Governance Bites #88, directors and officers insurance part 1, with David Burroughs

In this episode, Mark Banicevich talks to David Burroughs about directors and officers insurance. He outlines what it is, who it covers, and what kinds of events it covers. Mark asks about the types of costs it covers, common exclusions, and how the cover period works (claims made). David outlines run-off cover, and then shares advice he would give to directors. 
David Burroughs is a founding partners at Long Burroughs (https://longburroughs.co.nz/), a business risk advice business based in Auckland. Prior to establishing the firm, David worked at two major international broking firms, Willis and Marsh. David specialises in advising on all aspects of liability risk and provides detailed contractual risk mitigation advice and specialised insurance solutions. His expertise in these areas is enhanced and complemented by his law degree. David has comprehensive experience advising professional service firms, publicly listed companies, and privately owned businesses, across various industries.
#governance, #leadership, #corporategovernance, #boardcraft, #decisionmaking, #makingadifference, #governancebites, #boardroom , #cgi, #charteredgovernanceinstitute, #director, #insurance

Transcript

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Hi everyone, I'm David Burroughs. I'm a partner here at Long Burroughs Insurance Brokers. I've got a specialism in providing advice to a broad range of industries, including directors and officers and other professionals. We're here today to sort of go through, I guess, D&O [directors and officers insurance] 101 and provide some sort of advice around what's in, what's out and what else we can do. Hi, welcome to Governance Bites. My name is Mark Banicevich and, as you just heard, today I have the pleasure of spending time with David Burroughs. David, thank you very much for your time. No problem. I really appreciate this because this is a topic I've been interested in for some time. Directors and officers insurance is an area of quite import. I was speaking last year to a friend in the [United] States who was invited onto an international board that I'd previously been on, and he asked if there was D&O cover, and I said no, and he said, 'Not interested.' He's not going there without - of course, being from the States is not overly surprising given how litigious it is, but it was a very big factor. So, to start with, can you describe briefly what directors and officers insurance is? Sure, look, D&O, in its simplest guise, is a promise by the insurer to indemnify a director or an officer against alleged breaches of their duties. You know, the policies use the sort of phrase 'a wrongful act', which is a very nice wide definition of errors and omissions, negligence and other potential areas of claim. But, in its simplest, that's it. It's a promise to indemnify defence costs, and to cover any reparations, damages or settlements that may come out of that, subject to the rest of the exclusions and everything else within it, but that's it. Right, right. What other forms of cover exist that kind of fit into the suite of protection that a director might need to know about? Yeah, for a director, the key thing about a D&O policy is that it's protecting your own personal assets, right. This is, the role of a director is one that shouldn't be taken lightly, and I think you're reference in your story there around taking a board seat in an American company without D&O insurance, you know, this is the important policy for directors and officers to give them that protection. But within that, there are a range of insurance policies that a company will have that directors will have benefit from. You know, these are public liability, these are statutory liability, you'll have your, your domestic insurances, you'll have, you know, material damage covering assets. Those are sort of the key, you know, package of, of suite of insurances that a company will have. But when we talk about D&O insurance in particular, there is a D&O policy, and then there's also a management liability policy which also covers D&O to a certain degree, but the difference between the two of them is management liability is more suited for a mid-market company that provides other covers within the one policy, whereas the D&O policy just covers D&O exposures. So, which one you take will depend on the size and scale and I guess the obligations that you carry. So, every PLC [public limited company] will be on a D&O policy, but any private business would probably be on a management liability or something like that. Okay, right, thank you. Does the policy cover, you kind of mentioned this before, but does it cover the company, the board, or individual directors? And when I ask this question, a quick Google around this talked about Side A, Side B and Side C. What's that? The ABCs. Yeah, look, the way the policy is structured is in what we call these sort of three towers: Tower A, Tower B and Tower C. Now, Side A is the most important one for directors to understand, because that is the cover that provides personal indemnification for the directors only. Side B is what we call company reimbursement. So, if the company advances defence costs to the director to defend them, then the company will be reimbursed for that advancement. Right. So side B covers the balance sheet, covers most of the defence cost, but it gets reimbursed. But for whatever reason, if the company is not willing to indemnify the director, so that could be things like the company's in insolvency, or near insolvency, there's an allegation that it's a breach of, you know, the good faith duties to the company, or the board simply just or refuses to indemnify a particular director, whether there's some issue around conduct or the like. Side B will then be - Side A will be there to protect the directors personally. Right, and side C? Side C is what we call Entities Securities Cover. So, this is covering the entity itself and it's very limited in terms of what it's covering. It has to alleged a security breach, not a security breach, a securities breach and that's really for publicly listed companies around misstatements in the financials and that kind of thing. Right. But for the directors is that, they will have a separate policy limit that's just going for Side C, and Side B and Side A will share the same limit on that as well. Okay, right. What sorts of risks and events does it cover, directors and officers, coming back to that. Look it's very broad cover. Effectively, it's covering the civil liability for a director. So the best way to sort of look at that is probably who's suing, or what's the exposure really. And it could be from anyone from a shareholder to an employee, you've got vendors, you've got lenders, you've got regulatory investigations that may come, and you've even got activists that may bring claims alleging, you know, misstatements or other areas of claim. We were talking about the greenwashing cases before. This is the area, yeah, I think one of the big new areas to watch for directors, is the whole greenwashing and climate change. We are starting to see more activist-type claims coming in, and they're effectively, you know, look, I'm not a lawyer, but they're effectively looking to create a new legal definition of negligence, effectively a new branch of it, alleging that, you know, companies like Fonterra say that they are a green company, but [it is alleged] they're not actually going as far as they're saying they are. So, we're calling that "greenwashing" where the companies are trying to be green but then not actually following through. Yes. And what we're finding in the recent cases that are going through is that the courts are unwilling to throw these claims out early. So, it's going to be harder to get these sort of claims, you know, closed. Right. So, that's going to mean for D&O policies is more of an extension and you know, advancing more defence costs before we go through these sort of, each stage of the claim, whether it's going to go through the High Court trial or whether it's going to go into, you know, the appeal process going through there. So, we're watching that space very closely because, you know, obviously it'd be precedential, it'd be a precedent-setting matter and the insurance companies will then have to look around how they're going to defend the clients. Which, as you suggested before, are the ones that are more likely to make their way up there through the appellant courts and therefore cost a lot more in legal costs that you really want the cover for. Absolutely, absolutely. Right. And just on that, you know, the insurers are here to indemnify, and there's always this, there's always a sort of a Catch-22, where the insurance companies do want to settle things as quickly, as efficiently as they can, but they will take things to appellant level where they are looking at setting, you know, precedential value. Because they don't want to be able to, they want to sort of know, you know, with some certainty what they're offering and how they're going to go forward. Yes. So watch the space, it will be interesting. So, in those cases, is it the insurer that is then taking the action or is it the [client] that is, for example, appealing the case or is it the director themselves doing the appeal? No, well, it will be the insurer that will sit in there and take the appeal. So, whilst they're defending, you know, Fonterra, you know, Smith v Fonterra is the case, if anyone wants to have a look at it, but Fonterra is the named, you know, respondent in that case. Yes. But the insurer will be backing it, and then they will go to appeal if there's an award against them on that one. Yeah, right. That makes sense. And you know, the, yeah, the insurers will take that forward where they need to. Right, okay. In D&O cover, what sorts of costs can be claimed and what sorts of costs cannot be claimed? Okay, well, the key one is defence costs, so that's why we have liability policies, effectively. Nine times out of ten, you know, it's generally defence costs that are paid out and very rarely do we actually have settlements on the back end of it all. So, defence cost is the key thing and obviously they will provide settlement that comes in the back end of it all. They also provide regulatory investigation costs, which are like defence costs, but they are specific to regulatory reviews. I guess the key one there is, you know, health and safety defence cost, where the D&O policy will cover the defence cost, but won't cover any form of fines or penalties that come out of there because it's statutorily barred from doing so. Right. That's one of those ones. D&O policies in general will provide some additional extensions, which we sort of call, you know, there's PR [public relations] costs, that they'll bring in professionals if there's a particular nasty leg to that claim, you know, to try to protect the position. They've also got, you know, "asset of liberty cost", as well, where the individual director's assets and family are brought into the mix. So that's going to help them, you know, protect their property and help them defend their personal assets as well. And, yeah, and the other one, because directors take on such personal responsibilities for the company, they also provide tax liability cover as well, so if there is a tax obligation the company hasn't met, the directors will be personally liable for it and the policies can extend to cover that tax obligation, as well. So, extensions, they're optional choices that the client takes on when they take a policy out? Yeah, yeah, they're negotiable. Okay. So, generally speaking, most are automatic extensions. There are certain ones that become negotiable. These are the ones, we call them sort of, extended notice periods which allows another sort of 12 months after the policy lapses to then notify claims, they come with that. Right. Those sort of things can be negotiated onto the policy. And most insurers are open to, you know, tweaking certain clauses in there as well if there are need to do it, but for most part they're pretty much automatic. And picking up on something you said earlier about fines, in particular from the Health and Safety at Work Act [2015] not being covered, so fines would be covered generally unless the statute says they cannot be covered by insurance? Correct. Is that how it works? Correct. Yes, so the definition of 'damages', and the policy will be the key definition around what is covered and what's not, but generally speaking if there's not a statutory bar or prohibition for insurance to be able to pay fines, then policies can extend to cover those. Right. Not every policy is the same, each definition is different, so you'd have to look at that language in particular, see how broad that may be, but generally speaking if it's not barred, there is an opportunity for some of those costs to be covered. Okay, great. And in terms of settlements, I take it the insurer would then need to be involved in the negotiation around the settlement, because they wouldn't really want to sign an open cheque, would they? Absolutely. So, how the process sort of works is that a solicitor firm will be appointed to handle the claim. Now they sort of represent both the director and the company, and probably the insurance company, and there'll be a point where it's simple litigation management. They'll figure out what the litigation risk is to go all the way to court, they may come to a settlement point and then opportunities will be there. As long as it's within the the limit of liability then, you know, the insurers will make their determination. The tricky, where it gets tricky is where the policy limit is not large enough to cover a proposed settlement. Right. Where that would then mean, well, we have to come together with the directors and everyone else around how are we're going to contribute to that settlement. But again that's very rare, you know, even in the, even the sort of the, you know, the Bridgecorp kind of claims, you know, they carried a pretty decent limit, and that was enough to sort of get all the settlements done there, as well. So, we very rarely see those claims. It's probably going to be more acute for small, mid-sized businesses that may carry $1 million worth of D&O cover, rather than carrying 10 or 20 or that, as you would expect, for more established and, you know, governance, companies with greater governance oversight. Right, right. And when you, you know, if a risk of litigation, for example, comes out, there tends to be a whole lot of homework that is done within the firm before the legal costs are incurred, right. There might be investigations happening internally, you might have to engage experts to come in and do some consulting, is any of that covered by the policy? Look, if these are the costs that assumed after a claim is made, then generally they will become part of the defence cost and part of the litigation expenses that will be assumed. Right. Now, if there's cost assumed before a claim is made, that's going to be negotiation generally with insurer, to see what they would have paid. Yes. It becomes, it may not be a full dollar swap, but you might get 30 cents the dollar, or something like that, depending on the reasonableness. Yeah, right. It's the good old sniff test. The insurers will look at that, and figure out whether it was a sensible thing to do. Because all insureds have an obligation to act as a prudent uninsured. So that means, you know, if you have a claim, going to get your own, you know, solicitor to have a look at it pretty quickly will happen. There was one case, a good point of this, where we had an inside a trading allegation into a company. Both directors that were named went and got their own individual counsel, and didn't talk to each other, and didn't tell the board, and then didn't even tell us as their broker, until right at the end. Right. Now, the insurance came to the party and said, because of those gag orders, we will honour those costs and have a look at it. So, sometimes can get pretty grey around your obligation to notify versus a statutory gag order to say you shall not talk to anybody other than your solicitor, your family and all, and that kind of thing. Yeah, right. Because you want your broker to be on that list, wouldn't you. Yeah, yeah. Most times the regulators will agree to allow a broker to have information to then go and notify the insurer to give them indemnification. But in this case, it just took too long to sort of, to get that through. Right. But we, it was a good result all around at the end. Okay, what is commonly excluded in a D&O policy? Working in life and health insurance, you know, tend to get familiar with exclusions, so what things that they explicitly say, "this is not covered"? Well, I think it's more important to know what's not covered rather than what is. Yes. Yes, exactly. Because the way these legal contracts work, is that there's always interpretation with words. But the key ones I guess for pretty much standard is, the first one's insured versus insured, where the policy is not designed to pick up claims with infighting directors. Some policies are silent on an insured versus insured exclusion, but most have them specified as saying,"we will not cover internal bickering", and have a look at that. Right. So that kind of makes sense. Yes. The other key one that's usually put in there, is an insolvency exclusion. Now, that's generally applied for early-stage companies, or companies that are in a bit more financial distress. Now the insolvency exclusion is probably one of the most important ones we focus on, because we feel that, if you don't have cover for insolvency, then, you know, the old cliché analogy is that you're fighting a fire without a fire extinguisher. You know, you need it, because most of the time the allegations coming from a lender, or shareholder derivative action, alleging mismanagement are always going to have an element of insolvency in there. Yes. And so it's a key one to have a look at. And, as I say, it's generally for those early startup companies that will have an insolvency exclusion because, again, the insurer's perspective on this is that they're not here to underwrite the business; they're here to underwrite the exposure. And if a startup company is burning cash to get to market, we're not underwriting that exposure. Right. So that's always pretty difficult to get in place early on. Does that suggest then that, when you apply for D&O cover, the insurer seeks your financials, or seeks the company financials? Absolutely, yeah. That's one of the key elements in the underwriting. So, the proposal form, they'll want, you know, this year's financials, and they probably also want a business plan for that early-stage stuff to sort of understand it. And my role as a broker and advocate, I sort of try to present these companies as if the insurer is going to invest in them. So, the more you understand around the way you're going, you know, what your next two or three years is looking like, what your runway looks like, it's more likely that the insurer will take that risk on, if they've got comfort that there is a plan and we're getting to a certain point. But yeah, it can be one of those more daunting aspects when you're asking for personal information like financial accounts. You know, some clients don't want to do that, and so that's fine; you have an insolvency exclusion. Otherwise, if they don't want to come through us, because they've got some concerns around privacy, we arrange for the documents to be sent straight to the underwriter. Right. And so they give them, they can talk directly around what that looks like. Okay. I've got another client that, you know, the insurer goes down to their office and eyeballs the accounts, and they give the fine, you know, tick and say, "We're off," and off we go. So yeah, it could be one of those burdens. Okay. One other key thing about these kinds of policies: three situations around when the event occurs. One situation is you have your insurance policy in place for a 12-month period and you have an event occur and the claim made within the 12-month period. That's nice and simple. Yeah. But two other things that can happen: one is where the claim is made during that 12-month period, but the event happened five years ago; and the other one is where the event happens during the insured period, but the claim is made five years in the future. So, you hear the terms "claims-made" and "occurrence." Yeah. What is the most common arrangement with these kinds of policies? Yeah, the D&O policy, it's a claims-made structure. So, put simply, the claims-made policy means it's the policy in force at the time a claim is made that responds.

So, to use those scenarios, the easiest one: 17:36

if you have a claim today, it's within the insurance period — no problems, we're off. But if it was a mistake that was made two years ago that presents today, it's today's policy that responds to that act, error, omission, or wrongful act committed two years ago. Right. So that's the importance—you have to keep these policies running, concurrently - not concurrently - just consecutively, without a break. Yes. Because these policies also have what we call a retroactive date on them. So, the retroactive date will show when this policy became live. Right. So, that might be 1999 or it could be 2024, depending on when the policy was put in place. The other key thing there is a continuity date, which is how long the insurer has been continually insuring this client. Because maintaining that continuity date is an important aspect around making sure that nothing falls through the gaps. Yes. It's another safety net in a way. But the problem we have, given claims-made, is that when we get to a point when the company no longer trades, and we liquidate it and it moves on, at that point we need to get to a conversation around whether or not runoff insurance is appropriate. Now, the runoff insurance is something that you buy for two years, five years, seven years, depending on how conservative you want to be. You pay it, you put it on the shelf and hope you never have to use it again. Now that's important. It's more of an easier conversation when it's a private company, but when you've had directors that have come through year after year, and these directors that haven't been on the board for five years, then, when the policy stops, there's a potential exposure there for those directors, that they may not have cover there, because there's no policy that's going to be there. But that's going back to that extended reporting period endorsement, as long as that's been taken, there's probably another 12 months of opportunity to declare a notification, notify a claim. And often, when things start being liquidated, that's when most things come out of the woodwork anyway. So that year should give enough protection. Right. For that. But it is an exposure for those that, you know, that have gone before. That was the other thing that I was going to ask on this point. If, you know, you're a director for a term of maybe three years, maybe three terms of three years, whatever it may be, and you may insist that there's D&O cover in place during your term, but then you may get to the point at the end of your term where you're no longer involved in the company, and at some point in the future, they stop getting D&O cover and a claim is made, and you were a director at the time the event occurred, liability could occur in that place, right? Of course. So, a director would need to be in some, have something in their contract to insist that D&O cover continues to be in place in the future. Correct, yeah. The best place to really codify that is an employment agreement. In doing that. Now, you should be obligated— the company should be obligated — to provide an indemnity anyway, under the constitution or the charter, and then your contract will specify a requirement to have insurance for, you know, five years. Now, there's always different reasons why it may not be available, or that might just get too expensive, so they say, "We're not going to cover it." But those things, as long as there's a contract in place, becomes a little bit more acute for the directors at the time, - Yes. - to declare whether or not a policy needs to be renewed. But we're probably getting into a rabbit hole there a little bit. Yeah. But very important then, if you're looking at taking on a directorship, to ensure that the contract that you're taking on — the employment contract that you're taking on — has clauses in place around this point. Absolutely. Right, yeah. That's a bit of a fish hook to be careful of. Now, you mentioned runoff cover before, so I guess one closing question for you, off the topic a little bit. What advice would you give to a new director? Oh, new director is, you know, do your homework. You know, not all directorships are the same. Some propose more risk and reward than others, and they're different things. Being a director of a private company versus a publicly listed company are two different beasts altogether, right. But it still comes down to a policy. So, my advice would be to get your hands on the policy schedule, because that's going to provide the key information around what the D&O policy covers. It's going to cover what companies are insured. It's going to show you the insurance period, the retroactive date. It's going to show you the endorsements that have been applied. Generally, the endorsements will be more like exclusions, they are additions because they're taking that out and making it bespoke for that client. It would also show the territory and jurisdiction, so making sure that the policy can extend to international jurisdictions if the company's expanding that way, but that would be the first port of call, is to get that. Mostly you'll get given the insurance certificate, which shows very little, to be honest, so get your hands on the schedule, then seek some advice, some independent advice, if you've got any questions around it all. And you probably also want to sort of ask, you know, probably previous directors of the company if you can get a hold of it, to give some view on, you know, I guess claims performance previously. But you want to have a look at that. Look, not every insurer is equal, you know, the policies are different, so you'd also sort of want to have a look and have a bit of a think about, you know, who that is. But yeah, but look, seek your own independent advice because it is an, it is a key area of indemnity. Great, David, thank you very much for your time. It's been an awesome conversation. I really appreciate it. As I say, - You're most welcome.- it's been a topic I've been interested in for a while, so I look forward to chatting again soon. We'll see you next episode. Thanks very much. Thank you for watching this episode of Governance Bites. We have more episodes on YouTube and your favourite podcast channel where I interview directors and experts on various topics relating to boards of directors and governance. We'd love to see you back and please like, subscribe and share the videos and podcasts.