In the current economic climate, it continues to be anticipated that the climb back out of the economic pit that has resulted from the measures taken to combat COVID-19 will result in significant numbers of insolvencies.
D&O policies are designed to respond when the company becomes insolvent. It is one of the main pillars of Side A cover that the policy should respond to claims made against a director where the company is unable to indemnify the director because the company is insolvent.
In this article, we consider how D&O policies respond to insolvency and whether the measures taken by insurers need to be reconsidered. We are not talking here about insolvency exclusions. Some insurers have, over the last year, sought to apply extremely broad insolvency exclusions to D&O policies. Some insurers do this as a default for all SME business in industries challenged by COVID-19 while in other cases, it is an exclusion which is applied where an insurer considers the risk of insolvency specific to that client is not one that the insurer is willing to underwrite.
The breadth of some of these exclusions can severely limit cover which is intended to be a fundamental part of a D&O policy. However, those underwriting decisions are not what we are focusing on in this article. Rather, we want to look at the fact that some policies contain a built-in limitation in the event of insolvency. In those policies, the appointment of an insolvency practitioner – a liquidator, receiver, administrator, etc – is expressly defined as a “change of control” or a “transaction”. Where these provisions are triggered, the result is usually that cover for the directors (and indeed for all affected insured persons) is restricted to cover for acts and omissions which took place prior to the appointment of the insolvency practitioner.
The problem with these types of provision is that directors’ duties don’t cease on the appointment of an insolvency practitioner.
There are two recent developments which highlight where this could be problematic.
First, in the case of Hunt (as Liquidator of System Building Services Group Ltd) v Michie & Ors1, the court held that, while the powers of a director may be extremely limited on appointment of an administrator (i.e. they can only act with the consent of the administrator), that does not bring their appointment as a director to an end and their duties under the Companies Act and in particular under sections 170-177, do not cease upon the appointment of the administrator (and nor would they cease upon a creditors’ voluntary liquidation).
It is clear that acts and omissions of directors should usually be relatively limited after appointment of an administrator or liquidator and mostly, should be acts and omissions conducted in accordance with the administrator or liquidator’s instructions. However, in the case of Hunt (as Liquidator of System Building Services Group Ltd) v Michie & Ors, the person who was initially appointed as administrator and then acted as liquidator was subsequently replaced with a new liquidator.
Indeed, it is not that uncommon for one insolvency practitioner to be replaced with another – some recent high-profile insolvencies involved a change from one administrator to another. For example, where a company is put into administration following a large creditor calling in a floating charge, if there is a significant pensions deficit, the Pension Protection Fund can exercise its right as the largest creditor to appoint a different firm to act as administrators (and, eventually, as liquidators).
The appointment of a replacement insolvency practitioner brings with it the prospect of that second insolvency practitioner reviewing what was done under the previous insolvency practitioner. However, in those policies where appointment of an insolvency practitioner is defined as a change of control or a transaction, the directors would have no cover for anything they did when the first insolvency practitioner was in power. Whether or not the directors might have a good defence to such situations is not the point – D&O policies should stand behind the directors to allow them to defend allegations brought in those situations.
The new Corporate Insolvency and Governance Act 20202 (“CIGA”) also raises questions about the appropriateness of these provisions. CIGA allows a new moratorium process (similar to the way that Chapter 11 works in the US) whereby the directors of a company remain in control of the company, but overseen by an insolvency practitioner known as a “monitor”. However, as an insolvency practitioner has been appointed, some D&O policies may determine that there is no cover for directors’ acts during the moratorium while they try to save the company.
Both the case of Hunt (as Liquidator of System Building Services Group Ltd) v Michie & Ors and the new moratorium process demonstrate that there are situations where directors will have ongoing obligations despite the appointment of an insolvency practitioner. The question becomes, therefore, is it time for insurers to revisit the restrictions they put on cover in those situations?
Footnotes
- https://www.bailii.org/ew/cases/EWHC/Ch/2020/54.html
- https://www.legislation.gov.uk/ukpga/2020/12/contents/enacted
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