As the Indian corporate sector grapples with various issues like high non-performing assets, employee fraud and boardroom disputes, senior management officials and directors are coming under increased scrutiny.
Over the last few months, the country has witnessed various incidents including the winding up of several companies triggered by leveraged balance sheets, the collapse of one of the biggest commodity exchanges in the country, a large financial fraud at a large public sector bank, crisis in the non-banking financial company (NBFC) sector, alleged governance lapses, and conflict of interest issues raised at some of the biggest and reputed corporate house and private sector banks.
With the advent of the New Companies Act 2013 and regulations like Insolvency and Bankruptcy Code (IBC) 2016, the risk landscape for individual directors and officers has significantly changed in India.
The Companies Act, for example, empowers for investors to bring a class action lawsuit or independent directors to be held accountable for civil wrongdoing or encourage whistleblower protection. Hence, the duties, obligations and personal liability of independent directors as gatekeepers of companies has risen significantly under the new regulations, while at the same time, banks are increasingly pursuing non-performing asset (NPA) resolution and instances of public spats among high-profile directors have become more frequent.
Many independent directors have become concerned with new laws and recent court rulings that have resulted in severe fines or even jail sentences. Many have chosen to quit lucrative board positions especially if they suspect some wrongdoing in the company or if company is defaulting on its loans. In this environment of heightened regulatory scrutiny and increased liability and there is no doubt that adequate protection under a proper D&O policy will help directors perform their duties more effectively.
D&O POLICY IN INDIA
D&O insurance has been in India for more than 15 years and is now prevalent among most listed firms and some of the mid-sized firms, especially where there has been private equity or foreign investment. But comprehensive coverage and adequacy of limits remains an issue for the Indian market, as lot of the purchasing is done by procurement rather than through a risk-based approach that assesses the exposure for management.
D&O liability insurance protects individuals in the event investors, employees, regulators or competitors, among other parties, file a suit against them, in addition to the company. Such insurance policies cover any liability arising out of breach of duty, misstatements, errors and omissions, and civil fines and penalties. However, any kind of criminal act (if proven) and criminal fines and penalties are excluded under the policy as the purpose of this policy is not to encourage wrongful behavior.
Because of the ongoing challenges faced by the financial sector have led banks to re-think their D&O purchase limits and its coverage, demand for this insurance has increased. In addition, a directive issued by the Securities and Exchange Board of India (SEBI) in 2018 mandated compulsory D&O policies for independent directors of the top 500 listed companies.
(It must be noted that SEBI has insisted only that companies buy a D&O policy but has left it to the board to decide the quantum of coverage and limits purchased. “With effect from October 1, 2018, the top 500 listed entities by market capitalization calculated as on March 31 of the preceding financial year, shall undertake directors and officers insurance for all their independent directors of such quantum and for such risks as may be determined by its board of directors,” the SEBI directive said.)
Recent Trends
Since early 2019, Indian banks, including public sector lenders, have been looking to raise the limits under their existing D&O insurance policy by up to 50%.
With regard to the corporate sector, demand has been increasing by about 15% to 20% over last year, and given the regulatory mandate to buy such coverage, this growth will likely increase. However, in many cases, the limits taken by banks have been inadequate and in light of recent regulations, they would be used up quickly just to defend allegations made, thereby effectively leaving nothing for civil damages awarded.
The size of insurance coverage in the Indian banking sector varies significantly between private sector and public sector in general. Private sector banks, especially those listed overseas, tend to buy sizeable limits compared to public sector banks—some public sector banks have coverage less than 100 million rupees, although that is changing given the rapidly shifting risk landscape. (It must be noted that, overall, the coverage taken by Indian banks is below median levels compared to their global peers and even other Asian countries who tend to purchase limits that are two to three times higher.)
Overall, the risk of exposure to civil wrongdoing, fraud and class action lawsuits, global regulations like the Foreign Corrupt Practices Act (FCPA) and the U.K. Bribery Act, whistleblower situations, or simply financial misstatements make it imperative for Indian companies to buy D&O coverage in line with what their peers buy internationally.
If companies are not buying adequate limits, then independent directors will remain exposed to such risks. Since these directors cannot buy individual D&O polices, which are not prohibited by Indian regulators, they may need to explore other options. Internationally, many companies do provide for separate dedicated limits for independent directors via Side A policies. This ensures the company does not utilize all the limits when an event takes place leaving nothing to protect its directors and officers.