Directors' & Officers' Liability Insurance

In Switzerland, the basis upon which the personal liability of members (the ‘directors’) of the board of a joint-stock company (Aktiengesellschaft, herein a ‘company’) could be invoked is rather broad. However, court cases outside of the bankruptcy of a company are rather rare. Personal liability for a company's directors and officers (herein D&Os) is based on article 754 the Swiss Code of Obligations.

It is clear: D&Os are personally liable to the full extent of their assets towards shareholders of the company, the authorities and other stakeholders. If several directors are liable for a damage, any one of them is jointly and severally liable with the other directors to the extent the damage is attributable to each one of them based on their own fault and the circumstances.

In practice, shareholders’ actions against directors are rare outside bankruptcy but rather frequent if a company becomes insolvent. Recently, directors’ liability claims have also been brought in the context of unfriendly takeovers to put pressure on the board. That said, however, D&Os' liability has become an increasingly sensitive topic.

The global focus on corporate governance has resulted in a more rigorous standard for D&Os (through rules enacted by the SIX Swiss Exchange and by soft law, such as the Swiss Code of Best Practice for Corporate Governance, ‘SCBP’), which increases the risk of claims against them. Common D&O risk scenarios are

D&O can become subject to criminal liability if they do not comply with their corporate duties. Apart from fraud, misappropriation, general mismanagement or insider dealing, crimes or offences arising in connection with bankruptcy and debt collection are of particular relevance.

In general, as opposed to claims for civil liability, mere negligence will not be sufficient grounds for a criminal liability.

Swiss law does not explicitly address the question whether indemnification of the D&O is permitted, however indemnification or hold harmless agreements by the company are widely accepted provided the D&O has breached his duties only negligently (the legal situation in a nutshell). Such indemnification by the company -if legally permitted-, however, bears a 'credit risk' for the D&O (e.g. due to insolvency of the company, the relevant scenario when D&O claims arise) and a significant litigation risk should -after all- a company become reluctant to provide indemnification to the D&O in the given case.

Without proper insurance in place, directors, officers and professionals could find the firm's equity and even their personal assets at stake should claims arise. And, given the risk of liability, they may be reluctant to accepting certain positions. In fact, outside directors (those that are not also employed by the company)
are usually very vocal about requiring D&O insurance before agreeing to sit on a corporate board.

D&Os may be held harmless by a D&O liability insurance purchased by the company. As a liability insurance it pays to the directors and officers of a company, or to the organization itself, as indemnification (reimbursement) for losses or advancement of defence costs in the event an insured suffers such a loss as a result of a legal action brought for alleged wrongful acts in their capacity as D&O.

Such coverage can extend to defence costs arising out of criminal and regulatory investigations, trials or administrative proceedings as well; in fact, often civil and criminal actions often are brought against D&Os simultaneously. Intentional illegal acts, however, are typically not covered under D&O insurance.

'Claims made'-principle
D&O insurance grants cover on a claims-made basis. This means that claims are only covered if they are made while the policy is in effect or within a contractually agreed extended reporting period, which can extend up to another 72 months. Normally a policy will have an agreed-on, often unlimited, retroactive period as well, covering claims for wrongful acts that took place before the policy’s inception.

Common exclusions in a D&O-policy
Typically excluded from a &O policy are fraudulent acts, intentional non-compliant acts, illegal remuneration or personal profit, property damage and bodily harm (except Corporate Manslaughter), legal action already taken when the policy begins, claims made under a previous policy, claims covered by other insurance.

Cost of a D&O-insurance
The premium for D&O insurance is calculated on the basis of the estimated claims frequency and severity. This means that in addition to the size of the company (consolidated assets) there are a number of other risk factors that affect the pricing of an individual D&O risk, like domicile and international activity (especially US exposure), corporate structure and multi-jurisdictional setup, claims record, industry sector (for example: financial institutions are considered higher risk), stock exchange listing (i.e. market capitalization and place of listing), M&A activity, professional CVs of the management. That said, the cost of a D&O-insurance, being only a fraction of the insured limit amount, should be significantly lower than the cost of equity to provide for such exposure, even when taking into account the inherent uncertainty of an insurance contract.

For fund managers and for independent asset managers, there are combined insurance solutions available on the market, which include coverage for D&O-liability, professional indemnity and fidelity insurance.

Combined insurance solutions provide the advantage that certain coverage gaps are avoided from outset.

A standard product, - the name says it all - often does not match the client’s individual risk profile and maybe leaving the client unaware of critical gaps in coverage. Leading insurers often provide 'off-the-shelf' insurances with impressive features and attractive pricing. Such policies are sometimes very efficient to bind, no annoying questions asked.

However, most of the times these standard products contain unusual exclusions that limit coverage and/or the insured has to comply with specific contractual obligations as a condition precedent to an insurance claim made and successfully settled. We help our clients to eliminate such clauses from their policies.

For most companies, insurance represents one of their biggest investments and their largest source of contingent capital. The main purpose of insurance is to protect their balance sheet, and to reduce volatility in the profit and loss account following a large loss.

The challenge for insurance buyers is raising the awareness of the value of insurance beyond that of a commodity, and articulating how individual insurance covers can contribute to the financial strategy and financial modelling of the organisation.