Directors should be protected indemnity agreements in their corporate bylaws; but that is only the first line of defense. Ian Fraser explains that indemnification from a client’s company can become unavailable – and that is when a broker can play a crucial role.
People serve on Boards of Directors for a variety of reasons including an altruistic desire to give back, to assist with career and personal development, and to supplement income. By taking on a director or officer role, they agree to exercise due diligence in overseeing the organization they serve and act in its best interest. Yet both beginner and seasoned board members are often not fully aware of the personal risks they are exposed to by taking on these responsibilities.
Corporate governance is evolving at a rapid pace. Organizations are seeing a significant increase in governance requirements related to disclosure, the scope and timing of communication to shareholders and other stakeholders, and increased audit requirements. At the same time, litigation trends are on the rise, increasing board members exposure to legal and financial risk.
Securities class action lawsuits, breach of contract, wrongful termination, and discrimination lawsuits are just some examples of claims that could expose directors and officers to litigation – and potentially their personal assets. What directors and officers must ask themselves is what’s standing between their personal assets and litigation?
Directors should generally be protected by way of indemnity agreements in their corporate bylaws. That’s the first line of defense. But, what happens if indemnification from their company becomes unavailable, either because of a corporate insolvency or a court order prohibiting the company from indemnifying? If such a situation arises, there is no longer a corporate balance sheet standing in the wing to protect them, and leaves directors personally liable to cover their losses.
The Directors & Officers (D&O) insurance policy is the second line of defense. Not only does it provide protection for directors beyond corporate indemnification, it also provides protection for directors from instances where no indemnification is provided or available. The D&O policy is critical because it’s generally the last line of defense shielding personal wealth.
If the courts deem directors personally liable, absent of a D&O policy or corporate indemnification, they can go after every single asset that those directors hold in their name. It could be a house, retirement funds, cash account or stocks which could ultimately wipe out an individual’s personal wealth. (continued.)
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It is incumbent on directors and officers to ensure proper protection is in place starting with a well-constructed risk management framework that includes, amongst many things, iron clad indemnity agreements and a comprehensive D&O insurance policy. The larger the organization, the more robust this risk management program should be. For smaller organizations that do not have a risk management team in place, this process is even more challenging.
As part of its risk management framework, organizations should consider an element of independence on the Board of Directors as well as well-documented corporate policies addressing everything from disclosure to insider trading of securities for public companies. Ensuring annual employee and executive attestation to such policies further de-levers operational and financial risk for the organization and its directors and officers.
An insurance broker plays a significant role in educating stakeholders, whether it be senior executives, risk managers or directors and officers on how to protect themselves. Client education is critical, now more than ever. The D&O insurance market is one of the most fluid and dynamic segments within the industry. The exposures, regulatory and legal requirements change daily, as does the coverage itself. Brokers need to stay on top of this market day in and day out in order to adequately offer sound advice on the best policy to cover the specific needs of each Board of Directors within an organization’s financial realities.
Top Five Things To Remember:
- Governance requirements are increasing and litigation trends are on the rise, leaving board members at risk of personal liability;
- The first line of defence against personal liability is an indemnity agreement;
- The second line of defence is a solid D&O insurance policy;
- It is critical to put in place a well-constructed risk management framework; and
- Brokers need to stay on top of the D&O market, which sees daily changes in exposures, regulatory requirements and coverage.
Ian Fraser is National Director, ProFin at RSA Insurance, and is responsible for strategy & profitability for all Professional & Management Liability lines of business written in Canada. Ian joined RSA Insurance in 2012 and has extensive experience in financial and professional lines of business in some of the largest insurance companies in Canada. He specializes in Directors & Officers Liability, Employment Practices Liability, Fiduciary Liability, Fidelity and Crime and Professional Liability.
