Of course, startup founders shouldn't be risk-averse. Nevertheless, risk management is also an essential part of starting a business. For this reason, among others, startups are often founded as corporations. This is intended to limit the liability of the founders or management. However, a corporation doesn't always serve as a shield against personal liability. Managing directors, board members, supervisory board members, etc., can quickly find themselves liable with their personal assets, possibly even through no fault of their own. Directors & Officers insurance (D&O insurance for short) is an important component of risk management for limiting and outsourcing liability.
What is Directors & Officers Insurance for?
Despite the establishment of a corporation (UG, GmbH, AG, etc.), claims for damages can also be made directly against the managing directors, executive boards, supervisory boards, etc., for example, in cases of breaches of duty. The corporation is not a protective shield in this case. The personal assets of those affected are at stake. D&O insurance is ideal for controlling the consequences of this personal liability. D&O insurance is a liability insurance policy. This means that the focus of this insurance is to reject or satisfy third-party claims for damages.
In the event of a claim for damages, the insurer will cover the costs up to the amount of the coverage agreed upon in the policy. This applies not only to the actual payment of the claim, but also to legal advice and other defense costs, including expert witness and court fees. Some policies also cover the costs of additional services.
For D&O insurance policies for board members of stock corporations, the deductible is regulated by law. Currently, it is at least €10,000 of the loss per claim, up to a maximum of 1.5 times the annual fixed compensation. This deductible can also be fully covered by additional insurance, known as excess insurance. No such regulation exists for managing directors, authorized signatories, etc., and the amount of the deductible is contractually determined.
Special D&O insurance options are often beneficial for startups, as the risks and probability of loss occurrence for each risk category differ significantly from those of established companies on the market. D&O startup insurance products thus enable startup management to benefit from this coverage as well.
Directors and Officers insurance policies operate according to the claims-made principle. This means that insurance coverage must exist at the time of the claim in order to be eligible for the insurance. This has the advantage of providing unlimited retroactive cover. This means that all claims for damages are covered, even if the reason for them occurred before the insurance policy began. The disadvantage of this principle, however, is that when the insurance coverage expires, for example, due to cancellation, the insurance coverage no longer exists.
Maintain control through personal D&O insurance
In most cases, the company is listed as the policyholder in Directors & Officers insurance. This form of insurance is called corporate coverage. It insures all executives within the company. In the event of a claim, the coverage amount is available to all affected parties. This is a positive aspect. On the other hand, the available coverage amount per claim is not distributed evenly among all affected parties; instead, every euro spent on one affected party reduces the available coverage amount for all other affected parties.
Another limitation of corporate coverage is the lack of control over the insurance. Control over the contract lies with the policyholder, i.e., the company. Therefore, the insurance coverage often becomes void upon leaving the company. Control over the insurance can also be quickly lost in other cases. For example, if an insolvency administrator is appointed in the event of insolvency, they may terminate the insurance coverage without consultation.
Complete control over the insurance is possible with supplementary personal D&O insurance. In this case, the individual is the policyholder and pays the insurance. In the event of a claim, the agreed coverage amount of the personal D&O insurance is fully available to the individual. The insurance coverage also extends to other mandates held outside the company, for example, supervisory board membership in another company.
External liability and internal liability
The directors and officers are protected against both internal and external liability in the event of breaches of duty or allegations of such breaches. Importantly, the liability can be based on what is known as directors' and officers' liability. Directors' and officers' liability means that all members of a company's governing body, such as the management or the board of directors, can be held jointly liable.
In terms of internal liability, D&O insurance protects the affected group of persons against claims for damages from persons associated with the company, including shareholders and other investors. Protection against claims from third parties outside the company, known as external liability, is also included. This also covers claims for damages from the tax office or social security funds. Furthermore, D&O insurance also provides protection against claims for damages under the General Equal Treatment Act (AGG).
Conclusion
Startups, in particular, should address risk management at the outset of their business activities. D&O insurance limits the consequences of personal claims against management, both internally and externally. However, the appropriate form of D&O insurance and the amount of coverage depend on a detailed risk analysis.
Dennis Galla is Managing Director and one of the founding partners of InPignus GmbHInPignus GmbH specializes in the protection of professional and commercial risks, particularly for small and medium-sized businesses and industry.
