Below we outline the most common extensions found in the market.

Coverage extensions provide an organisation with protection in addition to what is offered by a D&O policy’s insuring agreements. They exist because insuring agreements, despite their broad construction, cannot always address all management exposures adequately. Extensions attempt to bridge this gap, providing coverage for situations which would otherwise not be enough to trigger a policy to respond.

In addition to their practical nature, extensions are offered by insurers to strengthen their product offering. They are created to solve a wide range of problems and are continually being improved to address the changing landscape of D&O liability. While many extensions are considered standard, others may be tailored to the needs of the policyholder. Outlined below are some of the most common coverage extensions in found in the market.

Advancement of defence costs

The advancement of defence costs extension compels an insurer to forward defence costs to an insured as they are incurred throughout a claim. Most commonly, it requires an insurer to settle an insured’s legal expenses within a defined period of time.

Without this extension, an organisation or its executives may be required to fund their own defence costs until an insurer can assess their claim and reimburse them at a later date, which may take some time. Most policyholders consider this coverage to be essential, as legal costs can be expensive and not everyone has the resources to pay for these services up-front.

Importantly, however, if it is eventually determined that a claim is not covered – i.e. because it is explicitly excluded by the policy – any defence costs that have been advanced by the insurer must be repaid.

Retired directors and officers

According to the claims-made and notified provisions of D&O, an organisation must have an active policy at the time a claim is received for it to be covered. As some incidents may take many years to materialise into a form that resembles a claim, if a policy is not renewed, an organisation’s retired directors and officers can be left unexpectedly exposed.

This is a relevant concern for retired executives, as once they have departed an organisation they have no control of its ongoing insurance programme. Therefore, they cannot guarantee that their former organisation will continue to purchase the insurance, which is required for their future well-being.

As a solution, insurers often agree to automatically protect retired directors and officers for a defined period of time, by providing them with an extended reporting period. An extended reporting period allows retired executives to report claims to an insurer after their departure, even if the organisation that they served no longer carries an active policy.

Outside directorship

Many insurers extend the coverage of a policy to protect directors and officers while they participate on the boards of external non-profit organisations. This coverage enhancement has evolved out of the common practice of experienced managers occupying non-profit leadership positions pro bono.

Provided that both the insurer and the insured organisation agree, outside directorship coverage protects managers over and above the indemnification and insurance protections carried by the non-profit itself. This provides executives with the comfort of knowing that they will remain protected in the event that their non-profit’s insurances are insufficient or completely exhausted.

This provides executives with the comfort of knowing that they will remain protected in the event that their non-profit’s insurances are insufficient or completely exhausted.

New subsidiaries

The new subsidiaries extension automatically covers any new subsidiaries acquired by an insured organisation during the period of insurance. This extension ensures that any new subsidiaries receive the same protection as their parent organisation, providing essential coverage to the directors and officers of these acquired operations.

For new subsidiaries seeking protection under this extension, it’s important to note that coverage commences from the date of acquisition, and only covers acts that are committed after this date.

Additionally, the automatic coverage provided is usually subject to the relative size of the acquired entity. Subsidiaries exceeding 10-20% of the parent organisation’s value will typically require approval by endorsement.

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Spouses, heirs & legal representatives

When confronted with an impending claim, some directors and officers may consider transferring ownership of their assets to a friendly third party, such as a husband, wife or legal guardian.

In doing this, their assets can be placed out of reach from a claimant’s demands. And while in some cases this may be a sensible legal strategy, it may also result in a friendly party being implicated in the same claim.

The spouses, heirs & representatives extension ensures that any related party who may be dragged into a claim, due to their ownership or control of an executive’s assets, is protected. The cover provided by this extension is generally very handy, but its scope is limited; as it will protect them from the consequences of an executive’s actions, but not their own.

Continuity of coverage

Continuity of coverage allows a claim notification to be accepted late, as long as the policyholder has held uninterrupted D&O coverage over a period of time. Continuity of cover is generally available to organisations with existing D&O coverage and it creates a strong incentive for an organisation to remain loyal to its insurer each renewal.

A late notification is a claim notification which should have been made in a previous policy period but wasn’t. Perhaps an organisation didn’t think that a particular circumstance warranted notification at the time, or maybe the notification failed to occur by mistake. Whichever the case, the continuity of cover extension allows a policyholder to successfully lodge a late notification with an insurer, which would otherwise be declined on this basis.

Whichever the case, the continuity of cover extension allows a policyholder to successfully lodge a late notification with an insurer, which would otherwise be declined on this basis.

For example, consider an organisation that has renewed its D&O policy for another year, but realises that it failed to notify its insurer of a claim (or circumstance which could lead to a claim) in the previous policy period. If it has renewed its coverage with the holding insurer, and the policy contains a continuous coverage benefit, the late notification may be accepted.

Now, instead of this circumstance being excluded due to its late notification, as the current policy excludes known claims and circumstances, the insurer may accept the notification provided the claim has not been prejudiced as a result.

Important! While continuity of coverage is a nice benefit to have, it shouldn’t be relied on as a substitute for prompt claims notification.

Other common extensions

While not as frequent as those listed above, the following extensions may also be available to policyholders:

• Civil or bail bonds: The cost of funding civil or bail bonds, allowing a director or officer to be released from prison.
• Public relations expenses: The cost of engaging a public relations firm to mitigate reputational damage to an executive or organisation.
• Extended reporting period: A designated time period after the expiration of a policy, whereby claim notifications will be accepted by an insurer.
• Deprivation of assets: Where an executive has their assets confiscated or frozen, an insurer will provide necessary payments for schools, housing, utilities and personal insurance services.
• Extradition costs: The defence costs associated with opposing an extradition proceeding, including any bail process and subsequent trial.
• Joint ventures: Coverage for claims arising from joint venture operations.

Conclusion

Coverage extensions provide an organisation and its management with a greater level of protection, over and above a policy’s insuring agreements. They are considered to be the ‘bells and whistles’ of D&O, and ensure that a policy will respond to circumstances and situations which would otherwise not be enough to trigger coverage.

The insuring clauses of a D&O policy perform a pivotal role in laying out coverage for an insured organisation and its management team. Below we take a look at the key terms which define the scope of a policy’s protection.

The insuring agreements of a D&O policy specify the scope of its coverage. Each one outlines the promise of the insurer to protect the policyholder, also known as an ‘insured’, in accordance with the terms and conditions of the policy.

While the exact structure of insuring agreements varies between policies, they typically follow a common format; covering an insured from loss arising from claims-made alleging wrongful acts during the policy period.

For a real-world example of what this may look like, consider the insuring clause for individuals on page 6 of AIG UK’s CorporateGuard policy:

The insurer shall pay the loss of each insured person except to the extent that the insured person has been indemnified by the company for such loss.

While this example doesn’t follow our template exactly, a quick look into the definitions of ‘loss’ and ‘insured person’ show that our highlighted terms eventually play a very important role.

A D&O policy usually includes separate insuring clauses for Side-A and Side-B coverage, as well as any entity coverage that may apply; such as Side-C, employment practices liability, or management liability.

Because insuring agreements are at the core of a policy’s function, it’s important to understand how to read and interpret them correctly. This is not only essential for placing cover but also handling claims, as they are often the subject of much scrutiny when determining whether an incident shall be covered or not.

Outlined below are the main components of an insuring agreement. In practice, these should be read in conjunction with coverage extensions, exclusions and conditions.

Key term definitions

D&O insurance, like other policy classes, relies on a range of key terms with special meaning. These terms are contained within the policy wording and play an important role in determining how a policy will respond to any specific claim or circumstance.

To assist with a policy’s interpretation, key terms are generally denoted throughout the document with bold, underlined or capitalised text. In AIG’s policy mentioned above, they are italicised.

Despite there being literally dozens of key terms scattered throughout a policy, none receive more attention than those within the insuring agreements; the definitions of insured, loss, claim, claims-made and wrongful act.

Insured

The definition of an ‘insured’ determines who is covered by a policy. For any individual or organisation seeking coverage for a claim, they must first fall within this predefined description.

The definition is usually broadly drafted, to ensure all those within an organisation who are exposed to managerial risks, are protected. A typical definition includes all directors, officers and corporate entities of the named insured.

Coverage is generally extended to protect the directors and officers of an organisation’s subsidiaries as well, provided that the parent entity has controlling ownership.

As some incidents can take years to materialise into a claim, all past, present and future directors and officers of an organisation are automatically covered. This retrospective coverage ensures that former managers remain protected for actions undertaken during their period of service, as long as their organisation continues to purchase ongoing D&O coverage.

For the actions of a person to be covered by a D&O policy, they must have been acting in their status and capacity as director or officer of the insured organisation. To satisfy this requirement, they must have been elected or appointed to their position, and been acting in their official capacity at the time of the alleged offence.

To ensure that adequate coverage exists for all managerial personnel, many policies broaden the insured person definition to include middle and front-line managers, as well as employees with supervisory functions.

If there is any uncertainty about whether a particular individual falls within this description, they may also be specifically noted on the policy as insured.

Loss

The definition of loss specifies what claim costs will be paid for by a policy. As D&O is a form of liability insurance, it intends to indemnify the policyholder from the financial implication of claims, which would otherwise be incurred by an organisation or the individuals themselves.

The definition of loss usually includes many of the typical expenses faced by defendants when involved in litigation, including investigation costs, legal fees, and the costs of settling any claim to make the whole thing go away.

It is also likely to include court awarded judgements such as damages, as well as civil fines and penalties as long as there has not been any intentional, deliberate or reckless breach of the law.

It’s important to note, however, that not all claim costs are covered. Of course, each policy is different, but many of the typical costs that are not included in the definition of loss include:

• Criminal fines and penalties
• Taxes
• Employment-related benefits such as retirement fund contributions
• Restitution and a host of others

Claim

In order for an insurer to indemnify an insured from a loss, the complaint against them must first fall within the definition of a claim. A typical definition will include any written demand received by an insured, as well as any civil, regulatory or administrative proceeding arising in the line of their corporate duties.

The definition of claim is also likely to include any criminal proceeding brought against an organisation or its managers, which may occur on its own, or alongside any pre-existing civil litigation.

And while any fines or penalties resulting from criminal prosecution cannot be covered, D&O will provide a policyholder with the resources to contest the allegations.

Allegations against an insured must generally be formal in nature to be covered, such as physically receiving a letter of demand from an aggravated third party claimant. However, some informal proceedings may also be included.

These slightly more informal claims may comprise of investigations, examinations, inquiries and formal hearings by regulatory authorities, including official requests for documentation. They can also involve mitigation processes to reduce the chance of a claim arising in the future, such as mediation, arbitration, and other forms of alternative dispute resolution.

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Claims-made (and notified)

D&O policies operate on what is known as a ‘claims-made and notified basis’. This means that a policy provides coverage for claims that are made against an insured and notified to the insurer during the period of insurance. Therefore, for a claim to be covered it must satisfy the following requirements:

1. Management must first become aware of the claim or circumstance during the policy period; and
2. The claim or circumstance must be notified to their insurer within the same policy period

As most policies provide some form of retroactive coverage, it may not be so important exactly when the alleged act took place, as long as the insurer is notified as soon as management become aware that a claim may materialise sometime in the future.

In practice, this means that a claim or circumstance is likely to be covered by the policy active at the time management become aware of the incident, and not necessarily policy period in which the alleged wrongful behaviour occurred.

For more information on claims-made reporting, I recommend taking a look at this post.

Wrongful act

The definition of a wrongful act specifies what type actions by an insured person will be covered by a policy. Once again, this term is often broadly defined to ensure that directors and officers are protected against the myriad of potential claims in existence.

Generally speaking, a wrongful act is considered to be any actual or alleged:

• Act: an action or decision that others deem to be wrongful, including breach of contract, intellectual property infringement, libel and slander
• Error: an honest mistake, poor and careless decisions, incorrect reporting and compliance
• Omission: omitting, or not presenting important information, relied on by others to make informed decisions
• Misstatement: making incorrect and false statements, whether innocent or deliberate
• Misleading statement: a statement that is unclear, deceptive or creates a false impression by remaining silent or telling part-truths
• Breach of duty: a failure to perform managerial duties with care and diligence
• Breach of trust: failure to perform adequately as a fiduciary. Claims may allege an abuse of power, misappropriation or other act, which violates the confidence of others
• Neglect: general carelessness, a failure to seek professional advice when required, or failing to satisfy the duty of care owed to stakeholders
• Breach of warranty of authority: performing acts on behalf of an organisation when unauthorised to do so

Covering allegations

The ability for a D&O policy to cover alleged acts, in addition to actions that are known to have occurred, ensures that management has protection for even the most obscure situations. This is important because claims often feature many details, recounts of actions, opinions and conflicting interests, for which the true position of liability is unclear.

Conclusion

The function of a policy’s insuring clauses is central to the operation of D&O insurance. A policy wording contains dozens of terms that have special meaning, including those terms which are absolutely critical to the interpretation of the insuring clause; insured, loss, claim, claims-made and wrongful act.

D&O insurance is purchased by organisations of all shapes and sizes. While the primary purpose of coverage is to protect individuals, depending on the organisation’s size a policy may also provide some benefit to the entity itself.

The coverage afforded by D&O insurance has evolved over time, with many improvements occurring in recent years. As more insurers have entered the market, increased competition has lead to broader coverage and reduced premiums, making D&O a valuable risk management solution for many organisations.

As the exposures faced by directors and officers are continually changing, insurers’ policies are regularly updated to address their needs. As new features are added, they become a point of difference for a while, before eventually being adopted by the market as a whole.

D&O provides an organisation and its management with coverage on many fronts. While no two policies are the same, a typical policy provides three forms of protection as standard, as outlined in its insuring agreements; Side-A, Side-B and Side-C.

Side-A: Directors and officers liability

Side-A, also known as directors and officers liability, is the first insuring agreement of a D&O policy. Side-A protects executives from claims when corporate indemnification is not available from their organisation.

As non-indemnification can occur for many reasons, Side-A coverage plays an important role in protecting individuals when this financial support is not available. It provides an essential last line of defence, ensuring that their assets remain safeguarded from the consequences of personal liability.

For example, consider a board of directors implicated in a claim following an organisation’s bankruptcy. As the organisation effectively has no money, it cannot fulfil its corporate indemnification obligations.

As a result, the directors immediately notify their D&O insurer and seek protection under the Side-A insuring agreement. The insurer is now responsible for financing the costs of their defence and any subsequent claims settlement.

Side-B: Corporate reimbursement

Side-B, also known as corporate reimbursement, is the second insuring agreement of a D&O policy. Side-B reimburses an organisation for the expenses it occurs when defending its management in accordance with its corporate indemnification obligations.

By indemnifying its executives, an organisation is responsible for paying all legal expenses and claim settlements on their behalf. The costs of doing this can be impairing for even the largest of organisations and can potentially affect its financial stability. Side-B coverage, therefore, supports an organisation financially when it is, in turn, supporting its management.

Take, for example, an executive who is named in a formal investigation by regulatory authorities following allegations of wrongful behaviour. The organisation, as per its indemnification obligations, begins to incur defence costs on behalf of the executive and therefore, lodges a claim with its insurer under the Side-B insuring agreement, requesting reimbursement for these costs.

Important! Side-B is only intended to cover the costs incurred on behalf of directors and officers, and will not protect an organisation from claims made directly against it.

Side-C: Entity securities coverage

Some D&O policies also include a third insuring agreement, Side-C, also known as entity securities coverage. Side-C coverage is typically reserved for publicly listed companies and protects the corporate entity from its own liability exposures.

The coverage provided by Side-C is limited to claims made against a company as a result of the offer, sale or purchase of its securities; in other words, the shares listed on the stockmarket available for purchase by investors.

Side-C has been developed in response to the increased frequency in which companies become involved in shareholder related disputes. By electing Side-C coverage, a company can be protected for the legal and claim settlement costs it incurs whilst defending its own corporate actions.

Side-C is typically offered by insurers as an optional insuring agreement, allowing policyholders to elect this protection for the payment of extra premium. The extra premium is charged to compensate the insurer for the additional claims exposure that Side-C brings.

Let’s consider that a company and its management are named in a securities-related lawsuit. The company indemnifies its managers according to its corporate indemnification obligations. In turn, the company makes a claim under Side-B for reimbursement of the costs incurred in defending management.

In addition to the claim against management, the company is also required to defend its own interests, and therefore, makes a claim under Side-C for the costs specifically related to the defence and settlement of the claim against the entity.

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Other forms of entity coverage

As well as the benefits it provides to public companies, D&O has become an increasingly popular risk management solution for private companies and non-profits. As a result, many insurers have developed policies specifically to meet the needs of these privately owned, unlisted organisations.

The differences between the D&O coverage available to private organisations, and that of their public counterparts, generally relates to the breadth of coverage available for the entity.

While it is certainly possible for the managers of private organisations to be implicated in a claim, more often than not, it is the entity that is targeted. To account for this and to ensure that an organisation’s assets are adequately protected, many private D&O policies include broader entity coverage than traditionally offered.

The theory behind this expanded coverage is that the personal wealth of private company managers is often closely tied to the organisation’s financial health. Many executives have a significant shareholding in the organisations they operate, so therefore, any loss incurred by the entity is likely to affect their personal net worth as well.

In addition to Side-C, the two most common forms of entity coverage available include employment practices liability and management liability.

Employment practices liability

Employment practices liability insurance (EPL) protects an organisation from employment-related claims. EPL ensures that the entity is covered for its own defence and settlement expenses if an employee (or similar party) makes a claim against it.

While EPL is often available to large organisations on a stand-alone basis, it may also be attached to a D&O policy as an optional insuring agreement, for the payment of extra premium.

Management liability

Management liability insurance (ML) is a type of D&O policy specifically tailored to meet the needs of small and medium enterprises. It is structured as a package-policy and contains a range of broad entity style coverages to protect an organisation and its managers from a variety of claims.

These entity coverages, typically only available to larger organisations on a stand-alone basis, make ML a very cost effective insurance solution. In addition to traditional directors and officers liability and corporate reimbursement insuring agreements, it often includes the following:

• Corporate liability: broad civil liability coverage for claims made against the entity
• Employment practices liability: entity coverage for employment-related claims
• Superannuation trustee liability: entity coverage for claims arising from the management of retirement, superannuation or 401k schemes
• Crime: coverage for crime committed against the entity, such as fraud and misappropriation
• Statutory liability: entity coverage for pecuniary penalties and possibly fines, resulting from breaches in legislation
• Taxation investigation: coverage for investigations undertaken by taxation authorities

The benefits of entity coverage

Entity coverage provides an organisation with peace of mind during difficult times. Without this protection, an organisation is potentially exposed to hardship whilst honouring its indemnification obligations and whilst defending claims made directly against it.

By transferring these liabilities to an insurer, an organisation can shield itself from claims. This proactive approach to risk management is not only wise from the entity’s point of view but also from the perspective of shareholders, who appreciate the preservation the company’s capital.

Conclusion

As we’ve shown, large organisations will acquire D&O coverage to protect their executives and the organisation’s interest in defending them. Depending on the size and corporate structure of their particular organisation a D&O policy may be able to expand to provide some level of protection for the entity itself. While this is not the primary reason for acquiring D&O, it is certainly beneficial.

Directors and officers inherit a great deal of responsibility and with that, we want to make sure that they’re protected. Corporate indemification and D&O insurance allow them to get on with the job without putting their personal assets on the line.

As we’ve seen from some of our previous posts, occupying a position of management has many underlying risks. Not surprisingly, these risks are often a major consideration when contemplating such roles.

A person is likely to question if the monetary and career rewards of becoming a director or officer are worth it, when weighed up against the potential for personal liability and its serious implications.

A risky proposition

For some, the risks are enough to deter them from stepping into management. While, for others it’s a risk that can be tolerated, provided they have access to adequate protection.

Many organisations recognise that personal liability is a strong deterrent, so over time, a number of defence mechanisms have been developed to encourage the best and brightest leaders to step into the ranks of management.

These safeguards have a strong influence on the recruitment of talented leaders and generally come in two forms, corporate indemnification and directors and officers liability insurance.

Corporate indemnification

The first line of protection for directors and officers is corporate indemnification. Corporate indemnification is an agreement between an organisation and its executives, whereby the organisation agrees to protect or ‘indemnify’ each individual from personal liabilities arising from the performance of their managerial duties.

This promise of indemnity is often stipulated in an organisation’s constitutional documents as well as a contractual agreement known as a deed of indemnity. Many corporate officers may also find that an indemnification clause is built into their employment contract.

Deed of indemnity

A deed of indemnity is usually drafted with the assistance of specialist lawyers and aims to indemnify an individual to the ‘maximum extent as permitted by law’. A deed will typically state that should an executive be implicated in a claim, the organisation will step in to protect them.

This protection generally comes in the form of financial support, whereby an organisation agrees to incur any costs associated with defending and settling claims made against them.

Directors and officers liability insurance

While corporate indemnification provides directors and officers with some comfort that they will be supported during times of difficulty, it has become common practice to arrange a second line of protection, directors and officers liability insurance; often known simply as D&O.

D&O, like corporate indemnification, plays an important role in protecting management from personal liability, albeit in slightly different circumstances; in instances of non-indemnification, whereby management is unable to obtain indemnification from their organisation as promised.

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Non-indemnification

Without the support of their organisation, non-indemnification leaves executives personally exposed to the consequences of litigation. This presents executives with the very real threat of facing the full brunt of personal liability on their own, as their organisation cannot adhere to its indemnification obligations.

An organisation may not be able to indemnify its directors and officers due to one of three reasons:

1. It is legally prohibited from during so

An organisation may not be able to indemnify an individual because it is legally prohibited from doing so. For example, if an executive is deliberately involved in fraud or other criminal activity, it may be unlawful for an organisation to indemnify them from any subsequent litigation.

2. It decides not to

In some situations, an organisation may be unwilling to extend indemnification to management. For example, in a derivative shareholder lawsuit, an organisation may decide not to indemnify an executive because it is technically the organisation itself that is suing them. In this situation, it would not make sense for an organisation to indemnify the same person that it is litigating against.

3. It is unable to

Directors and officers may not be able to be indemnified because an organisation cannot afford to do so. This is probably the most common scenario of non-indemnification and usually occurs when an organisation is in severe financial difficulty or is insolvent – which is, ironically, when directors and officers are most at risk.

D&O beyond personal protection

Modern directors and officers liability insurance has become more than just personal protection for an organisation’s management. As corporate indemnification provisions have expanded to protect executives, organisations are now also exposed to the financial implications of claims whilst fulfilling their indemnification obligations.

When an organisation indemnifies its directors and officers, it becomes responsible for their defence expenses. These costs, along with associated fines, penalties, settlements and court awarded judgements can have a serious impact on the financial health of even the largest of organisations.

As a result, today’s insurance market has evolved to offer policies that provide an organisation with support too, when fulfilling its indemnification obligations as well as personally protecting executives when it cannot. D&O has therefore become an important component of an organisation’s own risk management programme, in addition to the benefits it provides to executives.

Conclusion

For many companies and non-profits, the use of corporate indemnification and D&O insurance is a tried and tested method of protecting their leadership teams from the threat of expensive lawsuits. The combination of these two risk management strategies can ensure that managers go to work each day, without constantly worrying about the personal implications of their decisions.

Some managers can go through their entire career without so much of a mild disagreement. Unfortunately, many others won’t be so lucky and may encounter the full brunt of an investigation or lawsuit. Below, we take a look at what it feels like to be held personally liable for your actions.

When discussing directors and officers liability, insurance professionals are often quick to point out the importance of being protected by a good insurance policy. Conversations generally focus on how claims arise, how much it can cost to defend them, and why purchasing D&O insurance is an ideal solution.

While there is certainly nothing wrong about this line of discussion, often the personal implications of D&O litigation aren’t conveyed very well. That is, what being held personally liable means for an executive and their family, and how such a situation will affect their life.

Because the reality is, that if an executive is confronted with an investigation into their actions or a fully-fledged lawsuit, the journey is likely to be one of the most stressful experiences of their professional career.

What does it feel like to face a claim?

So what does it feel like to confronted by a claim? As an executive is guided through the legal process of defending a claim, they are likely to experience months (or years) of uncertainty, anxiety and fear, as sleepless nights become the norm.

They will work closely with lawyers to recount their version of events, spending countless hours responding to queries and providing documentation to support their position, all to explain how and why they made the decisions they did.

Whether they believe that they are guilty of the allegations made against them or not, executives are required to undertake the necessary and often expensive steps to defend and settle any claim made against them. Unfortunately, this may also include claims that they believe are unfounded or frivolous, as these incidents must be treated with the same seriousness as those with merit.

While not too many company executives speak publicly about their experiences, there have been a few people that have described the process in a commercial setting. Internet expert, Neil Patel, posted about what it’s like to face a class action, while Matt Warren, the owner of an online retailer, was interviewed about how it felt to be sued by some of the world’s largest watch companies.

Either way, it’s certainly not a pleasant experience. Even if you’ve been given tips on how to cope with it.

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A long, tedious process

The claim process will take its toll financially and emotionally, on the organisation and the executives involved. As a claim is defended, legal expenses will begin to mount. Even moderate claims can involve thousands of dollars of fees, per executive involved.

Lawyers are required to be paid throughout the duration of a claim. If an executive is lucky, these costs may be passed onto their organisation or an insurance company. Otherwise, the funds will need to be sourced through personal means.

Financial risks

If an executive has no financial support, their personal assets are at risk, as they draw down on private resources to fund the costs associated with defending and settling a claim. This leaves an their wealth exposed to the outcome of proceedings, which adds stress to an already unpleasant experience.

In these situations, once personal savings have been depleted, an executive will need to consider other forms of financing and necessary sacrifices. To fund proceedings, they may cut back on discretionary spending, take out a loan, or even consider selling personal assets such as the family home.

It’s not all about the money

While the financial implications of personal liability are certainly nothing to shirk at, the emotional effects can be just as devastating. Being at the centre of a claim places an executive in an extremely difficult position, and the subsequent challenges will be felt throughout their daily life.

Personal and professionals relationships will be strained, as executives lean on the people around them for support. Additionally, due to their involvement in a dispute, they may suffer reputational damage, especially if the details of the incident receive unwanted media attention.

By the time a claim reaches conclusion, either through successful defence or by reaching an agreed settlement, the entire process  may have taken years. As many grievances are resolved through mediation and other methods of dispute resolution, the claim may never see the inside of a courtroom.

If a claim requires court adjudication the process will be longer and even more expensive; probably adding an extra year or two of grief, and a few more zeros to the overall cost of the claim.

In addition to external risk exposures, claims can also arise from within an organisation and its management ranks. These claims, while somewhat less common, are often of quite a personal nature.

In addition to sources of claims which exist externally to an organisation and its management, claims can arise from within. Internal sources of claims typically arise either as a result of one director or officer suing another, or the organisation itself bringing a claims against the same executives trusted with its management.

In Part 2 of ‘Where do claims come from?’, we take a look at what exactly these internal sources of claims are.

Administrators and liquidators

When an organisation becomes insolvent, an administrator is appointed to take over its operation in place of management. An administrator’s primary role is to evaluate the financial prospects of the organisation and determine whether it is in a position to trade out of insolvency, or if it’s assets are to be liquidated.

If it is decided that an organisation is to be wound up, a liquidator, during the process of selling off assets, may undertake an investigation into the circumstances surrounding the bankruptcy. If it appears that an organisation’s directors and officers have allowed it to continue trading and incurring debt while insolvent, they may be held accountable.

In these situations, a liquidator may assume the position of the organisation and sue the responsible executives for their breach of duty. By doing this, a liquidator can attempt to recover monies to assist in repaying outstanding debts owed to stakeholders.

More often than not, it is these stakeholders who encourage liquidators to pursue legal avenues of recovery against directors and officers. However, even if liquidators choose not to investigate their actions, they are by no means discharged of liability – as many jurisdictions permit individual creditors to then seek recovery instead.

Subsidiaries and joint venture partners

The directors and officers of a parent organisation can be exposed to claims by its subsidiaries. This can occur when a subsidiary becomes bankrupt and its creditors, or a liquidator on their behalf, commences subrogation against the parent organisation’s management in an attempt to recover outstanding debts.

In these situations, executives can be held accountable by a subsidiary and its stakeholders for their breach of duty, and subsequent contribution to the insolvency. In addition to claims from subsidiaries, management can also be exposed to litigation from joint venture partners.

When organisations enter into a joint venture, its executives must comply with their corporate duties by acting in the best interest of the joint venture, not director or officer acts in a way that is deemed inappropriate, they may be held personally liable.

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The organisation itself

In certain situations, directors and officers may face claims brought against them by the organisation in which they represent. These claims generally occur due to an alleged breach in duty, whereby their actions have resulted in financial losses or their behaviour is not considered to be in the organisation’s best interests.

In addition to derivative actions, these claims often arise following mergers or acquisitions, a change in ownership, or alteration in the composition of the board of directors. A change in an organisation’s management personnel may uncover decisions made by past executives, which are considered to be negligent or wrongful.

If a subsequent investigation finds that they have acted inappropriately, the organisation, led by the new board, may bring a claim against those responsible – even if they have since moved on from the organisation.

Other directors and officers

Directors and officers are occasionally exposed to claims made by other directors and officers. This can occur because although executives are generally reasonable and considered when performing their duties, boardroom tensions have been known to rise during moments of critical decision making.

While emotionally charged discussion and disagreements between managers rarely lead to threats of litigation, it certainly has been known to happen. And while being implicated in a claim from a colleague is obviously undesirable, it is entirely possible if someone feels as if they have been discriminated, abused or violated during the performance of their official duties.

Common allegations include:

• Failure to adhere to by-laws
• Improper removal from the board
• Defamation

Conclusion

Internal sources of claims against directors and officers can be just as threating as those that exist externally. At the very least, these claims can quickly become very personal, as executives are forced to defend themselves from allegations against the same trusted parties which appointed them to leadership in the first place.

Management is exposed to claims from a variety of sources on a daily basis. Each source provides its own level of threat, and therefore, a different set of challenges for executives who seek to mitigate them.

The type, size and frequency of claims faced by directors and officers largely depend on how their decisions affect an organisation’s stakeholders. Stakeholders generally have a broad range of interests and are often prepared to hold management responsible for any mistakes or reckless behaviour. As a result, directors and officers can have claims brought against them from a range of internal and external sources.

In Part 1 of ‘Where do claims come from?’, we explore the sources of claims which exist externally to the organisational entity and its management. These consist of an organisation’s shareholders, employees, customers, suppliers, competition, the beneficiaries of its employee retirement funds, government and regulatory authorities, as well as its creditors.

Shareholders

Shareholders are an integral part of an organisation’s corporate structure. As part owners, they provide it with capital to maintain and expand operations. Due to their significant financial investment, shareholders have an incentive to monitor ongoing performance and ensure that directors and officers are acting with the organisation’s best interests in mind.

Shareholders vary in size and sophistication, ranging from large organisations, banks and fund managers, through to high-net-worth individuals and ‘mum and dad investors’. In return for their investment, they expect to receive a benefit, such as a regular dividend payments and/or capital growth. With potentially large sums of money at stake, if shareholders are not pleased with an organisation’s direction, they may take drastic measures to protect the value of their investment.

If it appears that management has breached their duties to the detriment of an organisation, shareholders may bring a claim against those responsible. This can leave directors and officers exposed to claims for any number of offences, such as:

• Inaccurate disclosure of information
• Misleading statements
• Undisclosed conflicts of interest
• Failure to keep proper accounting records
• Excessive executive compensation
• Poor financial performance
• Inadequate sales price, following a merger or acquisition

If shareholders wish to bring a claim against executives for any of these infringements, legal proceedings are usually commenced in one of two ways:

1. Direct action

In a direct action lawsuit, a shareholder or group of shareholders, called a class action, bring a claim against management for damages in their interests as shareholders, with shareholders being the benefactor of any financial settlement.

2. Derivative action

In derivative proceedings shareholders effectively ‘step into the shoes’ of the organisation, and sue the directors and officers on behalf of the organisation. In this form of litigation shareholders generally claim for damage caused to the organisation, with the beneficiary of any settlement being the organisation itself. As a result, shareholders only benefit indirectly, through the improved strength of their investment.

For example, News Corp. was sued by investors in the aftermath of the News of the World phone-hacking scandal. The newspaper was found guilty of engaging in phone-hacking and police bribery, which resulted in its advertisers withdrawing support and eventually closure of the publication.

In response, shareholders of the parent company launched derivative action against the board of directors for failing to investigate the allegations of inappropriate behaviour, rumoured years before. To settle the claim, the board agreed to pay the company $139 million without any admission of wrongdoing.

Employees

Employees present a challenging risk exposure for an organisation and its management. Directors, officers, and the employees they manage interact on a daily basis, working together to achieve a common goal. For the most part, they forge successful working relationships. However, from time to time the dynamic can change, with a breakdown in communication leading to frustration and strained relationships.

An organisation engaging labour in any capacity faces the prospect of an employment-related claim. Directors and officers are responsible for ensuring that all employees have access to a safe and culturally sensitive workplace, free of harassment and bullying. Therefore, it is not only full and part-time staff that present an exposure, as third-party contractors and volunteers have rights to the same working conditions.

If an employee feels mistreated during any phase of their employment, from initial recruitment through to termination, they may address their concerns to the organisation and executives involved. If they feel that their concerns have been not been acknowledged as expected, they may become disgruntled and see a claim as a means of rectifying their grievance.

Claims can be instigated by an individual, a class action, or by an employee representative group, such as a trade union. Common claims can include allegations of:

• Wrongful dismissal
• Discrimination, including workplace and sexual harassment
• Wrongful failure to employ or promote
• Wrongful evaluation or demotion
• Breach of employment contract, oral or written
• Invasion of privacy

Employment liability exposures exist in organisations of all sizes. However, it is often smaller organisations, lacking the skill and experience of a dedicated human resources department, which are caught out infringing on their workplace obligations. While many organisations find that workplace issues can be mitigated through the use of sensible policies and procedures, this isn’t always the case.

Finally, it is important to note that employment claims often attract opportunistic claimants. Unfortunately, this means that directors and officers may be drawn into claims, which have little or no legal merit. In these situations, even frivolous allegations may be difficult to disprove, often leading to an out of court settlement.

Customers

With ambitious goals of bringing new products and services to market, the trading practices of an organisation can sometimes appear to step beyond what is considered fair and reasonable. Creative marketing strategies and aggressive distribution methods can place management at risk of claims from an organisation’s customers if they feel unfairly sold or lied to.

Disgruntled customers can range from individuals consumers and other businesses, through to consumer advocacy groups and class actions. Allegations of misconduct may arise from the way a product or service is displayed, demonstrated, advertised, or in relation to its quality and the terms and conditions surrounding its use. Additionally, claims may come in the form of contract disputes, allegations of misleading and deceptive conduct, as well as a host of other wrongful behaviour, including:

• Predatory lending
• Collusive behaviour, such as price fixing
• Distribution of faulty and unsafe products

Suppliers

An organisation relies on its suppliers to deliver it with goods and services so it can conduct its own day-to-day business. Organisations require their suppliers to provide anything from raw materials and production inputs through to manufacturing, wholesale or transport services. While white-collar services, such as accounting, banking, insurance and information technology, are required by almost all organisations.

The relationship between an organisation and its suppliers can be sensitive. On one hand, an organisation relies on the prompt supply of goods and services to operate its business, while on the other, to ensure profitability they actively seek competitive deals. Negotiations with suppliers can be fierce, as management attempt to strike a balance between reducing expenses and agreeing to contract terms that suit all parties.

If a supply agreement does not turn out as expected, a supplier may attempt to hold directors and officers personally accountable for behaviour deemed to be unreasonable, unfair or illegal. Common claims include:

• Breach of contract
• Breach of fair trading legislation
• Intellectual property infringement
• Wrongful refusal of credit

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Competitors

An organisation is required to conduct its business activities within the boundaries of competition law, which specifies what is expected of it within the marketplace. These rules outline what is considered fair and reasonable behaviour, allowing all organisations to compete on a level playing field.

As an organisation attempts to grow its market share, management must ensure that this is done using honest and competitive practices. If an organisation’s competitors believe that they have been disadvantaged by dishonest or wrongful behaviour, management may be held personally responsible.

Claims against directors and officers can range from breaches of intellectual property and misappropriation of trade secrets, through to allegations of collusion and anti-competitive behaviour. Managers may also be held liable for actions that are perceived as misleading or defamatory, with claimants seeking damages for their perceived losses.

For example, consider the claim brought against the CEO of family-owned sporting goods business, who allegedly disguised himself as a manager of a competitor’s store in order to steal trade secrets. The CEO, who had previously starred in an episode of Undercover Boss, may have got a little bit carried away this time, when he persuaded employees to show him around the store’s private back areas and answer questions about store operations.

Retirement fund beneficiaries

In many jurisdictions, the directors and officers of an organisation are responsible for administering the retirement schemes of its employees. Retirement schemes, known as superannuation in Australia or 401k in the United States, allow employees to make regular contributions into an investment fund for the purposes of financing their retirement. If management fails to adequately manage this process, they can be exposed to claims alleging breach of duty or breach of trust.

Depending on the specific requirements of a jurisdiction, executives may be responsible for registering employees into approved schemes, managing accurate records, and ensuring that timely contributions are made. Administration of these schemes is generally subject to heavy regulation, with stringent monitoring potentially exposing executives to liability in the event of a discrepancy.

Common claims by retirement fund beneficiaries include:

• Wrongful administration
• Providing advice with negligent errors or omissions
• Failing to monitor an outside fund manager’s performance
• Inadequate management of conflicts of interest, between an organisation and its employee’s retirement fund

Government and regulatory authorities

Government and regulatory authorities establish and monitor the legal environment in which all organisations operate. They are present in each jurisdiction and ensure that directors, officers and the organisations they control, conduct their activities in a lawful and socially acceptable manner.

Government and regulatory authorities oversee an organisation’s compliance with the rules and regulations governing corporate behaviour. From management’s perspective, the enforcement powers held by these supervisory agencies present a real and significant personal liability exposure.

Regulators often take a proactive approach to their administrative duties, by aggressively investigating alleged breaches. If they discover that wrongful conduct is likely to have occurred, they have the ability to pursue the executives involved. Government and regulatory authorities typically monitor a broad range of laws, such as:

• Corporations law: governing the ownership and management of organisations
• Securities law: governing the administration of publicly listed companies
• Consumer protection law: governing the way in which organisations distribute products and services to consumers
• Occupational health and safety law: ensuring that organisations maintain a safe workplace
• Taxation law: governing the taxation of organisations and individuals
• Environmental law: ensuring that industry participants adhere to environmental restrictions

Directors and officers are required to stay informed of the particulars of each of these laws, or risk facing the consequences of a breach. Additionally, in many jurisdictions executives can be held personally accountable for breaches made by the organisational entity itself. A failure to meet these standards can result in severe civil, criminal or administrative penalties for individuals, including monetary fines, suspension, or even imprisonment.

As legislation is complex and forever changing, understanding and complying with it can consume significant resources. This can be particularly onerous for organisations operating internationally, as they are required to comply with laws in every jurisdiction of their presence. Without sufficient diligence an organisation, and in turn its management, can be exposed to accidental infringements.

A great example of a claim involving regulators can be found in the aftermath of the 2008 financial crisis, when the SEC brought a civil lawsuit against a former Procter & Gamble director for passing inside information to a hedge fund manager. Once the regulators were on his trail, criminal charges were eventually laid, ultimately resulting in a guilty verdict for insider trading and a two-year prison sentence.

Creditors

When an organisation becomes insolvent it often leaves many stakeholders, particularly creditors, owed outstanding money. A creditor is a party that has provided goods, services or finances to an organisation without receiving immediate payment. An organisation’s employees, who are owed unpaid wages and other entitlements, may also be considered creditors.

The management of an organisation has a responsibility to stay informed of its true financial position, and its ability to meet debts as they become due. If an organisation becomes insolvent, creditors will often scrutinise the actions of managers to see if they can be held personally responsible.

actions on creditors, particularly when entering the zone of insolvency. If this duty has been ignored, or errors have been made, and debts are left unpaid when an organisation goes into liquidation, creditors can pursue executives personally in an attempt to recover outstanding funds. Common allegations by creditors include:

• Breach of fiduciary duty
• Breach of duty of due care
• Negligence
• Deliberate misconduct

Conclusion

As you can see, directors and officers face a broad range of claims from sources external to the organisational entity and its management. In Part 2 of ‘Where do claims come from?’, we take a look at the personal liability exposures which arise from internal claim sources.