Should insurers settle a directors’ obligation to repay defense costs after criminal conviction?

gavel and open book

With the threat and reality of high profile white-collar criminal proceedings being brought against directors of very large companies in the U.K., it’s worth highlighting one extension of cover under directors and officers (D&O) liability policies that may not receive the attention it deserves. If it operates as it should (and it’s untested as far as I know) it might just spare directors some additional unpleasant financial consequences of a conviction where such conviction stems from their role as office holder.

Regular readers of my D&O blog will know that one of my favorite themes is the general need to approach D&O policy extensions policy with caution. Often they can be difficult to understand and insufficiently related to the core purpose of D&O policies, which is to protect individual members of management from liability. Occasionally, and on close inspection, extensions can also effectively amount to limitations of cover masquerading as enhancements. Examples in this category may include pollution and corporate manslaughter “extensions,” joined more recently by their cyber risk cousins, but that is a subject for another day.

The statutory clawback extension

The extension I have in mind is fairly widely accepted by insurers, but by no means universal. It tends to be referred to in unpromising sounding phrases such as “statutory clawback of defense costs” or similar. To understand the point behind them, the best starting point is the provisions under English company law governing the circumstances in which a company may and may not indemnify its directors.

The relevant rules are set out in sections 232 and 234 of The Companies Act. These provide that companies may advance defense costs in criminal proceedings, but not from the point at which the director concerned is convicted. A conviction is deemed under the Act to be “final” after the time for any appeal has elapsed or, if an appeal is underway, when it’s finally disposed.

What this means is that a company is entitled, but not obliged, to advance defense costs to a current or former director facing criminal proceedings.

The sting in the tail and the protection

The Companies Act provisions go further and require that the company MUST claim back from any individual who is subject to a “final conviction” all the money paid to the individual so as not itself to be in breach of Section 234. This is where the statutory clawback extension comes into play. It provides that when a director is faced with a demand from the company to repay defense costs which is triggered by a final conviction, the D&O insurer will step in and reimburse these funds to the company on the individual’s behalf.

D&O policies typically contain dishonesty exclusions. Would the dishonesty or other criminal conduct exclusion operate so as to deny cover under the extension? Much will depend on the language used. Many such exclusions operate on the basis that until “final adjudication,” all defense costs will be paid. That is probably in line with English law public policy, which would prevent someone from recovering indemnity in respect of his or her own dishonest conduct after the point at which such conduct had been established or admitted. How does this sit with an extension which, only comes into play (if at all) after a “final conviction”?

Conclusion

Of course the lawyers’ refuge here is that everything will depend on the precise wording both of the insurance contract and indeed on the nature of the individual director’s often contractual obligation to repay the company. Having said that, there might be the basis for a respectable argument that insurers must have intended to provide some cover in granting the extension. The argument would run that such cover is not necessarily inconsistent with the dishonesty exclusion because it operates to relieve the director of a contingent liability to repay costs that pre-dated the conviction, whereas the exclusion is focused instead on costs incurred after the conviction rather than before it.

It might further be contended that the extension would not necessarily defeat The Companies Act requirement that companies claim back funds from individual directors. On the contrary, it would provide the company with reassurance that shareholders’ funds would be replenished in the event and to the extent it was necessary to operate the clawback. We shall have to wait and see whether any of these arguments are ever deployed in court but in the meantime, if I were a director this would be one extension I would prefer to see in my D&O policy.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Directors & Officers, Insurance | Tags: ,

Leave a Reply

Your email address will not be published. Required fields are marked *