1

Sources of Liability
A reputed, publicly owned Automobile manufacturer is sued by his Customers
who were burned when their car exploded when faulty fuel tank ruptured in a
rear- end crash

The regulatory authorities ask the Company to withdraw the Cars

The Company fires Employees in the Fuel Tank division who then
sue the Directors and HRD Manager for wrongful termination

Expenses
Product As a result of various lawsuits, the Company’s share
Recall price drops sharply, then an investor holding five
shares sues the Directors for compensation for
Bodily financial losses on grounds of mismanagement
Injury Loss of
Earnings Financial
Product Will a D&O Policy Respond ?
Losses
Liability EPLI
2
 Sources of
The Automobile Manufacturer – under severe financial strain due to all Liability…
these suits – blames on the Vendor who designed the faulty fuel tank
and sues for compensation.
The Company fires Employees in the Fuel Tank division who then sue
the Directors and HRD Manager for wrongful termination

As a result of various lawsuits, the Company’s share price drops sharply, Financial
then an investor holding five shares sues the Directors for compensation Injury
for financial losses on grounds of mismanagement

Loss of
A reputed, publicly owned Automobile manufacturer is sued by his Customers who were
Earnings burned when their car exploded when faulty fuel tank ruptured in a rear- end crash

EPLI The regulatory authorities ask the Company to withdraw the Cars

Prof. Financial
The Company fires Employees in the Fuel Tank division who then sue the
Directors and HRD Manager for wrongful termination
Neg Losses
Expenses

Product As a result of various lawsuits, the Company’s share price

Errors D&O Recall drops sharply, then an investor holding five shares sues the
Directors for compensation for financial losses on grounds of
& Bodily mismanagement
Omissions Injury Loss of
Earnings Financial
Product Will a D&O Policy Respond ?
Losses 3
Liability EPLI
4
Need for E & O
Ask these Questions…..
Could your client suffer a significant economic loss
(with no bodily injury or property damage) due to a
failure linked to your product, service or advice ?
Does your business provide advice for a fee to
others ?
Are special training, education, licensing
requirements and/or skills generally required of
people in your business ?
Does your business provide a specialized service to
your clients ?
Do you consider your business a High-tech firm ?
Does Technology play a key role in some part of the
product or service you provide ?
5
Basis of E&O Claims

Tort Contract

Statute

6
Tort

Tort

Intentional Un-intentional

Negligence

7
Contract

Compensatory
Damages
Contract Nominal
Damages

Consequential Liquidated
Damages Damages

8
9
To whom the duties are owed ?

Shareholders

Employees Customers

Company

Director
Competitors Public

Government Regulators

10
A Company though a legal entity, cannot Directors having been entrusted with
Duties of the Directors
act by itself. It can act only through its
Directors and as such the relation of a
the affairs of the Company are Trustees
of the Company and therefore they are
Director with the Company is that of
Principal & Agent .
To The Company in a Fiduciary Relationship with the
Company
**** Ferguson Vs Wilson, 1866. Honesty
3 Duties
**** Forest of Dean Coal Mines, 1878.
Trust Good
Faith
With the care an ordinary man
Obedience
would take in the same Director Loyalty
With the skill one
circumstances on his behalf
would expect from
someone of his
Interest of the
particular
Company
knowledge takes
and
precedence
experience
Ultra vires
Dutyactivities
corporate of Care Diligence Duty of Skill
are to be avoided

11
Content of the principle of good faith and prudence

Loyalty,
including
Co
nf prohibition o
id n
en competition

Ca goo er”
tia

a “ n ag
m

re d
lit

a
y

of
dete e
Cor ining Rea
com rests

s
of t onable
inte

rect
rm

he b n
usin ess
t
pan
h

ess
ly

risk
Bal

Co l re
y’s

leg
of in ance

mp qui
a
in t terest
h

lia rem
s
of b e cour

nc
adm usine se

e w ents
inis ss
trat

ith
ion

12
 Potential Allegations
Failure of Supervision Inaccurate statements Errors in
of the Company of financial conditions Annual Accounts

Lack of judgment,
Mismanagement
Conflict of Interest Diligence or
Of Funds
Good-faith
Unauthorized or
Misstatements in
Allotment of Shares Imprudent loans or
Prospectuses
Investments
Unwarranted dividend
Imprudent expansion Using inside
Payment, Salaries or
Resulting in a loss Information
Compensation
Misleading Statements
Misrepresentation in Wrongful Dismissal
Filed with
Mergers & Aquisitions Of an Employee
Stock-Exchanges

13
(D)DEFENCES

Business Judgment Rule

Due Diligence
Acted reasonably in the
circumstances
Decision made without fraud,
illegality, or conflict of interest
Good Faith Reliance Defense

14
Directors Duties…
Shareholders

To ensure that advice /

recommendations given to
shareholders in respect of their
holdings is given carefully and in
their interest

15
Directors Duties…
Creditors

In the context of winding-up

16
Personal Liability of
Directors and Officers
Corporate directors and officers rely on two forms of protection
when it comes to risks they assume:
 Corporate indemnification - which can be:
 extremely difficult or time consuming to obtain

(limited to certain alleged actions only, or can only

be approved by shareholder vote after many years
have passed since the claim was settled); or
 non-existent (forbidden in many countries or due

to bankruptcy of the company

 Forbidden by law - US SEC law forbids

indemnification for SEC violations and new US

SEC statements indicate that the SEC may
require individual defendants who settle with
them to agree to forego their right to corporate 17
indemnification
When does the “Corporate Veil” get breached to reach out
to the personal liability of the “Men in Blue” ?

18
Personal Liability of
Directors
Directors who can be shown to be personally
involved may be unable to take shelter
behind the veil of incorporation
UK Rulings…..
A Director who personally directs and
procures the company to a tort is himself
liable to the victim in tort no less than the
company
If a Company faces a liability for breach of
trust or fiduciary duties, a Director may find
himself liable as an accessory to such breach

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 How D&O Insurance Works ?
Claim Against Directors / Officers
Side ‘B’ Cover Side ‘A’ Cover

Yes Can the Company No

Reimburse ?
Company pays the Director / First Dollar payment by D&O
Officer the Legal Liability + Insurer including
Company bears
D & O Insurer Pays
Defense Costs Defense Cost ( if covered ) Individual
D & O Insurer D&O
bears
Loss in excess of Pays Loss in excess of
Insurance Limit (if any) Insurance Limit

Indemnity Limit /
Company bears Insurance Limit Indemnity Limit /
Insurance Limit
Policy Excess /
Company Retention
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Policy Coverage..Loss
definition
Indemnity provided iro D&O’s Legal Liability for
 Damages awarded against D&O in a court of law or agreed

pursuant to a bonafide settlement

 Costs of representation and defence in civil or criminal

proceedings
 Costs of representation if required to attend an official

investigation or inquiry into the affairs of the Company

Public policy considerations generally preclude
indemnity for “punishment”
Criminal, fraudulent, dishonesty, or malicious
acts are excluded

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Policy Coverage - Insureds
Directors & Officers of the Company
including newly appointed after policy
inception
Company definition includes subsidiaries
(over which it has control) – Only Insuring
Clause A (D&O Indemnification) would apply.
The D&O estate, heirs, legal representatives –
in the event of death/insolvency of insured
Spouse (not for wrongful acts but for joint
interest in property etc.

22
Coverage – shareholders
actions

Shareholders sue Directors

alleging improper financial
statements presentation
Coverage ?
 Major shareholding exclusion

likely – moral hazard

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Coverage :
Insured V Insured
The Company itself or a group of
Directors could sue the technical
Director following losses on product
withdrawal
Exclusions :
 Insured V Insured

 Company V Insured

 But Derivative Actions are covered

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Policy Coverage :
Insured V Insured
Now, suppose the company goes bankrupt and
liquidator appointed to manage the affairs of the
company, then institutes suits for recovery
against Directors on grounds of wrongful trading
 Is the liquidator now regarded as an Officer of the

Company ?
 If so, would such suits fall foul of the Insured V

Insured exclusion ?
Case law suggest that this exclusion should not
be made applicable to claims by liquidators

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Policy Coverage –
Severability
D & O policies normally provide
for severability of coverage, ie a
claim against one director is
treated as specific to such
individual, unless another Insured
is shown to have been actively
involved or can have knowledge
or action imputed to him.

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Policy Coverage –
EPLI
If EPLI is bought as an extension to
the D&O Policy
The Directors could have
protection.
Awards could be significant in EPLI, and
if available only as an extension to D&O
Cover , would erode limits of indemnity
available to Directors

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Policy Coverage –
Pollution Liability
A pollution liability extension to the D&O
policy would not cover injury or Property
damage, neither fines or penalties and
would at best be limited to say, shareholder
actions for drop in share prices following a
pollution incident
Stand alone Pollution cover may
suit Companies better

28
Policy Coverage –
some other extensions
Entity coverage :
 Became popular in the soft market conditions
 To cover situations where D&Os and Company are

subject to action as joint tortfeasors in securities

action / employment practices
This avoided the “allocation” problem
However, it could cloud the coverage in event of
bankruptcy
Limits need to be set higher as a Company claim
would exhaust cover

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Policy Coverage –
some other extensions
Subsidiaries : including those created
after policy inception
 US subsidiaries excluded
Outside Directorships :
 for Directors sitting on boards of other
Companies, subject to declaration
This is available in excess of the cover
afforded by the “outside” company

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Policy Coverage –
some other extensions
Crisis Communication, Risk
Management
 Should a Director, apprehending a

claim, require urgent legal advice on

his position, responsibilities and
potential liabilities

31
Policy Coverage –
prior declaration
The following events if initiated after policy
inception need to be declared and information is
to be provided to underwriters for acceptance and
binding cover
Stock Offering / IPO
Take-over or Merger :
 the policy would otherwise only cover
wrongful acts committed by Insured persons
prior to the date of Take-over / merger

32
Policy Coverage –
Costs
Advancement of Defense costs and
expenses prior to claim settlement /
award is normally allowed under the
policy conditions
 This is subject to repayment of such expenses
by insureds, severally, should claim be found
inadmissible.

33
Policy Coverage -
Exclusions
“first-party” losses –
 Company V Insured,

 Insured V Insured

Property Damage, Bodily Injury

Breach of professional duty is excluded
Actions arising out of administration of
pension / superannuation schemes
Taxes, fines, penalties, punitive /
exemplary damages

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Policy Coverage -
Exclusions
Principals of professional practices (lawyers,
accountants) sitting on Company Boards do
not have coverage under their professional
indemnity policy
Write back of defense costs for pollution
claims; successful defense in action for fraud /
dishonesty / malicious conduct
Failure to maintain insurance is excluded
USA specific exclusions –
 ERISA Act

 Section 16 (b) of SEC Act 1934 (profits from

purchase / sale of securities )

35
D&O Exposures
in India
ADR’s
US Subsidiaries
Non-US investors have
successfully argued for US legal
jurisdiction based on merely on
US SEC filings

36
D&O Exposures
in India
Bankruptcy of companies – not
very significant in India – strict
winding up regulations
Securities Act violations – could
emerge as significant source for
D&O liability
More stringent reporting /
disclosure requirements by SEBI

37
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39
 D&O - ROW v U.S.
Litigation environment - significant differences
ROW
Cases tried before judges
Difficult to bring Class Actions
Derivative action not frequently
brought (Colombia)
Punitive damages nonexistent
Loser pays rule
Contingency fees not frequently
used (but increasing)
No Plaintiff’s attorney bar
Non-litigious culture - changing
due to foreign investment and
CNN
United States
Cases tried before jury
Class actions frequently
brought
Derivative actions brought
High severity with punitive
damages
No loser pays rule
Use of contingency fees
Effective plaintiff’s attorney
bar
Culture - suing as a way of
doing business/a way of life
40
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42
 Corporate Governance
What is Good Governance?
“A strong independent and knowledgeable board can make a
significant difference in the performance of any company. Our
corporate governance guidelines emphasize the qualities of
strength of character, an inquiring and independent mind,
practical wisdom and mature judgment. It’s not an accident that
we put strength of character first. Like any successful company,
we must have directors who start with what is right, who do not
have hidden agendas and strive to make judgments about what is
best for the company and not about what is best for themselves
or some other constituency.”

Kenneth Lay, Chairman & CEO of Enron

(excerpted from speech at the 1999 Conference on Business Ethics)

Source: Board Governance Services

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 Corporate Hall of Shame
Company Problem Potential Charges

D&Os created complex

Securities Fraud
outside partnerships that
kept billions in losses of Insider trading
Enron’s balance sheet; Perjury
Accused by CA of
manipulating energy
market

Lax oversight of Guilty of obstruction

some client books, of justice
conflicts of interest, Individual partners
shredded documents may be liable

Inappropriately
accounted for $3.8B Fraud
in expenses, inflated
profits
44
Accounting Problems are Getting
Many Companies into Trouble
•Enron was tip of an iceberg
•Major implications for insurers (p/c and life)

45
 The Risk of Being a Director
• Frequency has increased 137% over past 7 years
 18.5% of all public companies have been sued
Source: National Economic Research Associates

• Severity has increased 459% over past 7 years


Industry’s loss costs are more than 5x 2001 premiums
Source: National Economic Research Associates

• Risk of restatement has increased 184% over past 6 years

 14.6% of all public companies have restated
Source: Huron Consulting Group

• Risk of bankruptcy has increased 198% over past 6 years

 10.2% of all public companies have declared bankruptcy
Source: BankruptcyData.com

46
U.S. Securities Claims -
Frequency

Nearly 20% of all US Securities

claims brought in 2002 were
brought against non-US
companies. This is up from an
average of 5% in the preceding
years 1996-2000 and 15% in 2001.

47
U.S. Securities Claims - Severity

Indemnity only

Average settlement value of U.S. securities class

action (not inclusive of defense costs):
 in 2001 - $17.2M up 250% from 1996 ($6.9M)

 in 2002 - $19.9M up 275% from 1996

 first half of 2002 - $25.1M up 370% from 1996

48
U.S. Securities Claims -
Defense Costs
Defense costs
Average 20%-40% of indemnity payment, but can
vary widely
 Defense costs incurred for U.S. securities claims are

increasing dramatically as a result of many factors,

including protracted motion process, complexity of
the cases (accounting issues), inclusion of WW
shareholders, multiple class actions (US ADR holders
and shareholders outside the US)
 which means more attorneys and more billed

hours.
 (e.g. D&Os of Enron could incur as much as $70M

in defense costs alone) 49

50
US Securities Class Actions Against Non-
U.S. Companies 2002- by Country

7
6
5
4

3 2002

2
1
0
Bermuda Ireland UK Singapore

51
US Securities Class Actions Against Non-
U.S. Companies 2003- by Country

2.5

1.5

0.5

0
Netherlands Switzerland UK

52
US Securities Class Actions Against non-
U.S. Companies 2002/2003- by Industry

13% 4%
Electron
Commun
9% Bio Tech
35% Financial
4%
Software
4% Metals
Med Equip
9% Tech
Conglomerate
13% 9%

53
US Securities Class Actions Against non-U.S.
Companies 2002/2003- by U.S. Exchange/Market

17%

4% NYSE
49% NASDAQ
Amex
OTC

30%

54
US Securities Class Actions Against non-
U.S. Companies 2002/2003- by Allegation

6% 14%

Acc Fraud
29% 11% M&A Related
Revenue Rec
Non-Dislosure
False&Mislead
Breach of Duty
26%
14%

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