Directors and Officers Liability Insurance

Introduction

Directors and Officers (D&O) are considered to be the heart and soul of the company as they make crucial decisions for running the company smoothly. Such people are highly qualified, experienced, and well-versed with the affairs of the company. They undertake the responsibilities which are in the interest of the company for maximizing its profits.

However, while carrying out such functions, they are susceptible to certain risks which may make them jointly or severally and personally liable for the losses or harm suffered by the company. Moreover, they also have the duties towards various stakeholders such as shareholders, creditors, customers, etc. breach of which would result in claims against them. Hence, there arises a need to protect them from unnecessary claims.

Section 166 of the Companies Act, 2013 (“Act”), mentions about the fiduciary duties of the directors which inter-alia includes that the director shall exercise his duties with due and reasonable care, skill and diligence and should not attempt to achieve or attempt to achieve any undue advantage either to himself or to any of his relative. If the director takes the undue advantage, then, it shall be held liable to pay an amount equal to that gain to the company and he shall be liable to pay fine which may extend to Rs. 5,00,000/-.

Liability can also arise under other statutes, including the Income Tax Act, 1961, Central Goods and Service Tax Act, 2017, the Foreign Exchange Management Act 1999, the Factories Act 1948, and various environmental and consumer protection laws. Each of these laws carries its own definition of who is the “deemed person in default” and this frequently includes the directors.

Furthermore, as an increasing number of Indian firms go international, through both inbound and outbound investments, companies and directors are increasingly exposed to risks driven by changes in legislation, regulation, and heightened shareholder activism in their target foreign investment markets. There are also statutes with extra-territorial jurisdiction such as the US Foreign Corruption Practices Act and the UK Bribery Act.

D&O insurance under the Act

Companies Act, 2013 provides for D&O Liability Insurance under Sections 197(13) and 149(8) read with Schedule IV. The provisions do not mandate a company to take the insurance, however, it is recommended to have a D&O insurance to indemnify the injuries suffered except for fraud, wilful misconduct, bribery, insider trading, etc. Section 197(13) enables a company to take insurance on behalf of D&Os’ to indemnify them against any liability. Also, premiums paid by the company to the insurer shall not be considered as a part of the remuneration paid/payable to the D&Os’, however, if they are proven guilty for acting contrary to any provision given under the Act, the same shall be considered as a part of their remuneration. Section 149(8) provides for the manner of appointment of Independent Directors which may or may not consist of D&O Insurance.

Fraud, as defined under section 447 of the Act, includes any act or abuse of position committed with intent to deceive, to gain undue advantage from, or to injure the interests of a person, company, shareholders, or creditors, whether or not there is wrongful gain or loss.

Under section 150(12) of the Act, an independent director or a nonexecutive director can be held liable under the Act only for acts of omission or commission by a company that occurred with the director’s knowledge—attributable through board processes—and the director’s consent or connivance or where he or she failed to act diligently.

While it is difficult to provide any particular standard that will determine an individual’s exposure to liability, a person will generally be held liable for wrongdoing committed by a company if he or she falls into either of the following categories: 

1. any person who, at the time the offense was committed, was in charge of and responsible to the company for the conduct of its business; or 
2. any director, manager, secretary, or other officer of the company: 

1. with whose consent and connivance the offense was committed, or 
2. whose negligence resulted in the offense.

Liability under the Income Tax Act

D&O can be prosecuted with fines and imprisonment in various cases under the Income Tax Act, 1961 (“IT Act”). Some of the cases are – 

• Failure to deduct tax at source is punishable with imposition of fine to the extent of the amount of tax failed to be deducted. 
• A willful attempt to evade tax may be punishable with imprisonment that may extend up to 7 years with fine under the IT Act.
• Making a false statement in any verification required under the Income Tax Act will be punishable with imprisonment which may extend to 7 years or with fine.

The IT Act vide Section 179, imposes joint and several liabilities on every director of a private company for recovery of tax dues, incase they are not recoverable from the hands of the company. Upon the section becoming applicable, the directors would step into the shoes of the company as an Assessee for the purposes of payment of all taxes due under the IT Act from the company. Thereafter, the provisions of the IT Act, specifically, those relating to recovery would apply on the director as they were applied on the assessee company.

The liability under Section 179 will lie on every person who was, at any point in time, a director of that company for the previous year in respect of which the taxes are sought to be recovered. Further, even those individuals who have resigned from directorship during the relevant previous year or those individuals who were inducted into the directorship during the year would be covered by the provision.  The provisions would equally apply to nominee directors or directors appointed by interested parties like lender/ technology partner, etc.

Liability under Goods and Service Tax 

These provisions come into force when there is an amount due under Goods and Service Tax (“GST”) (tax, interest, penalty) which cannot be recovered from the taxpayer directly. 

Section 89 of Central Goods and Service Tax Act, 2017 states that if a private company does not pay its dues then the directors of the company will become jointly and severally liable for the dues. In this case, only the directors who were in office during the period when the tax was due will be held liable. If a Director can prove to the Commissioner that the non-payment was not due to any negligence or breach of duty due to his part, then he will not be held liable. However, if the company has been converted from a private to a public limited company, then the above will not apply.

Section 137 of the Central Goods and Service Tax Act, 2017 states that an offence committed by a company, the company as well as everyone who is in charge of and is responsible for conduct of business of the company will be held liable and punished accordingly. If it is found that any other person, who may be a Director, manager, secretary or other officer, was also involved in committing the offence, he/she will also be held liable and punished accordingly. There will however be no liability on the person if he/she proves that the offence committed was without his/ her knowledge and he/she had exercised all due-diligence for its prevention.

D&O Insurance Policy 

D&O insurance affords protection to D&O against liability arising from actions connected to their corporate responsibilities. The policy provides indemnity to the D&O in respect of: 

• Legal costs in defending proceedings brought against them alleging wrongful acts. 
• Any damages awarded to the claimants against the D&O, including out of court settlements.

What is covered in a D&O insurance policy 

Side A: This solely protects Directors of the company by paying all the defense cost and settlement which is the result of lawsuits levied on Directors. It will only pay the individual Directors when the entity is insolvent or legally not permitted to do. Side A coverage is the most important matter for corporations. 

Side B: this one indemnifies the entity after the entities have paid the individuals cited in the suits

Side C: this coverage protects the balance sheet of the company and will also reimburse and costs/settlements incurred.

It is to note that policies of D&O can be composed to assure a diversity of perils, but they generally rule out illegal profits, fraud, and reprehensible activity.

A D&O Insurance covers the repercussions arising out of decisions or actions taken by D&Os’ in the natural course of business, i.e., managing trade in the normal routine as per the object clause in the memorandum. Such policies are available to current, incoming and retired D&Os’ of a company or its subsidiaries. The company receives the money from the insurer only if the claim is made during the policy period within which the policy is in effect and therefore, enforceable. 

A D&O Insurance policy shall have the following indemnification clauses;

• For the protection of the personal assets of D&Os’ from being used to satisfy the claims against the company. Therefore, such cover directly protects personnel from personal liability.
• For indemnifying a company to the extent that it covers the litigation expenses and cost incurred by the company on behalf of its D&Os’.
• For providing indemnification to a company for its securities claims. This is the only clause that protects a company for its liability, distinct from the liability of its D&Os’. It provides coverage only against claims made by shareholders against the company because of an action of offer, sale, or purchase of securities. Therefore, such cover is often taken by listed public companies.

Who needs a D&O policy?

Insurance is famous with the quote, “Nobody wants it yet everybody wants it!”

• Businesses with large financial obligations 
• Public and Private businesses with a board of Directors – As general liability and umbrella insurance don’t cover liabilities of the board of directors of the company.
• Non-profit Organizations – to attract quality board members

Some of the specific exposures that make D&O insurance necessary are:

• Vulnerability to shareholder/stakeholder claims
• Sexual harassment, discrimination allegations and other employment practice violations
• Regulatory investigations
• Accounting irregularities
• Exposures relating to mergers and acquisitions
• Corporate Governance requirements
• Compliance with various legal statutes

Exclusions 

1. Any bodily injury, sickness, disease or death of any person or any damage to tangible property
2. Dishonest, fraudulent, criminal or malicious act.
3. Personal guarantee.
4. Libel and slander
5. Personal injury and damage to property.
6. Pollution damage
7. Directly resulting from goods or products manufacture or sold by the company
8. Fines, penalties, punitive or exemplary damages.
9. Any circumstances existing prior to inception date of policy

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Disclaimer:

The content of this article is for information purpose only and does not constitute advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer to relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up. The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that the Author / Treelife is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof.