Personal wealth at risk?

D&O Insurance: The Answer?

Personal wealth at risk?
In the last few months, we have been confronted daily with news headlines about managers’ "performance” and their role in financial scandals, involving companies thought to be solid titans of the market.

We were surprised by the recent collapse of several financial companies and institutions in the US (Lehman Brothers, Merrill Lynch, Citigroup), in Europe (UBS, Credit Suisse, Deutsche Bank, the Royal Bank of Scotland, HBOS, ING, Fortis (FORBBT), Northern Rock) and in Portugal (BPP, BPN, Aerosoles, Qimonda), which have, as never before, generated public discussion of managers’ diligence in carrying out their profession and their accountability as never before.

When we talk about management, in which operating means risk-taking, in which the financial markets’ behaviour is increasingly volatile, the same technically sound management decision can bring success or failure, the manager being either applauded or vilified according to its outcome.

The permissive, forgiving company has given way to a company with exacting standards, aware of its rights and operating according to its responsibilities, with modern companies showing a greater and deeper awareness of making its employees accountable.

In this context, we will certainly see an increasingly regulated market, in which directors’ duties and personal responsibility will increase and become tougher, following the trend already seen both in the European Union, with the publication of corporate governance directives, and in the USA, with the publication of the Sarbanes-Oxley legislation, a tendency that will go hand-in-hand with a greater intervention from the supervisory bodies.

In the latest Society Law revision in 2006, following the European and American lead, Portuguese managers’ duties were intensified, thereby increasing even further the importance of securing and protecting their wealth.

This year, in the USA, SEC increased its scrutiny and Barack Obama has promised a more rigorous approach and regulation. In Portugal the pre-project for the Good Corporate Governance Code, presented in March by the Portuguese Corporate Governance Institute, continues this trend, with a special emphasis on the "comply or explain” principle.

To avoid the excesses and self-orientation of management, in the section on executives’ pay, the code recommends that a part of the variable component be deferred over instalments for a period linked to the proven sustainability of directorial performance.

That component should not represent less than 50% of the variable remuneration for each year, and the deferrable period may not be less than three years.
We all remember the recent news and outcry over the AIG managers’ bonuses, which led to intervention from Barack Obama.

This trend of making managers accountable results also in an increase both in compensation claims against managers, and in the level of compensation awarded.

In the USA, the number of court settlements worth over USD 100 million from actions against managers grew 1.7% in 1998, to 5.2% in 2003, and to 8.1% in 20071, with the number of actions against financial institutions in 2008 reaching the highest level since 2002, totalling over 225 by mid-December 2008, with an increase of 37% expected on 2007 levels, driven for the most part by the financial markets crisis2.

And so managers are right to worry when they take on their role, not only about the risk they face to their reputation, which is now increasingly large due to media exposure, but also to their personal wealth.

In the case of Portugal, managers’ personal wealth is liable without limit, for their actions or omissions, for disregarding their legal or contractual duties, which cause damage, whether to the company, partners or third parties, in carrying out their role. This liability includes communal property through as well as marriage inheritance.

Managers are also criminally liable for damages, and jointly liable to the company for its tax debts when the cause is deemed to fall under his or her mandate. And the directors may be called into court proceedings for tax lien, being liable with their personal wealth.

D&O Insurance: The Answer?

This situation makes protecting the manager increasingly relevant and important. It is in the interests of the society, the shareholders and even the market that managers should feel free and confident to make their decisions, with risk and without the fear of a lawsuit which could compromise their entire personal and family life.

Protecting managers against risks arising from civil liability for acts or omissions incurred in the execution of their role is suitably and effectively solved by transferring that liability to an insurer, through Directors’ and Officers’ Civil Liability Insurance (D&O).

In 2008, due to the increase in the number of compensation claims against managers linked to the financial downturn, demand for D&O Insurance increased, and is expected to continue growing for the next few years.

The objective of the D&O Insurance policy is to transfer to the insurer the civil liability for illicit management activity by managers, or activity which is attributable to them in the execution of their administrative roles.

This guarantee protects property, and covers legal defence costs.
Today, the increasing importance and sophistication of D&O Insurance means that this insurance is an effective tool for management, not only because it allows the manager to undertake more aggressive management, running the risks needed to develop the company without restraining opportunities for expansion, but also because of the ability to contract out protection against typical company risks, like company compensation claims, management crisis (payment to the company for consultancy fees in case of management crisis) and compensations for securities.

Whether for corporate prudence, or for staff interest, D&O Insurance is shown to be important for a "normal and prudent director”, to protect their "at risk” wealth.

Managers’ civil liability: Compulsory guarantee
Following the trend of strengthening third parties’ rights in case of company directors’ and supervisors’ liability, in particular for companies admitted into the regulated market, it was decided under Article 396 of the revised Company Code to require directors and supervisors to bail this liability, having third parties in general as beneficiaries.

a) Minimum value of EUR 250,000 for:
• companies issuing securities tradable on the regulated market;
• the companies fulfilling the criteria of line
(a) of no. 2 of Article 413: companies which are not fully controlled by a securities-issuing company, and which in two consecutive years, exceed two of the following limits:
. total balance sheet: EUR 100,000,000;
. total net sales and other gains: EUR 150,000,000;
. number of staff employed on average during the year: 150.

b) Minimum value of EUR 50,000 for:
• the remaining companies (the guarantee deposit may be waived by authorisation of the Annual General Meeting or the Constitutive Meeting which elects the board or a director and also when it has been specified in the company contract).

The costs of the guarantee cannot have to be borne by the company, except for the part of the indemnity in excess of the minimum fixed value.
Guaranteeing the liability is a pre-condition of the role, and non-fulfilment is punishable by the immediate cessation of duties (no. 4, Article 396 of the Portuguese Commercial Companies Act.).

The Insured must underwrite a guarantee for each role that he or she undertakes.
The insurance policy addresses the legal requirement made in the Portuguese Company Code (CC) regarding the obligation to insure the liability arising from being the head of the administrative or supervisory body within the insured’s company.

Civil liability guarantee: It guarantees payment by the Insurer of the claims legally attributable to the Insured, for damages resulting from illicit activity undertaken in execution of their roles as head of the administrative or supervisory bodies of the company identified in the Particular Conditions, when such liabilities arise from Portuguese Law. Guarantee of the Insured’s defence costs, with specific capital.

By Ana Cristina Borges, Casualty& Financial Lines Managing Director MDS

(1) The Return of D&O: Trends Driving Increasing Costs and Frequency of Litigation Against Corporate Directors and Officers.” The report was released at the annual conference of the Risk and Insurance Management Society Inc. in San Diego
(2) 2008 Trends in Shareholder Class Actions, December 2008, Plancich and Starykc, NERA ("2008 NERA Report”).
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