Directors’ and officers’ (D&O) liability insurance has historically been more of a ‘box ticking’ exercise for Australian corporations rather than the insured really understanding the content of the specific insurance policies.

In light of the class action brought by shareholders of Forge Group Limited, it is evident that directors and officers are facing ever increasing exposure to personal claims. As such, it is crucial that corporations review their existing policies regularly to ensure that the coverage is adequate for its existing business operations and to ensure that personal asset protection is in place.

In this alert, Senior Associate Alex Davies discusses some of the important elements, and potential pitfalls, of insurance policies that directors and officers should be aware of.

Who is covered?

Most D&O insurance policies usually cover past, present and future directors and officers of the company. However, dependant on the size and level of a company’s business operations, additional personnel can also be included to cover management committee members, supervisory board members, management board members, corporate trustees of superannuation funds and any employee that has the right to govern, instruct and direct the company.

Timing considerations for notification

Whilst most policies will vary on what triggers a notification event, companies (and by extension, directors and officers) need to be aware that if the insurer is not notified, certain events after the fact may fall outside the coverage of the existing policy leaving directors and officers potentially exposed to claims. These notification events generally include:

  • acquisitions by companies where the value of the acquisition is greater than 25 percent of the consolidated gross assets;
  • a material change in the operations of the business;
  • a new exchange listing, debt or equity offering outside the policy thresholds;
  • a takeover or change of control event; and
  • any claim or incident that could give rise to a claim.

In circumstances where a takeover or a change of control event occurs, many companies are unaware that such a transaction will likely affect the existing D&O policy. More often than not, cover for target directors and officers will cease for claims arising from wrongful acts after the effective date of the transaction. Whilst ascertaining the ‘effective date’ for the purposes of the policy will depend entirely on the terms of the existing D&O policy and the nature of the proposed transaction, the effective date will usually be the date that a change of control (50.1 percent) occurs.

Standard policy exclusions

There are a number of standard policy exclusions which significantly restrict the ambit of their operation and directors and officers should be aware of how they may potentially affect the level of protection afforded to them under an existing policy. These generally include:

  • Insured v insured exclusion which excludes claims brought by two people covered by the same policy, including the company against a director.
  • Prospectus liability exclusion which will often be of importance to directors who propose to undertake capital raising activities;
  • Professional indemnity exclusion which excludes cover for claims arising from a breach of duty (other than directors duties); and
  • Personal conduct exclusion which excludes any deliberate criminal or fraudulent act if a judgement or final adjudication establishes that the act was committed.

Why is ‘run off’ coverage needed?

‘Run off’ coverage can protect past directors for claims arising out of wrongful acts that occurred prior to the retirement or removal from office for up to the seven year statute of limitations for ‘run off’ periods (which coincides with the statutory right under section 198F of the Corporations Act 2001 (Cth) (Corporations Act) for directors to access company books after ceasing to be a director).

It is important to note that under a change of control event, ‘run-off’ protection provided by the existing D&O policy will only last as long as the company continues to hold D&O insurance for those specific individuals. If the company ceases to do so or if the policy has a termination event on a change of control, then a retired or ousted director should consider taking out stand-alone special ‘run off’ cover for his or her potential liabilities.

How is coverage provided?

D&O insurance policies are drafted such that indemnification by the company under a Deed of Access, Indemnity and Insurance (Deed of Indemnity) is the primary facility to which directors and officers have recourse. However, in practice, the D&O insurance policy is the primary source of cover for directors and officers because the company is prohibited from providing indemnification for certain liabilities incurred by a director or officer, which tend to be amongst the most serious directors and officers can incur. Specifically, the cover provided under a company’s Deed of Indemnity is subject to the prohibitions on indemnity in section 199A of the Corporations Act.

In accordance with section 200B of the Corporations Act, to give a benefit in connection with a person’s retirement from office, shareholder approval must be obtained. With regards to ‘run-off’ periods, it may be considered that the proposed payment of insurance premiums, the benefit of an indemnity, a director’s access to company records (which continues for a period of up to seven years) and the provision of these during the ‘run-off period’ may be viewed as the provision of a benefit given ‘in connection with’ the retirement for the purposes of section 200B of the Corporations Act.

Additionally, the provision of insurance and indemnity may be considered to involve the provision of a financial benefit to a related party which would require shareholder approval under section 208 of the Corporations Act. Whilst an exemption may be relied upon under section 212 of the Corporations Act, companies may choose to seek shareholder approval because the provision of an indemnity or insurance is an appropriate matter for the shareholders of a company.

The take away

The recent downfall of Forge Group Limited serves as a sobering reminder of the liabilities to which directors and officers of companies can be exposed. Now more than ever, appropriate steps need to be taken by directors and officers to ensure they not only understand the insurance policy in place, but ensure that it is adequate for the company’s current business operations so that the appropriate protections are provided.