A look at the expansion in the directors and officers liability
As the D&O insurance market in India thrives, this article examines some of the key factors in its growth and other important product-related issues. There are three key elements in the expansion of the market:
- the corporate scandals;
- the overseas expansion of Indian businesses; and
- the tightening of domestic and overseas regulatory regimes.
Corporate scandals have an immense publicity (and persuasive) value. They challenge complacent attitudes by starkly revealing the liability risks to businesses – and their directors and officers – in a variety of real-life situations. Take, for example, the Satyam scam, which is by far the biggest in the history of corporate India.
Briefly, the scam came to light in January 2009, when Mr Ramalinga Raju – the founder and chairman of Satyam, India’s fourth largest IT company at the time – resigned and confessed to a fraud of over a billion dollars by inflating Satyam’s financials in various ingenious ways.
This was closely followed by 13 securities class actions in the US (subsequently consolidated into one action). There were also investigations and actions in the US by the Securities and Exchange Commission and the New York Stock Exchange, and in India by the Securities and Exchange Board of India, the Enforcement Directorate, the tax authorities, the accountants’ regulator, the Central Bureau of Investigation (the Indian equivalent of the FBI), the Serious Frauds Investigation Office, the Company Law Board, and various other individual civil and criminal actions.
Nearly three years on, the myriad of actions continues, with huge attendant costs. The scandal has arguably done more to drive up the demand for D&O cover than the collective marketing efforts of the insurance sector over the last decade.
The second driver is overseas expansion. Outward investment by Indian businesses stood at US$44bn in 2010-11 and is expected to grow, as Indian businesses continue to expand aggressively overseas. However, such growth also exposes them to a multitude of foreign legal regimes, which (by Indian standards) are usually more complex and stringent, have higher transparency and corporate governance standards, and invite more market discipline. To that, you need to add the cultural differences that can readily become a source of conflict between domestic management style and overseas employee practices and regulations. The expansion experience is, therefore, fraught with the risk of legal actions and investigations, and the resulting high costs of defending and meeting such liabilities.
Tighter regulatory regimes
Lastly, ever-tightening domestic and overseas regulatory regimes have also helped to widen the D&O market. In India, the public outrage at corporate swindles such as Satyam has heightened the demand for improved corporate governance norms, new laws and a stricter enforcement of existing rules.
Some resultant developments are proposed changes to the existing Companies Act 1956, focusing on the liability of independent directors and auditors, and additional provisions for shareholder class actions.
The securities regulator has also taken steps, including the provision of financial assistance for investor actions. In parallel, Indian courts now treat white-collar crimes far more seriously and there are recent instances where the directors and officers of top businesses accused in corporate scams have been denied bail and imprisoned for lengthy periods. With both inbound and outbound investments growing, Indian businesses are correspondingly more sensitive to the risks stemming from the extraterritorial reach of foreign statutes, such as the US Foreign Corrupt Practices Act and the UK Bribery Act.
Advancing defence costs
A key question that is sometimes asked about D&O insurance in India is whether insurers can advance defence costs in the light of section 201 of the Companies Act 1956. Section 201 prevents a company from indemnifying a director or officer against liability incurred in defending:
- proceedings for negligence, default, misfeasance, breach of duty or breach of trust in relation to the company; and
- penal proceedings for breach of provisions of the Companies Act (see Rabindra Chamaria v Registrar of Companies). However, in our view, a company can indemnify a director or officer against any liability incurred by him or her:
- in defending any proceedings in which they are successful; or
- in connection with relief granted to them by the court against liability (which the court can do under section 633); or
- where the allegations are raised by a third party (i.e. other than the company).
In any case, section 201 imposes no restriction on insurers from advancing defence costs to directors and officers under D&O cover.
There are, however, two D&O related issues that are not debated enough.
The first concerns domestic Indian risks. The common perception is that exposure in India is seldom anywhere near (in terms of quantum) that in other jurisdictions. Broadly speaking, that is true. However, it fails to take into account the defence costs. The rates of top-tier Indian law firms are now not far behind their US or UK counterparts. Coupled with the notorious tardiness of litigation in India – a commercial dispute can take approximately 12-15 years to be adjudicated to finality –significant defence costs can easily be incurred. This factor is frequently underrated by insurers while rating, and by the insured when deciding their policy limits, when it comes to domestic risks.
The second issue concerns the wording of D&O cover. This is usually imported into the Indian market from other jurisdictions. But this can lead to unintended results. For example, D&O cover is often written on the “duty to defend” basis, which can be inappropriate for the Indian market. Before assuming such an obligation, an insurer must ensure that it has an effective database of defence counsel covering a range of jurisdictions. If it does not have such a database, the insurer risks its credibility when the insured comes up with its defence to a claim.
Furthermore, an insurer must bear in mind the near total absence of Indian precedents on the interpretation of the scope of the duty to defend. Consequently, the insured may turn to decisions of foreign courts that have interpreted the duty in a wider manner (especially in the US) than that which the insurer may have intended.
Keeping your eye on the ball
In conclusion, the drivers discussed above are likely to grow stronger in the future, and expand the Indian D&O market still further. However, insurers (and insureds) must not lose sight of the issues highlighted in this article. Domestic risks should not be misjudged when focusing on overseas risks, and policy wording should be reviewed to ensure that a product intended for an Indian insured is Indian enough.