[By Varun Akar and Ashuthosh V]
The authors are students at the Institute of Law, Nirma University.
Introduction
Directors[i] and Officers[ii] (D&Os’) are considered to be the heart and soul of the company as they make crucial decisions for running the company smoothly. Such people are highly qualified, experienced, and well-versed with the affairs of the company. In the aftermath of the Kingfisher, PNB, L&T scams, etc., the role of D&Os’ has been given importance to improve corporate governance and reduce the possibility of financial fraud.
They undertake the responsibilities which are in the interest of the company for maximizing its profits. However, while carrying out such functions, they are susceptible to certain risks which may make them jointly or severally and personally liable for the losses or harm suffered by the company. Moreover, they also have the duties towards various stakeholders such as shareholders, creditors, customers, etc. as mentioned under Section 166[iii], breach of which would result in claims against them. Hence, there arises a need to protect them from unnecessary claims.
Companies Act, 2013 provides for D&O Liability Insurance under Sections 197(13) and 149(8) r/w Schedule IV. The provisions do not mandate a company to take the insurance, however, it is recommended to have a D&O Insurance to indemnify the injuries suffered except for fraud, wilful misconduct, bribery, insider trading, etc. Section 197(13) enables a company to take insurance on behalf of D&Os’ to indemnify them against any liability arising out of default, misfeasance, negligence, breach of duty & trust. Also, premiums paid by the company to the insurer shall not be considered as a part of the remuneration paid/payable to the D&Os’, however, if they are proven guilty for acting contrary to any provision given under the Companies Act, 2013, the same shall be considered as a part of their remuneration.[iv] Section 149(8) provides for the manner of appointment of Independent Directors which may or may not consist of D&O Insurance.
Key Features of D&O Insurance Policy:
A D&O Insurance covers the repercussions arising out of decisions or actions taken by D&Os’ in the natural course of business, i.e, managing trade in the normal routine[v] as per the object clause in the memorandum. However, in some cases, the benefits of these policies are extended to the employees by including them in the definition of ‘Insured Person’. Such policies are available to current, incoming and retired D&Os’ of a company or its subsidiaries. The company receives the money from the insurer only if the claim is made during the policy period within which the policy is in effect and therefore, enforceable. Such a policy period is usually for 12 months but it may extend on the mutual agreement between the parties.
A D&O Insurance policy shall have the following indemnification clauses;
- For the protection of the personal assets of D&Os’ from being used to satisfy the claims against the company. This clause shall be enforceable when the company does not indemnify its D&Os’ against any claim. Therefore, such cover directly protects personnel from personal liability.
- For indemnifying a company to the extent that it covers the litigation expenses and cost incurred by the company on behalf of its D&Os’.
- For providing indemnification to a company for its securities claims. This is the only clause that protects a company for its liability, distinct from the liability of its D&Os’. It provides coverage only against claims made by shareholders against the company because of an action of offer, sale, or purchase of securities. Therefore, such cover is often taken by listed public companies.
Benefits of D&O Insurance Policy:
- It enables the company to hire and retain qualified and experienced D&Os’.
- Protects the directors and the company from the unprecedented and high litigation cost and expenses against claims made by the stakeholders and also prevent invocation of personal liability in case of defaults.
- It facilitates the personnel to take risky decisions with confidence in the interest and growth of the business.
- Improving better corporate governance practices by providing coverage only in cases of genuine defaults or negligence, and not wilful defaults or fraud.
- It provides compensation for the harm caused to the reputation of the personnel during the litigation.
Lastly, the amount of coverage shall vary in each D&O Insurance policy based on relevant factors such as the nature and size of the business, the line of business, industry or market conditions, associated risks, and “penalties provided in the Companies Act, 2013“.
Possible Impacts on D&O Insurance after enforcement of Companies (Amendment) Act, 2020
The Ministry of Law and Justice on September 28, 2020, brought in significant changes through the Companies (Amendment) Act, 2020 in the penalties of the personnel under a variety of sections of Companies Act, 2013. Few of which are mentioned below[vi]:
- The penalties provided under Section 135 of the officers has been amended from the imprisonment up to 3 years and fine which may range between Rs 50,000 – Rs 5,00,000 to a new reduced penalty of 1/10th of the amount required for the CSR or Rs 2,00,000 whichever is less and with no imprisonment.
- The penalties in case of delay in filing of financial statements with the registrar under Section 137 has been reduced from a minimum of Rs 1,00,000 and a maximum of Rs 5,00,000 to Rs 10,000 and Rs 50,000 respectively.
- Penalties under Section 167 for vacation of Office of Director has been reduced from imprisonment of one year or fine of Rs 5,00,000 or both to only fine of Rs 5,00,000.
- For the contravention of the provisions of Chapter XI, the penalties under Section 172 have been reduced from a maximum of Rs 5,00,000 to Rs 1,00,000.
Similar reductions in penalties have been made under various sections.
The above reductions constitute a material change in the policy. Materiality is the basis on which the insurance company decides whether or not to go ahead with the policy. Every fact which has an impact on the risk-bearing shall constitute a material fact. Further, any decision of the insurance companies to accept or not to accept the undertaking of the risk after assessment in a contract of insurance shall be a material fact.[vii] Hence, if any changes are there in the material fact then the contract of insurance can be repudiated.
Thus, reductions in the penalties of the personnel shall be considered as a material change of risk as such risk is the determining factor based on which a D&O Insurance was granted. Further, the sum assured in the policy needs to be re-evaluated because the valuation of the risk now is much lesser than it was at the time of taking the policy.
Moreover, Section 62 of the Indian Contract Act, 1872,[viii] provides for the principle of novation and alteration of the contract. The Effect of Novation is that the parties choose to rescind the old contract and substitute it for a new contract, whereas, in alteration, the parties alter the contract altogether. Thus, under both, the original contract between the parties need not be performed.[ix] This is beneficial if the parties mutually decide to make a new agreement altogether or can make certain amendments in the existing contract relating to the sum assured and premium paid.
The Calcutta High Court in Juggilal Kamlapat v. N.V. Internationale opined that the novation should be made in the situation wherein the modification to the old contract must go to its root and change its essential character. It is considered that the sum assured is the most essential credential in a D&O Insurance Policy as the insurer will decide the same after assessing the risk of the D&Os’. Thus, any change in the sum assured can be said to be a modification to the old value and can change the essentials of the D&O Insurance Policy which can lead to novation of the contract of insurance.
The Andhra High Court in V. Kameswararao & Ors. v. M. Hemalathammarao & Ors., held that the material alteration affects the rights and liabilities of the parties and can only be made with the consent of both the parties. Thus, any change in the risk assessment can materially affect the rights and liabilities of the parties and can be resolved by altering the sum assured or the premium amount in the existing D&O Insurance policy.
Conclusion
Uday Kotak Committee on Corporate Governance directed that the D&O Insurance shall be mandatory, w.e.f. October 1, 2018, for Independent Directors of the top 500 companies in India, the quantum of risk & sum assured of which will be decided by the Board. It was also suggested that Section 197(13) should be made mandatory for all the listed companies as the other D&Os’ were equally vulnerable. Further, a good D&O Insurance policy will help D&Os’ to work efficiently, without the fear of facing any unnecessary liabilities, towards the growth of the company.
Lastly, the implications of any change will depend upon the content of the insurance policy. If it has been explicitly mentioned that the outcomes of the policy shall not be affected by any statutory change or any other change, then the policy will continue to exist in its original essence as agreed earlier by the parties. But if the same does not find any place in the contract of insurance then the outcome may depend upon the further negotiations of the parties with regards to the novation or alteration of the contract.
Endnotes:
[i] The Companies Act, 2013, §2(34), No. 18, Acts of Parliament, 2013.
[ii] The Companies Act, 2013, §2(59), No. 18, Acts of Parliament, 2013.
[iii] The Companies Act, 2013, §166, No. 18, Acts of Parliament, 2013.
[iv] Umesh Pratap, Is D&O Liability Insurance Mandatory, The D&O Diary (October 11, 2020, 4:14 AM), https://www.dandodiary.com/2016/07/articles/international-d-o/guest-post-india-is-do-liability-insurance-mandatory/#:~:text=Directors%20are%20liable%20personally%20to,in%20managing%20the%20Company’s%20affairs.
[v] Bryan A Garner, Black’s Law Dictionary (8th ed., Thomson Reuters 2004).
[vi] The Companies (Amendment) Act, 2020, §27, 28, 34 & 35, No. 29, Acts of Parliament, 2020.
[vii] Reliance Life Insurance Co. Ltd. v. Rekhaben Nareshbhai Rathod, Civil Appeal No. 4261 of 2019.
[viii] Indian Contract Act, 1872, §62, No. 9, Acts of Imperial Legislative Council, 1872.
[ix] R.S. Amarnath Mehra & Co. v. Union of India & Ors., 51 (1993) DLT 455.