COVID-19 creates new D&O claims risk

Directors & Officers
The COVID-19 outbreak is affecting the risk of litigation against Directors and Officers as potential plaintiffs scrutinise the way the board manages the company through the coronavirus crisis. While US courts have received the first securities class actions against company directors, the majority of lawsuits for UK companies are likely to focus on alleged mishandling of insolvency procedures.

Directors and officers (D&O) insurance policies provide protection for company board members, executives and managers from claims or investigations arising from their decisions and actions within the scope of their regular duties. COVID-19-related lawsuits may be launched by shareholders, competitors, customers, vendors, suppliers, employees or regulatory authorities.

 

Directors need to take difficult decisions

The coronavirus outbreak is putting management under immense pressure to take wide-ranging decisions that protect the interests of the workforce, the business itself as well as clients and wider stakeholders under constantly changing circumstances. Necessary decisions may include enabling staff to work from home, shutting down production, taking out a loan to bridge a period of squeezed cash flow or making staff redundant to reduce cost as revenues decline. 

To support businesses in these difficult times, governments around the globe have introduced a variety of support measures including guarantees for corporate loans, grants covering up to 80% of the salary of workers to avoid layoffs and tax relief measures.

 

The increased risk of wrongful trading

If it is difficult to identify the precise point in time at which insolvency cannot reasonably be avoided under normal circumstances, now it has become even harder. 

Revenues are under pressure for many companies and clients may be slow to pay bills. Further, there is uncertainty as to when restrictions are going to be lifted. A director who continues with normal trading past a point when liquidation or administration cannot be reasonably avoided
may be liable for wrongful or (more unusually) fraudulent trading. 

Broadly speaking, a claim will only likely arise if it becomes clear that the company or its creditors and shareholders are worse off as a result of the continuation of trading. While one aspect to consider is solvency, e.g. the availability of sufficient cash flow and an ability to pay debts when they are due, directors also need to consider the future financial prospects of the company. 

 

Securities class actions in the US

For companies listed in the US there is also the threat of potential securities class actions claiming that directors were negligent or breached the fiduciary duties to the corporation in their response to COVID-19. 

An early lawsuit has been filed at the US District Court, Eastern District of Pennsylvania (McDermid v. Inovio Pharmaceuticals) against Inovio’s CEO alleging that the company made misleading statements about the development of a purported vaccine for the novel coronavirus, artificially inflating the company’s share price and resulting in significant investor losses after the alleged false statement was exposed by a company called Citron Research.

In another case a shareholder of Norwegian Cruise Lines filed a securities class action lawsuit in the Southern District of Florida against the company, its CEO, and its CFO, alleging that Norwegian made false or misleading statements in filings with the SEC that downplayed the current and potential impact of COVID-19 on Norwegian's operations and concealed information regarding Norwegian's response to the virus.

Companies regulated by the Securities and Exchange Commission (SEC) are required to “provide investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments.”

In response to a coronavirus-based loss in value, directors and officers may find themselves targets of claims that the company disseminated false or misleading information or omitted material facts, such as risk factors of coronavirus, in required disclosures or failed to update disclosures, resulting in shareholder loss.

 

Notifying insurers on potential claims

D&O policies typically require companies to provide notice of a claim during the policy period in which the legal claim is filed. Those policies also give insureds the option to report circumstances that may reasonably be expected to give rise to a claim in the future. Where there is dissent communicated by the company’s stakeholders or scrutiny from any regulatory authority, Directors should consider notification of circumstances where the situation suggests that there may be a reasonable expectation of a claim under the policy. It is recommended that policyholders seek to tailor such notification to the requirements of their D&O policy with the assistance of external legal counsel to set out details of why the notification is being made, and to refrain from submitting a general blanket notice of “coronavirus circumstances” as there is a significant risk that insurers will reject such notices.  

D&O Policies typically require notices of circumstances to contain specific information, including:

• The probable claimant and defendants.
• The wrongful acts that would be alleged.
• The date the company learned of those acts.

If there are changes in those specific circumstances, companies should consider updating the notification.  

If the insurer accepts the notice of circumstances, any future claim will be deemed to have been made during the policy period in which the insured submitted the notice of circumstances and any related claims and costs would fall to the same policy year.

It is possible that insurers may respond to blanket coronavirus notifications by refusing to accept them due to lack of the specificity required under the policy terms, and impose an exclusion at renewal. Therefore, any notification must be carefully considered. Greater emphasis should perhaps be placed on the importance of maintaining continuity with insurers, to minimise the risk of claims falling between any gaps between one policy period and the next.


Consequences for the D&O insurance market

Potential claims arising from the COVID-19 breakout are likely to further reduce insurers’ appetite for growth in D&O risk and the immediate impact of the pandemic is already noticeable at renewals. Insurers are introducing specific question sets relating the company’s exposure to the virus in order to assess their preparations. In the event that the questions are not addressed to the satisfaction of D&O insurers we are seeing Covid 19 exclusions imposed on renewals.

 

Short-term impact of COVID-19 on D&O renewals:

• Increased scrutiny on the financial health of a company, application of more insolvency restrictions.
• Questions around COVID-19 preparedness both from a business continuity perspective but also how the company is looking after, and communicating with, its employees.
• Some insurers are applying a CoVid-19 exclusion across the board meaning that market capacity is further squeezed; restructuring programmes could minimise the impact of coverage restrictions.
• At least one insurer has ceased to consider new business whilst they review their book and their longer-term strategy.
• Expect longer sign off/approval process at insurers and therefore longer lead times for renewal quotes.
• Expect a reluctance to extend cover, even for short periods.

Whilst the insurance market is well placed to continue functioning as near to normal as possible by taking advantage of quoting and binding risks electronically, it will inevitably take longer to renew placements over the coming months. The situation is constantly evolving and Lockton strongly recommends binding cover layer by layer as terms are confirmed, to lock in quotes as soon as possible. 

For further information, please contact: 

Jo Newman
Account Executive, Global Professional & Financial Risks 
Tel: +44 (0)20 7933 2674 
Email: jo.newman@uk.lockton.com

Or:

Michael Lea
Partner, Global Professional & Financial Risks
Tel: +44 (0)20 7933 2669 
Email: michael.lea@uk.lockton.com
 

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