D&O Insurance - Why South African directors risk their homes and savings when promoted

Congratulations, they say. You have been promoted.

Company car, petrol card and possibly, unlimited liability. Sorry, the last bit is bad news for the house you have been paying off since you were twenty.

I do exaggerate. Slightly.

If your job lets you approve budgets, hire, fire or generally say yes on behalf of an organisation, you have moved into a different legal duty neck of the woods. These titles come in many forms like directors, executives, officers and managers. You may get your coffee served with cream and a leather chair. It does not necessarily mean you are personally liable, but you are now close enough to the decisions that you should assume you are financially exposed, until a professional risk practitioner proves otherwise. Your risk clock is running the day you accept the appointment.

This is where Directors and Officers insurance or D&O, enters the fray. Insurance people have an annoying habit of giving useful policies names that mean diddly squat to Joe Schmo. D&O. It sounds like a law firm from the 1970s. Something like “Decision Makers Legal Risk” would at least give you a clue and probably save 10 minutes of explanation.

D&O generally protects directors and officers against personal financial loss arising from claims where they breached their duties in managing the organisation, including fiduciary duties and the duty to exercise proper care, skill and diligence.

Bored? Thought so, I got bored writing it.

One word is doing more barking than your dog. Fiduciary. It comes from Fiducia, which is the Latin for trust and attorney speak for fancy words that cost money. The root word is Fido, which literally means “I trust.” So, in addition to being entrusted to exercise proper care, skill and diligence, a manager or officer is also expected to behave like Fido the dog. Charming.

D&O has always struck me as insurance with an image problem. Motor insurance has cars. Marine has ships. Cyber has bad hooded men typing malicious green code in dark rooms. D&O has Section 76 and a bunch of agreeable middle aged people in a boardroom nodding at each other while the minutes get typed. Not exactly Netflix material. Which is unfortunate, since rhythmic nodding is where the claims come from.

You can see why nobody thinks it is worth paying premium for. Which is a pity, since it is one of the few policies a business buys to protect the personal balance sheets of the people running it. The Companies Act 71 of 2008 did not invent these duties, but it did put a fair amount of them in writing. Act in good faith and in the best interests of the company. With care, skill and diligence.

Then Section 77 explains, in less comforting language, when personal liability may attach. One, if you participate in reckless trading. Two, if you approve something unlawful. Three, if you sign off on something you should not have. In plain English, there are some decisions you are allowed to get wrong. There are others the law expects you to have got properly right. One and two are standard no no’s insurance wise. Three is where D&O cover may shine.

So, eureka, there you have it. All the company’s problems have your surname on them. And your life savings. And that beautiful house.

Now, this does not mean every manager who makes a bad call loses the Range Rover, the holiday house and is forced to move in with ma in law. Business involves judgement. Sometimes you get it wrong. That does not automatically make you negligent. If it did, no one with personal wealth would ever go near a boardroom.

Cue the D&O stereotypes. If the image in your mind is the cigar smoking captains of industry, who have misplaced R400m in Mauritius, you have missed the mark by a country mile.

The claims and cases I come across are duller than that. Duller, unfortunately, is the problem. It is usually those groupthink pesky decisions that go pear shaped. And that, for my money, is where we fool ourselves. Where everyone says ja and nobody says nee and somehow this is passed as a strategic board resolution. It is the corporate version of the Mzansi braai argument that starts with “just one more and I will stay” and ends with someone sleeping in the garden. Everyone is nice. No one out of some sense of Saffer brotherhood wants to be the difficult one. Three months later the minutes are in the High Court and a grumpy judge is asking why not a single person said “wag ‘n bietjie.”

The least glamorous part of D&O is, in my view, the most valuable. Defence costs.

Most people think liability insurance exists to pay the amount at the end of a court case. In D&O, the costs before the final settlement are often more likely and more personally expensive. Say somebody sues you personally for twenty million Randelas. Fido did not see this coming either. The claim may be frivolous and you may well win. Your big problem is what proving your innocence costs. Senior counsel do not generally accept Discovery Miles or eBucks. And even if they did, you would need heaps of them.

A decent policy pays the lawyers, while the allegation is being fought and often advances them before the case is decided. This is gold dust where fraud is alleged.

In civilized societies, fraud is not something one can insure. And Saffers are pretty civilized, most of the time. But an allegation is not a conviction. A proper policy can pay the defence costs while that gets sorted, with the fraud exclusion usually kicking in only once there is a final finding or an admission.

Venator Africa v Bekker, which eventually reached the Supreme Court of Appeal as Venator Africa v Watts, gives this some local flavour.

Two directors faced a personal claim of some R41.4m over allegations connected to a fraudulent VAT scheme. The court did not find the directors innocent. It found that Venator had used the wrong legal route to hold them personally liable. This was a technical win, not a moral one. So, these very relieved directors never needed to find R41.4m out of their own pocket to pay someone in damages. They needed to pay lawyers capable of making the claim go away, whether they deserved to win or not.

This judgment was not an insurance case. That is the point. Sometimes the most valuable thing a liability policy provides is not the settlement. You can be innocent, guilty or somewhere unpleasantly in between. You still need a lawyer to resolve this.

There is another trap lurking in the policy. One director does something dishonest. And the other six know nothing about it. A poorly constructed policy can turn one skelm into the whole board’s problem, wiping out cover for everyone, innocent or not. Here is another word that is doing more barking than your dog, Fido. Severability.

It means one insured person’s dishonesty is not automatically imputed to the innocent ones. A robust D&O wording will say, in black and white, that one insured person’s knowledge or misconduct will not be pinned on any other insured person.

This is generally standard across the market. Some insurers cover severability properly. Others just hope you do not ask. So check. And even the strongest severability clause will not save directors who knew and said nothing, it only protects authentic ignorance. Not intentional silence.

Invariably, no one asks about it at renewal. Everybody is too busy haggling over the premium like it is a Waterfront parking ticket. This is where you need a proper risk advisor, a professional who starts with risk analysis first and deals with the premium last.

How many Saffers have no D&O insurance at all?

Stats SA puts the managerial population at roughly one and a half million. This suggests a substantial majority of smaller to medium sized businesses have no D&O at all or have an insufficient sum insured. Using conservative assumptions you get around a million Mzansi people with real personal financial exposure and no insurance parachute.

This is an estimate, mind you, halve it if you like. Half a million is still a hell of a lot of houses.

Do not make the mistake of a proxy vote when making insurance decisions, especially catastrophic liability or asset insurance. A business client once told me his attorney said they did not need D&O. I said, fabulous, please ask them to put that in writing. As far as I know, the letter was never received. Maybe the attorneys realized they needed D&O cover too? Advice becomes extraordinarily more cautious and well informed when somebody has to put their own name at the bottom of the email.

Ironically, failing to properly insure the business can itself become a question of care, skill and diligence. Leave a R100 million factory uninsured against fire and expect a personal liability backlash when the building goes up in smoke. D&O is no different in principle, the issue is not whether you bought a policy, but whether you properly identified and considered the risk.

How does one set the sum insured?

There is no magic formula for a D&O limit. Start with the number of directors, officers, managers and other decision makers who are exposed, then increase it for business complexity and the potential severity of claims (trustees face a similar exposure, which is usually dealt with under trustees liability rather than company D&O).

A serious D&O dispute can easily chew through R2 million to R5 million in legal costs. That is a larney flat in Sea Point, plus three kids through varsity, res fees and all. Take a complex matter through the High Court and on appeal, add senior and junior counsel, attorneys, preparation, experts and a costs order if you lose and R5 million can vanish before anyone has paid a cent in damages or said hello to Jack Robinson.

Also, remember that the limit is usually shared and defence costs will eat into it. The takeaway. Buy as much cover as the business can reasonably afford. Unlike a building, you do not know in advance how big the claim will be, how many people will need defending or what the lawyers will cost.

Two answers I get, usually from well intended Saffers. I did nothing wrong, so nobody can sue me. Nope. Anybody can sue you and doing nothing wrong is a position you have to prove, at your own expense. Over the next three years.

And the other one. The company has cover, so I am hunky dory. Lekka.

Possibly. The better question is whether the policy protects you properly. Some of them do, more or less and can be found filed away gathering dust with the lease and the POPI policy. Would suggest you dig it out now. Not at claim time.

And other common questions include, are defence costs inside the limit or on top of it? And what happens when the company goes belly up and cannot meet its obligations and you are the one left holding the can?

And the one I would ask first. Is the sum insured adequate to defend all the decision makers before considering the settlement award?

If you are the oke who approves the deal, signs off the accounts or tells the room that ja, we should probably proceed, then the company is not the only balance sheet at risk. Yours is too.

So is your beautiful house and your beautiful life. Stapled to the minutes.