Directors and Officers (“D&O”) indemnity and insurance is an essential component of any effective and sustainable corporate governance regime. While D&O insurance remains available in the current ‘hard market’ in New Zealand, reduced cover and increased premiums are now applying. As the risk environment faced by directors continues to evolve, it is important for directors to be aware of the market constraints and ensure that D&O insurance policies continue to be relevant and effective.
We discuss the fundamentals of D&O indemnity and insurance together with some practical considerations below.
D&O indemnity and insurance: back to basics
Section 162 of the Companies Act 1993 (“Act”) regulates the way in which a company may indemnify and insure its directors and employees.
A company may indemnify a director or employee of the company (or a related company) for:
- costs incurred in defending proceedings relating to liability for an act or omission in their capacity as a director or employee in which judgment is given in their favour or in which they are acquitted or which is discontinued; and
- liability to a third party for any act or omission in their capacity as a director or employee (and for costs in relation to any claim or proceeding relating to that liability), excluding:
- criminal liability; and
- liability resulting from breach of a director’s duty in to act in good faith and in the best interests of the company (section 131 of the Act).
The exclusion in relation to criminal liability stems from public policy – an indemnity in respect of criminal liability would prevent the criminal penalty imposed from having a deterrent effect.
For a company to indemnify a director or employee as above, the Act requires that:
- there must be express authorisation in the company’s constitution; and
- the board of directors must ensure that the particulars of any such indemnity are entered in the company’s interests register.
An indemnity given in breach of these requirements will be void and unenforceable (and any amount paid to a director or employee pursuant to a void indemnity will be recoverable from them). It is therefore critical to ensure that the procedural requirements of the Act are observed.
A company may take out insurance for a director or employee of the company (or a related company) in accordance with section 162 of the Act in respect of:
- liability (except criminal liability, for the policy reasons outlined above) for any act or omission in the capacity of a director or employee;
- costs incurred in relation to defending or settling any claim or proceeding relating to that liability; and
- costs incurred in relation to defending any criminal proceedings that have been brought against a director or employee in relation to any act or omission in his or her capacity as a director or employee in which that person is acquitted.
In order to take out D&O insurance, the requirements of the Act are as follows:
- there must be express authorisation in the company’s constitution;
- the board of directors must give their prior approval;
- a certificate must be signed by the directors who vote in favour of the insurance stating that, in their opinion, the cost of that insurance is fair to the company; and
- the board of directors must ensure that the particulars of any insurance are entered in the company’s interests register.
While the insurance will not be void if the procedural requirements of the Act have not been complied with, the directors or employees of the company may be personally liable to the company for the cost of the insurance, except to the extent he or she can prove it was fair. Essentially, the directors need to be able to prove that they turned their minds to the company’s insurance arrangements and there was a reasonable basis for their conclusion that the cost of the insurance was fair to the company at the time.
It is also important to be aware of any “failure to insure” exclusion in a D&O insurance policy, pursuant to which directors and officers will incur personal liability for losses resulting from failure to purchase appropriate insurance coverage for the company.
Deed of indemnity and insurance
A deed of indemnity and insurance will document the terms agreed between the company and a director in relation to D&O indemnity and insurance. It is crucial to have a well-drafted deed because a court of law will interpret such a document “on the ordinary meaning of the words” (NZ Forest Products v NZ Insurance Co Ltd (1997) 6 NZBLC 102,368 (PC) (at p 102,372)). Key protections that should be present in a deed include:
- all acts and omissions of the director when that director is or was a director or employee of the company should be covered (including those that occurred prior to the date of the deed);
- D&O insurance should remain in effect (or be replaced) and apply for a period after the director ceases to be a director or employee of the company; and
- the director may, for an agreed period after ceasing to be a director of the company, access and inspect company documents which are relevant to and will assist in defending any claim or proceeding brought against the director.
Interplay of indemnity and insurance
It is good practice and there is a general expectation from insurers that a company with D&O insurance will adequately indemnify its directors.
It is also important to have valid indemnities in place in case of any issues in relation to the D&O insurance cover, particularly given the reduced scope and restrictive conditions that currently exist in the D&O insurance market in New Zealand, as discussed further below.
Extent of cover
Central to an effective D&O insurance policy is the extent of cover afforded to the directors and officers concerned. Those tasked with arranging cover need to take care when negotiating the terms and conditions, especially in this tightening market. In particular:
- How many directors are covered by the same policy?
- Does the policy cover former directors?
- For a company that is a subsidiary of an overseas parent company:
- Where do the directors of the subsidiary company rank in terms of claims?
- Could the level of cover be exhausted by claims against directors of the parent company or is it a stand-alone cover with a limit applicable to the relevant local directors?
- Given that policies are written on a ‘claims made’ basis, if a claim is not settled for 10 years, for example, would the current policy limit be sufficient?
- How might legal defence costs (discussed further below) rise in that period? Could those costs increase due to an increase in the number of directors and officers over time and the possible need for separate representation?
Further, D&O insurance taken out by a company should include separate policy limits for liability cover and defence costs. This was established by the Supreme Court in the case of BFSL 2007 Ltd v Steigrad  NZSC 156. In this case, investors in Bridgecorp (a finance company) made a claim for insurance money under the company’s D&O policy, which indemnified the directors for any liability incurred to third parties as a result of their actions as directors as well as providing cover for costs incurred in defending civil or criminal proceedings. The Court ruled that the investors claim had priority over the payment of defence costs to directors under the D&O policy. The upshot is that third party claimants will have a charge with priority over all insurance monies payable under policies with a single indemnity for both third party liability and defence costs. This demonstrates the importance of setting coverage limits in a structured way.
It is also important to consider recent developments in the D&O insurance market in New Zealand that have contributed to the restrictive conditions now applying.
Regulatory oversight in relation to directors and officers continues to increase. Recently, there has been a focus on continuous disclosure obligations, scams and fraud, anti-competitive behaviour, privacy and cybersecurity (with the new Privacy Act coming into force in December 2020) and director’s duties, amongst other areas.
In particular, in the recent case of Debut Homes Ltd (In Liquidation) v Cooper  NZSC 100, the Supreme Court considered whether a director was in breach of his directors’ duties under the Act by continuing to trade against the background of an insolvent or nearly insolvent company. A key takeaway from the Supreme Court’s landmark decision is that there will be very low tolerance for directors who trade on insolvent businesses that have little or no prospect of recovery. This decision raises the risks for directors of companies in financial distress. As a consequence, an uplift in premiums and/or reduced scope of D&O insurance is anticipated to balance the elevated risk profile for directors (among other market drivers). You can read our previous article on this Supreme Court decision here.
In this heightened risk environment, directors should take a proactive approach to disclosing relevant information to insurers upon renewal of cover or in the event of a potential claim, i.e., anticipate and notify any circumstances that may give rise to claims to reduce the risk of insurers alleging late notification or determining that an insured had knowledge of potential claims prior to the claims arising.
Further, due to COVID-19, insurers are undertaking more rigorous due diligence about the financial position of a company in issuing or renewing D&O insurance policies, including in regards to solvency, the effect on employees and clients and business succession plans. Where the financial sustainability of a company is a concern, insurers may also incorporate insolvency exclusions in D&O policies. This highlights the importance of keeping company affairs and records in order and up to date.
If you are a director or officer of a company, it is essential to ensure that your company obtains effective D&O indemnity and insurance to protect your governance position and the longevity of the board and the company it represents, particularly given the raised risk environment that directors and officers are operating in today.
We have highlighted some of the key risks and issues to be aware of in relation to D&O indemnity and insurance. It is essential to ensure that indemnities given to directors and officers are in a proper form and the procedural requirements of the Act are followed. For any advice or assistance, including in relation to the preparation of a deed of indemnity and insurance, please get in touch with Sarah Gibbs or Christie Doolin from our Business Advice Team or your usual contact at Hesketh Henry.
Disclaimer: The information contained in this article is current at the date of publishing and is of a general nature. It should be used as a guide only and not as a substitute for obtaining legal advice. Specific legal advice should be sought where required.