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Director’s liability insurance

Director’s liability insurance

PUBLICATIONS \ 28.04.2022

Directors & officers liability insurance is a service that is gaining popularity in the Russian market. Andrey Chernyak, Acsour’s Legal Assistant, told what this type of insurance is and what risks the conclusion of such a contract can create for the company.

Today, insurance companies offer businesses a variety of options for protecting the liability of officers. Usually, the policy extends its effect to all the executive management of the organization, from members of the board of directors to managers. This is the most popular product among businesses, although it is possible to provide another option for extending the insurance coverage, for example, to a set of people.

What is the mechanism of officers liability insurance? We will tell you on the example of the Chief Executive Officer. As it is known, the head of the company ensures financial and economic activities, as well as its legality. The position is very responsible, because it is the director who is responsible for the consequences of the decisions taken, the results of the business, as well as for the safety and effective use of property.

The law in each case differentiates who will be responsible for the fault of the CEO. In some cases, it is personally borne by the head, in others – by the legal entity itself, in third cases, joint and subsidiary liability may arise. The most reasonable action on the part of an organization interested in optimal financing of its protection is the director’s liability insurance. The object of insurance in this case will be the property interest associated with the obligation of the business to recover the following losses:

  • director’s expenses, if by law the company itself is not able to recover the losses incurred;
  • expenses of the company in connection with the payment to its CEO on claims of third parties;
  • expenses of organizations on claims brought personally against them in connection with erroneous actions associated with the turnover of securities and the hiring of personnel. It is worth noting that the expenses on defense in the framework of the claims, namely, costs for the services of lawyers and legal experts, can be reimbursed if this is provided for by the insurance contract.

 

TYPES OF INSURANCE RISKS

What are the insurance risks, namely, who and for what can make claims against the CEO? The set of persons is quite wide, for example, it can be participants and shareholders of the enterprise, creditors, government authorities, employees and clients.

Thus, in particular, a shareholder may make a claim in connection with the sale of shares at a below-market price on the recommendations of the director without taking into account the opinion of an independent auditor or in connection with the company’s unprofitable transactions. An employee may make claims in connection with improper performance by the head of the terms of the employment contract. Cases of creditors filing claims in the event of a company’s bankruptcy are common. Usually, the company’s director is accused of negligent actions that led to bankruptcy.

Please note: claims may also be filed owing to the director’s violation of antimonopoly legislation, the use of insider information, mistakes in financial statements, as well as owing to violations of the procedure for conducting large transactions and related party transactions.

These are just a few examples where requirements are applied to the director. Once again, we note that their list is very wide.

 

SPECIAL CHARACTERISTICS OF LEGISLATION

It is important to clarify that the possibility of insuring the director’s liability from mistakes is not mentioned in the Civil Code and other laws. This means that, in compilation with some conditions of standard insurance contracts that contradict the law, such a contract may be declared null and void.

In 2019, the text of the draft federal law “On Amendments to the Federal Laws “On Joint Stock Companies” and “On Limited Liability Companies” was formed. The document was supposed to legislate the possibility of business entities to insure at their own expense the property liability of members of management bodies, as well as other persons.

The explanatory note to the draft described the possible problems of concluding such contracts. The authors of the initiative drew attention to the high risk of recognition of liability insurance contracts as null and void. This type of contract can be qualified as a civil liability insurance contract (article 932 of the Civil Code of the Russian Federation) or as a financial risk insurance contract (clause 23 of article 32.9 of the Law of the Russian Federation No. 4015-1 “On the organization of insurance business in the Russian Federation” dated November 27, 1992). However, these types of contracts do not take into account the specifics of the topic we are discussing.

Moreover, according to article 932 of the Civil Code of the Russian Federation, risk liability insurance for violation of the terms of the contract is allowed in cases provided for by law. At the same time, under the contract of risk liability insurance for violation of the contract, only the risk of liability of the policyholder himself or herself can be insured. A contract that does not comply with this requirement is null and void by virtue of the above rule. Because of this, the probability of recognizing liability insurance contracts of officers as null and void increases, since such a contract is not directly provided for by law. Also, companies do not insure their own risk, but the risk of members of management bodies, which directly contradicts article 932 of the Civil Code of the Russian Federation.

But the difficulties with this type of insurance do not end here. Even if the possibility of using such a contractual structure is recognized, there is a high risk of courts evaluating such insurance contracts as contrary to the rules of clause 5 of article 53.1 of the Civil Code of the Russian Federation. The norm prohibits the conclusion of agreements that exclude or limit the liability of members of management bodies for losses caused to the company by their unfair and unreasonable actions. With a broad interpretation of the norm, it is possible to see the nullity of liability insurance contracts of members of management bodies.

Market experts approve of the prospect of legislative changes. It is assumed that the amendments motivate entrepreneurs, moreover, they do not create an environment in which the price of an error will be covered by insurance payments, if such contracts will compensate only losses incurred as a result of the actions or omission of the director and not related to intentional fault.

At the moment, the fate of the draft is unclear, information about it has not been updated for a long time, which does not prevent insurers from offering liability insurance services to officers. Nevertheless, the very idea of liability insurance is an effective tool when the possibility of concluding such contracts is established by law.

Andrey Chernyak

Legal Assistant