rticles

Directors’ and Officers’ Liability Insurance – the Need

of the Hour
Rupanjana De, ACS, Director, Nandi Resources Generation Technology Pvt. Ltd.,
Kolkata.

Directors’ and officers’ liability insurance is relatively a new concept in India though
it has its existence for long in the western countries. While emphasizing the
importance of such insurances the article goes in to further explain its scope, coverage,
e-mail :
formalities, etc.
rupanjana_de@yahoo.com

THE IMPORTANCE OF INSURANCE
Risk management is an important component of corporate
governance practices and efficient management of the risk
that key persons in a company are exposed to is therefore vital
for every company. Insurance is the best tool for risk
management. The recent years have seen a lot of developments
in the insurance market in terms of products and services.
Directors’ and Officers’ (D&O) liability insurance is one such
product which has now become an important part of
management liability insurance. Globally, in most of the
countries in Europe and America, majority of the large
corporations maintain D&O liability insurance today. In
general, the D&O liability insurance claims are more from
larger companies, whether listed or unlisted, but for that matter
it is erroneous to conclude that private or smaller companies
and their directors are immune to such an insurance product.
Even in the latter type of companies litigation possibilities are
not completely ruled out and there are numerous instances of
litigation between members of the family or once-upon-a-
time friends who mutually agreed to start a company. These
apart, companies, big or small, listed or not always stand open
to the risk of litigations from creditors, customers, employees,
banks, vendors, competitors and other public institutions.
SOME NEW AGE CONCEPTS IN INSURANCE
MARKET
Directors’ and Officers’ (D&O) liability insurance might be a
relatively new concept in the Indian market but the western
countries have seen its presence across the last several decades.
Some insurance companies have even come up with the
Independent Director Liability Insurance (IDLI) policy which
is a welcome development. It goes a step further and protects
the Independent directors’ personal assets as conventional D&O
policy might not suffice for their total protection. It is slowly
gaining popularity in the US. The importance of such a policy
to protect the independent directors of companies was felt
consequent upon the major recent corporate scandals of Enron,
WorldCom, HealthSouth etc. all of which came to light with
the dawn of the new millennium. Another new product in this
market is the Employment Practices Liability Insurance (EPLI)
which provides coverage in respect of certain claims relating
to employment made by employees.
DIRECTORS’ AND OFFICERS’ LIABILITY
INSURANCE
Directors’ and Officers’ Liability Insurance, often referred to
as just D&O Insurance, is one type of liability insurance whose
beneficiaries are the directors and key officers of a company
or the company itself. The payment of this liability insurance
is made in order to cover various costs of a lawsuit like
damages, defense costs, lawyers’ fees, consequent losses etc.
resulting from the wrongful acts and deeds of directors and
officers of a company in their capacity as such. Such wrongful
acts might be omissions, errors, misstatements, misleading
statements, neglect or breach of duty by such directors or
officers. Suits can be brought for various reasons by various
stakeholders like the shareholders for insider trading, or
shareholder derivative suits, by the creditors for

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misrepresentation of financial health of the company, by
competitors for unfair trade practices, by consumers for defect
or deficiency of product and services and by public
organizations for various issues like pollution and other health
hazards. Lawsuits covered may range from both civil and
criminal suits to regulatory investigations and trials.
The Directors of a company are bound by their fiduciary duty
towards the company and the shareholders. There is a principal-
agent relation between the shareholders and the directors, and the
directors, as agents are bound to act in the best interest of the
shareholders. In this age of corporate governance, the scope of
directors’ duties have been enhanced so much so that in most
cases the term ‘shareholder’ is replaced by the term ‘stakeholders’
and it is believed that the directors are bound by their duty of
care not only to shareholders but also to creditors, employees,
suppliers, customers and so on. They can therefore be liable for
breach of contract or breach of duty, non-disclosure of interest,
negligence, mismanagement of assets etc. to all stakeholders. This
substantially enhances their risk. In countries like the United States,
corporate law makes it mandatory for companies to indemnify
their directors and key officers against risk of personal liability
arising by virtue of their position in the company. The idea behind
is to encourage qualified and capable people to take up these
important positions in the companies and for the companies to be
able to retain them. However, there are numerous situations in
which the companies are not allowed to indemnify its directors
or officers in which cases the D&O insurance comes in handy.
Following is a brief note on the possible ways to relieve
directors from liability:
 Ratification by shareholders: Certain breach of duty by
directors can be ratified by an honest disclosure of the
same in a shareholders meeting and the latter deciding
to ratify the directors by passing the required resolution.
 Indemnification by company: While the company cannot
enter into contract with directors to exempt them from
any liability arising out of negligence, fraud etc. towards
company, the company can definitely indemnify directors
against liability arising out of their dealings on behalf
of the company with third parties.
 Business Judgement Rule: Next comes the business
judgment rule which the courts might apply when a suit
is brought against the directors and none of the above is
applicable. This is the essence of section 633 of the
Companies Act, 1956.
 D&O liability insurance: When all the above fails then
comes the D&O insurance cover for protecting directors.
PURCHASING THE INSURANCE
It is conventionally the company that purchases the D&O
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insurance and pays the insurance premiums although the sole
beneficiary may be the directors and officers in most cases.
However, sometimes in order to avoid problems like that of
income tax etc. the premium is split up and a portion is paid
by the company while the remaining part is borne by the
directors and officers themselves.
THE INSURING CLAUSES
Traditionally D&O policies had three insuring clauses viz., Side-
A or Insuring Clause 1 provided insurance coverage to individual
directors and key officers of a company when because of the
legal provisions or financial constraints of the company, the
indemnity against any losses are not or cannot be provided by
the company, examples are in case of the company being bankrupt
(financially incapable) or for derivative suits brought against
such insiders by shareholders on behalf of the company (legally
incapable); Side-B or Insuring Clause 2 provided insurance
coverage not to individuals but to companies when the latter
indemnified its directors and key officers and thereby incurred
cost or losses and in this way it protected the company’s balance
sheet; and Side-C or Insuring Clause 3 which provided coverage
to the companies for losses incurred by it, e.g. when any claims
are made against the company itself.
EVOLUTION OF THE INSURING CLAUSES OVER
TIME
For many decades, there existed only side-A and side-B policies
with hardly a thin line of differentiation with the result that
much depended upon interpretation of clauses when actual claims
were to be made. To resolve this ambiguity the ‘presumptive
indemnification’ clauses were introduced much later in the mid
1980s and then permanently built into the policies thereafter. It
started with a Philadelphia based NYSE listed company that
had taken a Side-B policy of $5 million and that was the
maximum they could take at that point of time. A class action
suit followed shortly after naming all directors as defendants
and the cost was much higher than the policy retention. The
policy was ambiguous on when the Side B would apply and
when side A would be applicable. It followed that the lawyers
creatively deduced that if the company simply refused to
indemnify its directors, the Side-A would be applied and the
company would be saved of the high cost. Since the wording
was vague on this issue, the courts upheld the interpretation and
this was how simply because of inappropriate and exclusive
language of the policies, the company could shift a Side-B claim
to a Side-A claim and managed to get a $5000 million in place
of a mere $5 million as originally taken in the policy. Taking
this case as a precedent, the ‘presumptive indemnification’
clauses were introduced and all future policies were endorsed
with the same. This clause stated that Side A would apply only
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Directors’ and Officers’ Liability Insurance – the Need of the Hour
when an insured company is legally or financially incapable of
indemnifying its directors and officers and that the company
has no right to simply refuse to indemnify and thereby change
a Side-B claim into a Side-A one.
It was not until mid 1990s that Side-C insuring clauses came
into being. Historically the concept of D&O insurance has
primarily been individual protection and so whenever the
company was named as a co-defendant in suits along with the
directors and officers, there invariably was a great difficulty
in making a fair allocation of defense and other costs between
the companies and individuals and those by far led to further
disputes. This dilemma was finally resolved in the case of
Nordstrom v. Chubb in 1995. Post this decision, the insurers
were made to add a new Side-C insuring clause thus putting
an end to the entire confusion.
Though introduction of Side-C policy, solved one problem, it
gave rise to some new problems. One such problem related to the
fact that consequent upon the increase in exposure, the insurance
companies could not do much about increase in premium pricing.
Almost for the same premiums the insurers were now insuring
both individuals and companies. Consequently the risk to the
underwriters increased many folds. Another problem related to
the limit of liability purchased by companies. After addition of
companies in the insured list, the insurance policy limit were not
consequentially increased implying that the directors’ and officers’
individual protection got substantially reduced as they now shared
it with their employer companies as co-insured. This is one of
the reasons that have led to a renewed interest in Side-A only
policies, the others being factors like increased cases of companies’
financial bad health, increased number of litigation and higher
defense and other related costs. The companies tend to prefer not
to indemnify its directors and officers and get an insurance
coverage instead.
EFFECT OF D&O INSURANCE COVERAGE ON
THE INSURED’S BEHAVIOUR
It would be erroneous to deduce that D&O insurance makes
directors or officers negligent to their duties and that it
encourages them to undertake unauthorized activities
intentionally. While unintentional wrongs are covered by most
D&O liability insurance, intentional, unlawful and
unauthorized acts by directors and officers of companies
howsoever high positions they hold are not covered by D&O
insurance policies. In order to be so covered, the wrongful act
should come under the definition of “wrongful acts” in the
concerned policy, and ideally it includes those acts, omissions,
commissions or mis-statements made by such directors or
officers in good faith in their capacity as such director or
officer of the company. This does not imply that D&O
insurance would cover fraud, illegal and unlawful activities.
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CLAIMS THAT ARE COVERED UNDER D&O
POLICY
For the purpose of claims things that are typically covered by
the definition of loss are damages, settlement cost and defense
cost. Punitive and exemplary damages may be included only
if specifically mentioned in the policy taken. Losses from
wrongs that are legally uninsurable are not covered. Also not
covered are penalties, fines and taxes. There are certain
exclusion clauses that might be there in the D&O insurance
policy taken. These are:
(a) Exclusion of coverage of dishonesty or intentional wrong
by a director or officer
(b) Exclusion of coverage of an insured person against
another insured person (e.g. a company cannot claim
against a director in a case when both are insured)
(c) Exclusion of coverage of liability arising from
professional services (e.g. doctors)
(d) Exclusion of claims arising out of acts committed on a
date prior to a specified date (ideally the date of taking
the policy).
(e) Exclusion of claims already pending at the date the policy
is taken
(f) Exclusion of claims resulting from insider trading
(g) Exclusion of claims relating to bodily injury, mental
distress, sickness, death etc.
THE ECONOMIC PRINCIPLE BEHIND D&O
INSURANCE
The basic principle that governs the D&O insurance regime is
the economic concept of risk aversion and its effects. Risk aversion
implies the unwillingness of a person to accept a proposition
which has an uncertain result and instead opt for another
proposition that guarantees a certain result even if it be lower
than the highest expected result in the first case. This concept of
economics would apply to a highly knowledgeable individual
who might be unwilling to take up the position of a director
simply because he is afraid of ending up with personal liability.
D&O insurance provides a shield in these cases. Such insurance
can make a director or an officer risk-neutral if not risk-loving,
both of which will benefit the company ultimately. By being risk
neutral they can take important decisions for the company based
upon all necessary information available at hand at the time of
taking decision and in this manner they can give their 100% to
the company. In addition to the above, purchase of a D&O
insurance policy by a company will also give it the signaling
strength by which it can claim to be a good employer in the job
market. It can have an edge over its competitors. A liability arising
from their position in the company might not only cause financial
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losses to directors and officers, but at the same time their personal
goodwill might also get tarnished. There is no denying the fact
that they have a large specific investment involved. So, with the
right D&O coverage in place, a company will be able to attract
the most efficient and able candidates on board and key positions.
In the long run, the shareholders will be benefitted in the form of
getting better returns and the society at large will also be better
off in the sense that there will be increased productivity and
increased job security. For companies, therefore, it is a cost-
benefit analysis. The better you pay for insurance, the more
qualified people you get.
LEGAL PRINCIPLE BEHIND D&O INSURANCE
D&O liability insurance policies promote the concept of Business
Judgment Rule which states that law presumes that directors of
companies have bona fide regard for the interest of stakeholders
of a company in running the management of the company and
in taking important decisions. Under this rule, in plain language,
it is to be presumed that in taking any decision about the company
management, the directors pay utmost regard to the interest of
all the stakeholders. The intent of legislation is to encourage
just and well informed decisions by the company management
without fear of personal liability and thereby to help the business
to progress and to ensure that the shareholders’ wealth is
multiplied. D&O insurance is just another assurance of putting
into practice the business judgment rule and protecting the
directors who work in the best interest of the company. In running
a business, if a gap is created due to lack of express legal
provisions, D&O insurance would fill the gap. The ultimate
objective is to have the best business decisions.
A WALK DOWN THE HISTORY OF D&O
INSURANCE
The history of D&O insurance dates back to the 1930s when
the first policy was introduced by the British insurance and
reinsurance provider Lloyd’s of London. They foresaw the need
of such a product in the face of the great economic depression of
1930 that upset the economies of the United States and many
other countries in a major way. However, despite the vast
consequences, the product did not sell well with the directors
and officers of corporations and the D&O insurance policy failed
to gain the required popularity. The law did not empower
companies to indemnify their directors at that time.
A decade later, the popularity of this new product in the insurance
market began to gain and laws were passed in the US that
empowered companies to indemnify their directors and officers.
During the 1960s there were several mergers and acquisitions
that led to litigations against companies and their directors
and officers exposing their personal liability which only
reconfirmed the need for companies to have D&O insurance
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policies in place. It gave this product a strong foothold that
was to stay for many decades to come.
FORMALITIES TO BE COMPLIED WITH BY A
COMPANY BEFORE PURCHASING D&O
COVERAGE
D&O policies from various insurance companies do have the
similar structure and may appear to be the same, but they do
have different composition, terms and conditions as well as
benefits and language and clauses differ from insurer to insurer.
A company interested in taking coverage needs to closely
scrutinize exactly what kind of coverage it is looking for and
who would be the best insurer. In the absence of proper care
before taking the policy, companies are likely to end up in
trouble. In purchasing the right policy, an attempt should be
made to get the most favorable terms and conditions and for
that the underwriter has to have a proper idea of the insured
company’s nature of activities, its financial position, its
shareholders, mergers and acquisitions in the past or probable
in the near future, any changes in business activity, kind of
risks that it is exposed to etc. For this the important documents
to be consulted are the company’s audited balance sheet and
profit and loss statement and income tax returns for the last
few years, current quarterly or half yearly unaudited results
as applicable, the prospectus or information memorandum if
there has been a share issue, details of loans, list of
shareholders, creditor information, details of shareholder
grievances over the past few years and a basic understanding
of the competitors and any likely suits from their side.
THE POSITION IN INDIA
The Companies Act, 1956 makes directors and company secretary
the officer in default. The Act specifies several provisions that,
if contravened, can lead the liability and expose them to heavy
penalty or even land them in jail. There are other enactments
also that make the directors liable for contravention by the
company and the directors may be prosecuted under those acts
like the environmental laws, tax laws, labour laws, anti-trust
laws, securities laws etc. Apart from statutory duties, there are
also many common law duties of directors that have not been
codified by any statute but are conventionally considered as
binding on them. India being a common law country, these
duties find special importance. Such duties are duty to take care
and exercise diligence, duty not to be negligent, duty of loyalty
to the company, duty to put the interest of the company first,
duty to avoid conflict of interest, duty to act in good faith, duty
not to make any secret profit, duty to make proper disclosure,
duty to abide by the company’s articles and memorandum of
association, duty not to delegate (delegatus non potest delegare)
and so on. If the director fails to take care of his duties, depending
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Directors’ and Officers’ Liability Insurance – the Need of the Hour
upon the breach, he may incur liability for breach of fiduciary
duties, for ultra vires act, for wrongs committed by co-directors,
for breach of contract, for wrongful act or acts mala fide, for
negligence or statutory negligence. He may incur both civil and
criminal liability. While for non-statutory liabilities the courts
might apply business judgment rule to protect the directors,
statutory liabilities will be dealt with according to statutory
provisions. Statutory penal provisions provide for fines, penalties
or even imprisonment depending upon the gravity of the offence
or contravention and the director may also incur unlimited
personal liability under certain provisions under the Companies
Act, 1956.
In countries like US, directors and officers are very much
conscious of the D&O insurance programme of the employer
company. This serves as an important consideration before
joining the board. In India, barely one-tenth of companies
listed on the Bombay Stock Exchange seem to have proper
D&O liability insurance in place. The coverage limit is also
much narrower and the insurance claims for directors and
officers can generally be made for liability arising from
misleading financial statements and mismanagement of funds
only. Companies are indemnified against cost of litigation that
it bears on behalf of its directors and officers. Considering the
benefits and necessity, of late the Securities and Exchange
Board of India has been considering making it compulsory
for all listed companies to have proper D&O liability insurance
cover to protect their directors and officers from exposure to
personal risk arising from corporate frauds and scandals. While
mutual funds and insurance brokers in India are compulsorily
required to take liability insurance cover, there is no such
mandate for companies as of now.
D&O INSURANCE COVERAGE IS VITAL FOR
INDIAN COMPANIES
In the wake of the Satyam scandal that shook the Indian
corporate sector, D&O insurance policies need all the more
attention. It was initially stated to be a Rs. 7000 Cr. scandal
and now the fresh estimates by CBI show that the scandal is to
be valued much higher at Rs. 24000 Cr. We all know that for
many years the senior management of Satyam under the
leadership of its founder Chairman had been cooking the books
of the company under close attention of unsuspecting directors
and executives many of whom were men of great reputation
and goodwill. The scam almost terrorized many directors across
companies and a few hundreds of such directors across the
country on boards of elite companies decided to step down
due to fear of possible consequences in case there were any
frauds in companies they were serving. This sudden wave of
risk averseness amongst the corporate elite was fueled by this
ground breaking corporate scam. In recent verdict on the
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Bhopal gas tragedy a non-executive chairman was sentenced
to two years’ imprisonment. While many have opined that the
sentence is very less compared to the magnitude of the effects
of the tragedy, others do also show concern about the law
being so strict on a non-executive director. In the wake of
huge emphasis on corporate governance in Indian companies
now where even non-executive directors can be brought to
trial, D&O insurance seems all the more imperative for Indian
companies at present. This would not only come handy for
directors and officers not willing to take risk, but at the same
time would also imply new business of vast magnitude for
general insurance companies. While for most top ranked
companies abroad, D&O insurance is either mandatory or
suggestive, in India, it was never so popular. However,
consequent upon the Satyam scam, highly capable directors are
now pressing upon companies to take D&O insurance cover
before they join the board. The Companies Bill, 2009 if enacted,
will bring enhanced risk to directors as it provides for class
action law suits by shareholders against companies and the
management. Such litigation might be very expensive and in
the absence of D&O insurance cover to protect the directors,
companies would have a tough time convincing qualified people
to join the boards. What follows from the above discussion is
that D&O insurance is the need of the hour in Indian companies.
In India, the D&O insurance policy is provided by
 National Insurance Company Ltd. (NIC)
 The Oriental Insurance Company Ltd. (OIC)
 United India Insurance Company Ltd. (UIIC)
 The New India Assurance Company Ltd. (NIAC)
 Some other private parties
CONCLUSION
Government regulations for running the companies are becoming
tougher and stricter day by day with the result that the risk of
directors’ and officers’ personal liability is extending. This makes
the D&O liability insurance coverage the need of the hour for
corporate houses in order to enable them to attract and retain
big brains and talents in their boards and important positions to
steer them to success. At the same time, corporate scandals are
on the rise, so are shareholder derivative lawsuits. This has
resulted in premiums soaring higher and higher over the years.
There is a dire need to strike a balance. Also the D&O insurance
products by different insurance providers in India have much
narrower scope than their western counterparts. The products
need to be made more mature by inclusion of more clauses and
bringing more ‘losses’ under the scope of claimable losses. Last
but not the least the general understanding of the various new
products in the insurance market needs to be enhanced in order
to take more benefit out of them. 
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