D&O insurance increasingly important in restructuring

Over the last 12 months, procuring D&O cover for directors whilst a company is going through a distressed financial restructuring process has proven to be, at best, punitively expensive and, at worst, impossible.  Accordingly, directors should consider this eventuality well in advance of renewal dates and plan around it.

Our experience is supported by reports from insurers. For example, according to the Allianz Directors and Officers Insurance Insights 2020, although around $15bn of premiums are collected annually for D&O insurance, the profitability of the sector has been challenged in recent years due to a number of factors including increasing competition, growth in the number of lawsuits and rising claims frequency and severity.

According to Allianz, "the loss ratio for D&O insurance has been estimated … to be in excess of 100% in numerous markets including the UK, US and Germany since 2017". The drivers for this include "event-driven litigation, collective redress developments, regulatory investigations, pollution, higher defence costs and a general cultural shift even in civil law countries to bring more D&O claims both against individuals and the company in relation to securities", it said. Allianz said it has seen "double digit growth" in the number of D&O claims it has received over the past five years.

Insurers are seeing increasing risks and those risks are of course greatest when a company goes into an insolvency process, or undertakes a financial restructuring which seeks to compromise the interests of stakeholder groups.

Given the length of time a financial restructuring typically takes, D&O policies come up for renewal more often than not during the process and brokers are frequently unable to place the cover at all. Where they can, it is likely to be at a significantly greater cost than has been included in the business plan and cash flow forecast approved by lenders. If cover is offered, it is likely to be more limited with lower caps on liability and higher excesses. This frequently leaves directors in difficult situations, trying to consider whether it is in creditors' interests to incur the significant cost, or whether they are willing to take the risk of continuing uncovered.

In distressed situations, directors’ equity stakes or other long-term incentive plans, if they have any, are often completely under water pending the outcome of a successful financial restructuring, so they often have little appetite to take personal risk. Interim chief restructuring officers, who often work on a daily rate without an equity upside, are typically even less willing to take the risk. In light of the rise in claims being brought, who can blame them? 

There are actions directors can take to mitigate their risks in this situation:

Plan ahead 

Allow sufficient time

Securing D&O cover in these circumstances is unlikely to be straightforward, so start the process early. 

The premium is likely to be significantly more expensive and often a significant increase on the amounts in cash flow forecasts. It may therefore be necessary to seek lender approval, which may also take time. 

If cover is unavailable, directors will need time to consider alternative support (see below) before the expiry of the existing cover.

Information

The more information that can be provided to insurers on the prospects of success of the restructuring, the greater the prospects of getting cover. Information around cash flows, lender support, voting lock-ups etc. will be particularly relevant.

Include a significant uplift in D&O premium costs in cash flow forecasts.

Indemnity from the company

A company may provide an indemnity to directors to the extent allowed by the Companies Act 2006, which precludes indemnities for liabilities:

• to the company itself, where the company sues the directors;
• for fines for criminal conduct or fines imposed by a regulator; and
• other liabilities, such as legal costs, where the judgment (criminal or civil) goes against the director.

So a company can give an indemnity for any or all of the following:

• directors’ legal costs in civil claims brought by a third party, even if the judgment goes against them;
• costs of any damages or award made against a director if they lose civil claims brought by a third party;
• directors’ legal costs if they are acquitted in criminal proceedings; and
• directors’ costs in fighting civil proceedings brought by the FCA.

A significant limitation on the effectiveness of an indemnity from the company is that claims against directors commonly arise when the company has failed and is accordingly unlikely to have the resources to pay in a timely manner or, possibly, at all.

A company’s articles will usually permit the giving of these indemnities but it is a mistake to think that an indemnity in the articles is all that is required. A separate commitment should be provided.

Indemnity from a parent or other group company

Although the Companies Act limitations also apply to associated companies, this may have benefits if the indemnifier is at a lower risk of insolvency or has deeper pockets.

Corporate benefit issues may be more difficult here, especially if the proposed indemnifier is not a parent company.

Indemnity from the secured creditor or other relevant stakeholder

Even better, but less likely to be deliverable, is an indemnity from a third party, typically one with a stake in the outcome of the restructuring, such as a secured creditor. Whilst that may be commercially unlikely from a Bank, it can be possible from a sponsor or debt fund investor, especially if the board includes their nominee director(s) who are not otherwise willing to continue.

Options where no insurance or indemnity cover is available

Continue without cover

Directors may be willing to continue without cover.  If they do so, they should:

• Increase focus on high risk areas. What is high risk will depend on the nature of its business but may include issues such as on-going trading decisions, regulatory obligations, securities laws, health and safety rules and environmental law;
• Take detailed advice in all risk areas.

File for a protective procedure, such as administration

If no directors are willing to continue and it is not possible to appoint alternatives that are so willing, there may be no alternative but to file for a protective procedure such as administration. Directors will need to consider the interests of creditors and other stakeholders carefully in taking this step.

Resign

Individual directors may wish to resign from the board if others are willing to continue.

Summary

The availability of D&O cover is becoming increasingly difficult for all companies and has become acute for all companies trading in financial difficulties. As such, boards and their advisers undergoing a financial restructuring should anticipate and plan for a D&O renewal in good time and take steps both to increase the likelihood of cover being available and to mitigate risks for the company in the event that it is not.