EXPLORING DIRECTOR AND OFFICER INSURANCE FOR BETTER LIABILITY PROTECTION

Posted by Kellie Bright on September 1 2023 in News

Company directors are facing increased risks of personal liability stemming from regulation and the evolving business environment.  Personal liability can arise under legislation (including the Companies Act 1993, Privacy Act 2020, Fair Trading Act 1986, Financial Markets Conduct Act 2013, Resource Management Act 1991 and Health and Safety at Work Act 2015) and common law (i.e., for breach of a fiduciary duty). Directors should seek appropriate levels of protection, limiting their exposure to such liability.

Key Considerations

Obtaining director and officer insurance (D&O Insurance) is a potential means to protect against many risks associated with running a business and will be an obvious consideration for any competent director. A broker can advise companies and directors of the appropriate type and level of cover.  However, there are important considerations:

• Does the insurance fully cover the risks and liability arising from the operations of the relevant business? Are there any exclusions?
• Does the company indemnify the directors for those risks that are not insurable?
• Does the company’s constitution expressly permit the company to indemnify and effect insurance for the directors?

Under section 162(5) of the Companies Act, a company may, if expressly authorised by the company’s constitution and with the prior approval of the board, effect insurance for a director or employee in respect of:

• liability, not being criminal liability, for any act or omission in his or her capacity as a director or employee; or 
• costs incurred by that director or employee in defending or settling any claim or proceeding relating to any such liability; or
• costs incurred by that director or employee in defending any criminal proceedings against the director or employee in their capacity as a director or employee and in which they have been acquitted.

In addition to board approval, the board must certify that the cost of the insurance is fair to the company. If D&O Insurance is taken out without the required approval and certificate, or there are no reasonable grounds for giving such a certificate, then a director may be personally liable for the cost of the insurance. 

D&O Insurance is not likely to cover all liability. For example, D&O Insurance often excludes cover for claims brought against directors by the company itself and/or “major shareholders”, and/or for loss arising from or connected to an insolvency event.  It is important that a company and its directors fully understand the terms and limitations of the D&O Insurance, and whether any extensions or separate insurance may be necessary to cover what would be otherwise excluded under the policy. 

Whether or not D&O Insurance adequately responds, it is generally good practice for the company to indemnify its directors separately.  In the event that an indemnity is put in place and the company pays out under the indemnity, then the company may be able to claim under the D&O Insurance.  However, such an indemnity is likely to provide little comfort to the directors where the liability is excluded under the D&O Insurance, and the company is in financial difficulty.

First, however, before the company indemnifies and effects any insurance, the company must have a constitution in place, and that constitution must expressly authorise it to indemnify and effect such insurance.  If it does not, then such an indemnity is void. 

Conclusion

Given the increased exposure to liability, it is critical that a company seek to indemnify and effect insurance for the benefit of its directors and employees. In doing so, the company needs to fully understand the terms of the cover, including the types of liability and claims that may be excluded.  To the extent that the D&O Insurance does not respond, separate cover may be necessary. Finally, such indemnity and effecting of insurance is not possible unless the company is permitted by its constitution to do so, and the board provides the necessary approval and certification. 

Kellie Bright | Special Counsel| kellie.bright@shieffangland.co.nz