2.4.4.2 Directors’ and Officers’ Liability insurance and indemnification

Indemnification and D&O insurance seem to be considered institutionalised instruments of director liability protection. All of the 83 companies that I examined in this research have transferred directors’ liability risks to a third party, a D&O insurer. About one-third of the companies provided both indemnification and D&O coverage. Companies that provide indemnification will not do so without having taken out D&O insurance. The participants in the research considered D&O insurance to be like any other company insurance, such as property or fire insurance, and simply part of the company’s ordinary business insurance plan.Moreover, D&O insurance and indemnification are tightly linked in the sense that, when indemnification is provided,D&Ocoverage is seen as part of the company’s obligation to reimburse company directors for damages based on the indemnification provision as established in the company’s articles of association.

The participants used two major important arguments to justify indemnification. The first is that some D&O insurers do not cover damages that company directors may incur as a consequence of personal fines imposed by regulatory authorities. The participants considered such fines to be inherent to the risks attached to the position of a company director.2 Nevertheless, it has long been the prevailing opinion under Dutch contract law that insurance contracts should not cover any such fines imposed for reasons of public policy.3 Companies have overcome this problem by providing indemnification applying to the damages resulting from fines. As I was informed by the legal counsels who I interviewed, the companies for which they work typically agree to indemnify directors until an individual director is adjudged liable for conduct qualified as ‘serious reproach’, wilful misconduct or deliberate recklessness. As one cannot determine beforehand when norms have been violated, companies take the stand that, pending the outcome of a case, there is continued entitlement to reimbursement.

The second argument relates to the liability limits of D&O insurance. D&O policies are subject to a maximum monetary amount payable under the policy for loss resulting from claims first made during the policy period. Under an A/B/C D&O policy, the aggregate limit of liability usually applies to all claims first made in a single policy year, and constitutes a combined limit of liability for both direct coverage and company reimbursement coverage. Directors are concerned that several different types of proceedings (multiple claims) may be brought against several different groups of insured persons (company directors, employees, and the company) at the same time (multiple insured persons). As a consequence, the D&O coverage may be exhausted to the extent that individual directors run the risk of incurring out-of-pocket expenses. It was argued in the interviews that, should the D&O coverage be exhausted or the D&O insurer insolvent, a second line of protection must be available: the company’s indemnification coverage.

The interviews revealed important positive side-effects attached to such forms of protection against directors’ liability. If the threat of a court trial is a potential instigator of defensive action, then the liability protection may be effective in reducing this behaviour. It seems that such protection provides psychological comfort, being perceived to reduce uncertainty. The instruments adjust liability risks in the sense that a certain loss – in terms of an insurance premium – is offset by a small chance of a significant loss, should litigation arise. Thus, perceiving liability risk as a sure loss and confining it to an insurance premium makes the possibility of occurrence of liability somewhat more bearable for company directors. Moreover, these instruments provide company directors with the advantage of settlement and the ability to resolve disputes outside the courtroom, where there is less public exposure and less damage to their reputation.

Nevertheless, contractual liability protection does not prevent the threat of litigation. On the contrary, it may in fact increase the risk, as indicated by many of the participants themselves. Thus, company directors still face liability risks in their daily practice. The research demonstrates that the most valued function of D&O insurance and indemnification is the fact that they provide company directors with the resources to restore their personal and professional integrity, albeit by appearing in court. This gives reason to believe that the origin of defensive behaviour may lie in the fear of the threat of public proceedings in which the directors’ professional actions and integrity are called into question.