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.
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.
