In view of the strict directors’ and officers’ liability as a managing director or board member, it is up to you to take comprehensive precautions. It is important that your company takes out and maintains D&O insurance for you. Your security can be guaranteed by a so-called D&O procurement clause in your service contracts. A corresponding clause for the Supervisory Board should also be anchored in the Articles of Association.
In the following article, you can find out which other parameters you should take into account when designing optimal D&O insurance cover.
I. Strict directors’ and officers’ liability as a reason for the necessity of a D&O procurement clause
Board members who fail to fulfill their duties are liable without limitation with their private assets even in cases of slight negligence. The ARAG doctrine of the Federal Court of Justice (BGH, April 21, 1997 – II ZR 175/95 – ARAG/Garmenbeck) is a driver of directors’ and officers’ liability. Accordingly, the Supervisory Board is generally obliged to assert claims for damages against members of the Management Board. If the company and the board member agree that the company should take out D&O insurance, the existence of D&O insurance cover should be contractually guaranteed in the service contracts by means of a D&O procurement clause. In many employment contracts, D&O insurance cover is dealt with in just one sentence – if at all: “The company undertakes to take out D&O insurance for the managing director or to maintain existing D&O insurance cover.” Such a simple contractual provision only offers deceptive security and says nothing about the quality of the insurance cover.
II Parameters for high-quality D&O insurance cover
The following points should be considered when drafting a D&O procurement clause:
1. selection of the D&O insurer
The selection of the D&O insurer is important, whereby the regulatory behavior is decisive. Statistics from the practice of D&O claims settlement show that in only 7% of reported D&O cases is there a clear liability situation. Around 70% of payments from D&O policies relate to legal costs. More than 90 % of claims for damages are settled. In practice, the loss compensation function of D&O insurance has therefore taken a back seat to the defense and legal protection function.
2. sum insured
Another cornerstone of the insurance cover is the amount of cover. The insurer’s obligation to pay benefits within an insurance period is limited per insured event and for all insured events together to the documented sum insured. In D&O claims involving several insured managers, their claims for cover may exceed the contractually agreed sum insured.
If necessary, the administrator can negotiate a contractual claim to replenishment of the sum insured. However, this presupposes that the D&O insurance conditions provide that the company as policyholder can acquire a new full sum insured for further insured events for breaches of duty not yet known at the time of reinstatement (so-called “reinstatement”).
3. entitlement to transfer of the D&O policy
A D&O procurement clause in the contract of employment should absolutely oblige the company to provide the manager with a copy of the current D&O policy and its terms and conditions. Directors and officers often do not know whether and to what extent the company has taken out a D&O policy for them.
4. quality of the D&O insurance conditions
The terms and conditions of D&O insurers differ greatly from one another. This concerns the quality of the insurance conditions. As the D&O market is constantly changing, the annual renewals should always be reviewed with regard to the quality of the terms and conditions. Particular attention should be paid to the following:
a. Fee guarantee clause
Lawyers specializing in directors’ and officers’ liability usually charge on an hourly rate basis and not according to the German Lawyers’ Fees Act. The quality of a D&O insurance policy is shown in particular by whether the insurer actually pays the lawyers’ fees. The D&O insurance conditions should therefore stipulate that no agreement with the insurer regarding the choice of lawyer and the fee agreement is required if the lawyer is arranged via a lawyer panel accepted by the insurer.
b. Court of arbitration
For complex claims, D&O contractual terms should offer the option of institutionalized arbitration proceedings. The advantage is that in the event of a D&O claim, liability and cover can be bindingly clarified in a uniform procedure. Arbitration proceedings – without a court of appeal – are dealt with more quickly than proceedings before the ordinary courts and are not associated with a public court. When considering the option of arbitration, it should be noted in advance that, in principle, no notices of dispute are possible in arbitration proceedings.
c. Reputational damage
If the determination of liability is clarified in the ordinary courts, the associated court publicity is often accompanied by negative press coverage. If media coverage of a D&O insurance claim threatens to damage the manager’s career reputation, the D&O insurance cover should grant public relations costs as part of the defense costs and cover the costs incurred for the fees of a public relations consultant engaged to mitigate or prevent the reputational damage.
d. Insurance cover for operational activities
D&O insurance policies may contain invisible exclusions of cover. This applies in particular to operational activities. The D&O insurer then refuses to pay benefits, arguing that the D&O insurance only applies to “management decisions” and not to breaches of duty in day-to-day business. If, for example, board members themselves decide on the granting of a loan, the D&O insurance does not cover breaches of duty if operational activities are not expressly included in the insurance.
e. Continued salary payments and severance payments
In D&O claims practice, companies often attempt to offset their alleged claims for damages, which would be insured under the insurance terms and conditions, or to assert rights of retention against claims of managing directors or board members under their employment contracts. This is why high-quality D&O policies include clauses that allow for continued salary payments and also cover severance payments within a sub-limit.
f. Continuity guarantee
If the insurer demands exclusions of cover as part of the annual D&O policy renewal – for example for corruption, antitrust violations or due to cum-ex – and possibly reduces the sum insured at the same time, this limited insurance cover applies retroactively for any breach of duty and subsequent claims for damages are excluded from D&O insurance cover due to the claims-made principle. The continuity guarantee in the D&O insurance conditions excludes this cover-destroying retroactive effect, so that reductions in the sums insured and insurance exclusions only have an effect for the future and possible “inherited liabilities” remain insured. Board members can then counter future liability risks with increased compliance measures.
g. Late registration deadline
If the insurance relationship ends, insured events that occur after the end of the contract within the subsequent notification period remain insured if the corresponding breaches of duty were committed within the term of the contract or the period of agreed retroactive cover. Directors’ and officers’ liability claims expire after five years, e.g. for managing directors of a GmbH and board members of a stock corporation. It should be noted that the limitation period begins to run when the damage has occurred. It is therefore important that the insurance relationship is maintained or, in the event of termination, that sufficiently long subsequent registration periods are stipulated in the insurance conditions.
h. Criminal law protection module
The D&O insurance conditions should include a criminal law protection module. It is not uncommon for a possible breach of duty to result in a preliminary investigation or even a remand in custody. The D&O insurer must then cover the costs of defending these proceedings. The criminal law cover module is usually provided with a sub-limit.
It is important to note that the D&O insurance clause in your employment contract as a board member or managing director is just as important as the D&O insurance itself. It is essential that the drafting of this clause is examined individually by a lawyer. An experienced lawyer can help you avoid pitfalls and ensure that your interests are protected. As recommended by a lawyer, you should also consult an independent insurance broker to get the best possible insurance cover.
Literature references:
Attorney Dr. Burkhard Fassbach and Prof. Dr. Peter C. Fischer, M. C.J. (NYU), Düsseldorf University of Applied Sciences, Die D&O-Verschaffungsklausel im Lichte der aktuellen Rechtsprechung, GWR – Gesellschafts- und Wirtschaftsrecht Heft 8, 2024, p. 123 ff; available at beck-online.de
Attorney Dr. Burkhard Fassbach and Prof. Dr. Peter C. Fischer, M. C.J. (NYU), Düsseldorf University of Applied Sciences, The German D&O Procurement Clause Revisited, guest article in the D&O Diary of May 15, 2024; available here: https://www.dandodiary.com/2024/05/articles/d-o-insurance/guest-post-the-german-do-procurement-clause-revisited/
