What a D&O policy does

Managers perform a delicate balancing act in their line of work: on the one hand, they are expected to conduct themselves responsibly and avoid risk to the company. On the other, they have to be entrepreneurial, take on risks and constantly navigate uncharted territory.

This brings along with it legal frameworks with a great number of potential pitfalls, such as the German Act on the Appropriateness of Management Board Remuneration or the German Act on Combating Corporate Abuses. Compliance rules must also be kept in mind. In theory the boss also has to ensure that all the regulations in Asia or South America are observed – which is hardly possible in practice. The fact that company directors are occasionally ill-advised and make mistakes is hardly a surprise. When the media reports on mistakes at the executive level, these incidents tend to involve accusations of criminal behaviour, which lead to police investigations and prosecutions as well as civil lawsuits – Siemens, Middelhoff and Volkswagen spring to mind here. It gives the impression that managers are held liable primarily for intentional wrongdoings. In actual fact, however, company bosses usually find themselves in hot water due to unintentional mistakes or negligence that exposes them to civil lawsuits – and they face unlimited personal liability even for slight negligence. 

Rising sense of entitlement 

Lars Heitmann, Head of Professional Risks at Funk and D&O specialist, says of current trends: ‘For years we have been observing a rising sense of entitlement among companies and shareholders toward managing directors. And insolvency administrators add to the mix – they often demand high sums.’ So the number of extrajudicial as well as judicial proceedings due to claims from executive bodies is increasing. ‘The allegation is usually not one of deliberate intention, but of negligence. So we’re talking about oversight and control failures that arise from improper actions by other company employees and executive bodies,’ explains Lars Heitmann. ‘This is an unending minefield of liability – nationally, internationally, and also thematically, since a wide range of legal fields may be involved.’ For this reason, directors and officers insurance, which came to Europe from the USA and is known as D&O for short, has since become securely established on the German market as well. In light of the very real risks of an unintended error, this insurance has become standard in large and small companies. D&O insurance is professional liability insurance for executive bodies that a company takes out for the benefit of its executive members. The insurance cover both provides protection against unjustified claims and settles justified claims (damages and compensation). 

In a vast majority of cases, claims involve internal liability – when the company itself asserts claims against the managing director. ‘Only around ten per cent of damages are incurred through claims from external parties,’ says Dr Sonja Kottnik-Timmermann, D&O expert at Funk. Since the D&O class is relatively new, there is still very little case law and significantly experience in this field than in other classes. At the same time, this class involves situations that are so legally complex that experience with specific cases is necessary in order to come to a well-founded estimate. Lars Heitmann says: ‘Funk is one of the largest brokers in the D&O field. We process approx. 100 new cases every year. Based on this extensive experience, we dynamically and flexible develop our solutions further and adapt them to case law accordingly.’ Heitmann also says that Funk has been successful in positioning its own wording, with Funk’s own mark on it, for decades. Different aspects need to be considered when devising D&O cover: for example, it is important for the cover to be retroactive with no time limits. A sufficiently long reporting period should also be ensured. It is also important for a cost-related proxy regulation for different positions to be legally sound. The installation of international insurance programmes is also becoming increasingly important. This helps avoid implications under tax law and supervisory board law, which could ultimately impact local protection of executive bodies.Another important requirement is that claims must be able to be adjusted locally. ‘In this regard, Funk has an international network in the Funk Alliance, which can support clients where they are,’ says Lars Heitmann.

Current judgement of the German Federal Court of Justice 

While these aspects are part of the D&O standards, a current judgement of the German Federal Court of Justice (BGH) shows just how frequently new concepts are arising on the legal front: in 2016 the BGH ruled that the insured party is entitled to cede their indemnification claim under insurance law to the insured company, which would want to make the insured party liable internally. The benefit of this new approach is that under certain conditions, the insured company is then able to assert both an insurance claim and a liability claim directly against the insurer (making it a ‘direct claim’). This is linked to process uncertainties on the one hand, because case law has not revealed any judgements so far on the specific design and effects of a direct claim. The manager must also consider whether they want to cede their indemnification claim. After all, the manager’s obligations to the insurer remain in place in this case, but the manager can no longer influence the implementation of the insurance claim. On the other hand, this procedure can also be a practical route to adjusting the claim. An example of this is provided here: a company sues a managing director because he conducted a bad audit in the course of a corporate purchase (‘due diligence’). But since the managing director had enjoyed years of success with the company, the company does not want to get rid of him despite the mistake. If the managing director cedes his claim to the company, the company can then assert its claims directly to the insurer. Otherwise the company would need to sue its managing director, even though it still wants to continue working with him. ‘The Funk wording contains a corresponding clause that opens up a route for this procedure to take place,’ explains Lars Heitmann. Overall, says Lars Heitmann, numerous details have been added to the D&O field in previous years, whereby the broker must represent the claims of the client against the insurer and must have well-founded knowledge to do so. 

A mix of interests

One peculiarity of D&O cover that always needs to be considered in practice is that the company takes out the insurance, but the manager is the insured party. In the event of a claim, then, a mix of different interests arises. Above all, in addition to having a good legal overview, a special touch is needed to navigate this triangle of interests of the company, the manager and the insurer. These cases naturally tend to be emotionally loaded. Yesterday everyone was happily working together, but today someone is being sued – and tomorrow they may want to work together again if the circumstances allow. ‘Our role as a broker here is to be a moderating force and balance the legitimate interests in the mix, always with knowledge of the legal situation,’ explains Dr Sonja Kottnik-Timmermann. 

Insured sum should be sufficiently high 

The trend in this country is clear: the German D&O market is one of the world’s largest – after the USA. At the moment the premiums are still relatively affordable, but they could increase significantly in the foreseeable future, because insurers are hardly covering their costs currently due to previous major claims. Lars Heitmann recommends setting a sufficiently high insured sum in every case. After all, claims can come to hundreds of millions of euros. Examples of such huge claims include well known cases such as DaimlerChrysler, Lufthansa or Siemens. Only around five per cent of all D&O claims actually fall into this category. ‘But if a small-to-medium-sized company is affected, then we are quickly talking about a total loss scenario,’ says Heitmann. Cost drivers are usually legal costs because proceedings can stretch on for years. 

Accompanying criminal defence insurance

Keep in mind, though, that D&O insurance does not cover all conceivable claims in relation to mistakes or misdeeds by managers. For this reason is it a good idea to also take out criminal defence insurance. This insurance provides protection in connection with proceedings in investigations and prosecutions. It also covers costs when it is not the manager but the company itself that is investigated, for example due to a suspicion of cartelisation or environmental damage. In particular, the costs of the sanctioning instrument of fines must be considered here. Criminal defence insurance also covers the costs of assessors or internal research.

09.07.2020