As we covered in the article, D&O explained, directors and officers are required to perform specific duties in their roles. In performing these duties, directors may be held personally liable should they fail to fulfill those duties or sued for allegedly failing to fulfill those duties.
There are three tools available to directors and officers for protecting their personal liability. These tools fit together to become a comprehensive indemnity and insurance program. The three tools are:
- Corporate Bylaws
- An Indemnification Agreement
- D&O Insurance
Indemnity is key to understanding the structure of a D&O policy. Therefore, it is essential for insurance brokers, underwriters, and directors and officers to understand the purpose of each of these tools and how they work together.
1. Corporate Bylaws
Each company has its own unique corporate bylaws which spell out rules and guidelines on how the corporation will run. Included in the corporate bylaws are specifics about when, where, and how the organization will and will not indemnify its directors and officers. Sometimes people confuse corporate bylaws with articles of incorporation. While these documents both include necessary information about the company and directors, they are not the same document. The corporate bylaws are a far more comprehensive document.
Provincial, state and federal regulations establish what an organization may or may not do in terms of indemnifying its directors and officers. While the corporate bylaws may be unique to each company, they are in line with provincial, state, and federal regulations.
2. Indemnification Agreement
The dictionary defines ‘To Indemnify’ as
- To save harmless;
- to secure against loss or damage;
- to give security for the reimbursement of a person in case of an anticipated loss falling upon him.
- Also to make good; to compensate; to make reimbursement to one of a loss already incurred by him.
An indemnification agreement is the first line of protection against liabilities for corporate directors. The indemnification agreement may be a separate document or may be embodied in the corporate bylaws or articles of incorporation.
An indemnification agreement states when and how a director or officer will be indemnified by the organization. The indemnification agreement may contain a D&O insurance requirement as a provision. You can think of the indemnification agreement as part of the employment or engagement contract between the corporation and the director or officer. Indemnification agreements, like employment agreements, vary and may be negotiated.
Even when corporations purchase D&O insurance, indemnification agreements are critical for directors because they are broader than insurance policies and do not contain a policy limit.
3. D&O Insurance
A D&O policy stipulates how much and when the corporation will be paid in the event of a covered claim by the insurance company. The goal is for the insurance policy to indemnify the organization when it indemnifies its directors or officers (as per the indemnification agreement), and indemnify directors directly when the corporation cannot indemnify the directors and officers.
D&O insurance policies, like all insurance policies, contain exclusions and restrictions, as well as a policy limit and subject to a deductible or retention.
Assuming the corporation is financially able and legally allowed to indemnify the directors, the indemnification process looks like this:
Remember, there are situations where the corporation may be unable to indemnify the director, such as in the case of bankruptcy. In these cases, the D&O insurance policy responds by indemnifying the directors directly. Such a situation triggers the policy’s non-indeminifiable loss insuring agreement, also called Side A coverage.
Now that you are familiar with indemnification have a look at the D&O policy structure article!
