For when things go wrong: directors and officers insurance and indemnities

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By Andrew Egri, Lawyer

 It is clear that officers of not-for-profit organisations contribute a great deal to their cause, often at a personal cost. In addition to their investment of time and energy, officers are also authorised and expected to take risks on behalf of their organisation.

It is good governance to protect those who are exposed, as officers, to risk on the organisation’s behalf. Indeed, many officers will insist upon comprehensive protection by their organisation.

Organisations can bear much of the financial burden should their officers be threatened with legal action through the use of:

  • indemnities contained in the organisation’s constitution;
  • Deeds of Indemnity, Access and Insurance; and
  • directors and officers insurance (D&O Insurance).

1. Indemnities in Constitution

Officers are often indemnified under their organisation’s constitution in respect of personal liability. The constitution may also provide for D&O Insurance. However, officers should review those provisions carefully, as in some cases, the constitution may simply provide that the organisation may, rather than does, indemnify officers. Careful review will also reveal how broad an indemnity is provided.

Officers, however, should be mindful of the limits to the effectiveness of an indemnity in a constitution. Those limitations include that:

  • the constitution can be amended by members, without the consent of the officer;
  • the constitution is arguably only enforceable by current, and not former, officers; and
  • the indemnity provisions in the constitution may be out of date or lack sufficient scope.

2. Deed of Indemnity, Access and Insurance

To provide them with greater protection, officers should require that their organisation enter into a Deed of Indemnity, Access and Insurance with them. The deed sets out the basis for the organisation to indemnify the officers for personal liabilities and associated legal costs which result from their role as an officer.

A Deed of Indemnity, Access and Insurance operates in a comparable manner to the organisation’s constitution. It has, however, a number of advantages, including that it:

  1. requires any amendment to be agreed between the organisation and officer;
  2. may be enforced by both current and former officers; and
  3. may also provide the officer with access to documents and D&O Insurance, during and after the period they hold office.

 2.1 Specific limitations and obligations

2.1.1 Public Companies Limited by Guarantee

Under the Corporations Act 2001 (Cth) and the Competition and Consumer Act 2010 (Cth), a company is prohibited from indemnifying an officer for liabilities:

  • owed to the company, for example a breach of duty owed to the company;
  • for certain specified penalty orders and compensation orders;
  • arising out of fraudulent, dishonest or criminal behaviour, or conduct involving lack of good faith; and
  • for legal costs to the above matters, where the officer does not successfully defend the claim.

These limitations are a major reason why D&O Insurance is necessary. Without sufficient coverage, officers are exposed in respect of the liabilities listed above.

2.1.2 Incorporated Associations

Victorian associations are required, under section 87 of the Associations Incorporation Reform Act 2012 (Vic), to indemnify their officers from liability for activities they undertake in good faith on behalf of those associations.

While associations incorporated in other States and Territories are not under the same obligation, in many cases it will still be appropriate to enter into a deed. A small association may determine that the risk is not at a level that requires the protection of a deed in addition to the indemnity contained in its constitution.

2.2 Issues to consider when preparing Deed of Indemnity, Access and Insurance

Not all indemnities are the same and organisations as well as their directors should at least consider the following issues:

  • The deed should be primary. That is, that the indemnity can be called upon without first needing to determine whether a claim may be made under the D&O Insurance policy.
  • The degree to which the organisation maintains control over the conduct of legal action brought against an officer.
  • Whether the indemnity is subject to a monetary cap. The indemnity contained in a deed usually provides the officer with unlimited coverage.
  • The length of the period covered. It is common for a deed to respond to liabilities incurred by officers regardless of when a claim is made.
  • Officers should give attention to any provision in a deed which reserves the right for the organisation to revoke the indemnity or to amend it without the consent of the officer.
  • It is important that the constitution and the deed are consistent, to avoid disputes over the different provisions in the two documents.
  • Whether the officer is given the specific right to select his or her own legal representation, irrespective of cost, when they defend a claim made against them.

3. Insurance

D&O Insurance is an important part of the protection afforded to officers as it addresses the gap in coverage given the various prohibitions on indemnities.

D&O Insurance commonly has three ‘sides’ of coverage:

  • Side A provides the indemnity for officers;
  • Side B provides reimbursement to the organisation for its indemnity of officers; and
  • Side C provides cover to the organisation directly for securities transactions.

3.1 Specific limitations

A company is prohibited from paying an insurance premium for an officer’s:

  • wilful breach of a duty to the organisation;
  • improper use of his or her position to gain a personal advantage or cause detriment to the organisation; or
  • improper use of information to gain a personal advantage or cause detriment to the organisation.

3.2 Issues to consider when selecting D&O Insurance

D&O Insurance policies can differ substantially among providers. When comparing policies, consider the following issues:

  • When the legal fees will be paid and whether the officer is entitled to select their own legal representation. Some policies reimburse defence costs once the claim is resolved while others advance costs as the proceedings progress.
  • Whether the policy contains an “insured v insured” exclusion, which excludes claims brought by one insured against the other. This exclusion was intended to prevent the manufacturing of claims where officers in breach of a duty to their organisation may resolve to sue themselves in order to get damages for which the organisation is insured. However, some policies instead contain a “consensual claims” exclusion, which excludes any claim which is brought with the assistance of participation of the insured against whom it is brought.
  • The degree to which the coverage offered by the policy is restricted by other exclusions, such as professional services, or personal injury or profit.
  • Whether the policy contains a severability clause which provides that the fraud of a single officer will not adversely impact the cover available to other innocent officers.

4. Summary

In summary, officers need to ensure that they are adequately protected under a variety of mechanisms. Often, this will include a deed of indemnity, access and insurance. Further, not all indemnities are the same and officers should carefully review their coverage and seek legal advice if clarification is required.

For further information, please do not hesitate to contact us.

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