Manager liability insurance: mostly worthless for managers and companies?

– Why so-called Directors & Officers (D&O) liability insurance policies often do not cover –


Manager liability instead of risk management

Self-employed persons, i.e. tradesmen and freelancers, often use corporations for their own professional activities. Out of fear of so-called “liability for breaching private assets”, you then have a manager liability insurance policy sold to you in the form of a so-called Directors & Officers liability insurance policy (D&O), instead of first of all better controlling the operational risks by improving the organisation and operating a quality and risk management system. Often the operational risks are not known and sometimes they even emanate from the responsible persons themselves. Then there is the issue of compliance, which everyone is aware of but which is only half-heartedly implemented.


As a rule, the companies have signed insurance contracts in which the insurer is entitled to inspect or have inspected down to the individual document level in the event of a claim, and it also happens that the insurer, together with the investigating authorities, tries to clarify the facts of the case.


However, when an insured event occurs, it is not uncommon for the insurer to have an easy way to avoid paying its own benefits by contesting the contract. This is because the insurer will often later be able to say that, although it negotiated with a bona fide managing director, some other managing director or board member already had important knowledge at the time the insurance contract was concluded, the concealment of which entitles the insurer to contest the contract.


Although this statutory right of rescission is expressly waived in customary manager liability terms and conditions, such a waiver is simply invalid as a deviation from the law, as the Federal Court of Justice (BGH ruling of 21 September 2011, Case No. IV ZR 38/09) has already decided.


Liability insurance costs without effective risk coverage

As soon as business managers are subsequently informed of the ineffectiveness of the stipulation of the insurer’s statutory right of rescission, they will ask themselves why their intermediary had not informed them of this. This hits insurance brokers particularly hard, because they are obliged to examine the risk and the object and are therefore responsible like a guarantor. In practice, questionnaires are usually used. It is decisive that such questionnaires are not prepared by the insurance broker himself, but solely by the insurer, because only his questions have to be answered correctly.


It would be typical, for example, that a person responsible for answering such questions in the company is not aware of all the skeletons in the closet. What would be called for, however, is a major hour of confession for all those affected with the aim of subsequent comprehensive absolution by the D&O insurer. Imagine that the associated documentation feeds the various EDP systems of the insurers and that the now cleansed affected parties do not have the faintest idea who has access to these documents. Due to the legal overall responsibility of the board of directors, no later whining and lamenting will help when realizing that an agreed division of labor in the board of directors and thereby caused own ignorance does not protect from own responsibility.


In addition, insurance intermediaries often ask the customer for the amount of cover by means of questionnaires, without discussing the real need and examining the actual risk in terms of type and amount. Just as with D&O insurance, this procedure is also quite common in the area of liability insurance, for example in the case of pecuniary loss liability insurance and business liability insurance (BGH Sachwalterurteil of 22.05.1985, file no. IV a ZR 190/83). As a rule, however, this question already arises because insurers could considerably limit or extend their coverage with clauses of varying effectiveness. In addition, there are often glaring misconceptions about how high a loss can be that falls within a board member’s area of responsibility. And this is the only explanation for the fact that in the D&O insurance policy for an insurance company the clause was found that damages from the settlement of insurance contracts are excluded.


Incorrect strategic design by insurance of the company

In general, the capacity of the company as policyholder proves to be prone to error, because then the managing directors or board members are only insured persons. Although the company receives the insurance cover, the insurer recourses to the private assets of the managing director or board member, depending on the structure of the insurance cover. In most D&O insurance policies, therefore, an express waiver of recourse is not agreed. For example, an insurer’s standard policies may provide that, in the event of the most serious breaches of core obligations (so-called knowing breaches of duty), the company is indemnified against claims for damages, but that recourse against the responsible insured persons is reserved. The normal case should be that the insurer, on the other hand, will pay the benefit correctly, and then will not take recourse against the insured persons. According to the Insurance Contract Act, however, a benefit is simply excluded in the case of intent, which means that recourse will then also be unnecessary in most cases.

As soon as a later recourse against insured persons is indicated, the insurer will also select a lawyer who is agreeable to him and who also has the recourse interests in mind. Even if intent on the part of the insured person is obvious anyway, the lawyer selected by the insurer will ensure that this is also stated in the court records.


Sometimes new managers, an insolvency administrator or a liquidator take over the management of the company. This leads to a strange behavior between the insurer and policyholder. It may happen that the D&O insurance is terminated immediately for cost reasons and, according to the terms of the insurance, the insurance coverage ceases immediately, for example, in the case of a less expensive claims-made coverage.



Legal extortion for serious damage?

In serious cases, the company makes a claim against the D&O insurer. In many cases, of course, the relevant board member will have to be removed from the company and possibly also from supervisory board functions at banks and insurers. Almost always, the amount of the damage will never be determined exactly, and this will then, for example, be based on visits to brothels, bribe payments or other criminal behaviour, or a third party will be found who has already been positioned in advance and in good time for the role of the future scapegoat. Only if the company has earned something from it – i.e. the expenses have been amortised by the resulting income – has no loss been incurred at all. Illegal behavior can benefit the company. The burden of proving the amount of loss is on the company, but the board of directors is not prejudiced by such ambiguities – if insured. In the case of criminal charges, such as embezzlement or fraud, for example “black funds” (also known as reptile funds), it may be of benefit to the responsible manager if damage cannot even be ascertained expertly in the criminal proceedings, because without concrete damage a criminal conviction will no longer be possible (BVerfG 23.06.2010, Ref. 2 BvR 2559/08 et al.)


In the event of intent on the part of a manager and verifiable damage, the Insurer will only be obliged to pay if this is provided for in the terms and conditions of the insurance. In most cases, recourse against the manager who acted with intent will then be the consequence. Without express inclusion, intent is not insured – but possibly also conditional intent or knowing breach of duty is expressly excluded from the insurance cover. However, some insurers promise to pay even if the individual, as policyholder or insured, is not responsible for another person’s misconduct – a somewhat helpless provision given the board’s overall responsibility ultimately for everything.


The company is given the option of settling the claim “on its own” because the insurers threaten to take action against the board of directors or managing director, for example on the grounds of so-called tort or organisational negligence, § 823 II BGB, § 130 OWiG. From a D&O insurer’s perspective, “designed regulation” occurs primarily to retain the client.


If “deserving personalities” are involved and sometimes criminal law also comes into focus, the company then has a problem that it would rather not have to deal with publicly. No one will feel sorry for most board members – deserving personalities are rare or are only thought to be so until they fall from grace. In addition, the public is often already informed anyway, for example through house searches carried out with media attention, removals for questioning and the arrest of the CEO at the airport. It is not uncommon for the media to have uncovered a scandal in the first place. In this case, it is better for the company to distance itself immediately from the identified delinquent, even in public. Many just deserving personalities have been surprised when they were banned without warning and their personal belongings were placed in banana boxes in front of their feet by security (so that everyone could see it, in front of the main portal) and his just chauffeur left him there after he had to hand over the car keys. Or as one insurer quipped, when asked why so many deserving people are just let go “No one left here that we wanted to stay.”

Many a case of non-payment by the insurer then results in deliberately brought about insolvency by the claims department or external claims adjuster, and this because of the prospect of easier or more favourable settlement of the claim in favour of the insurer, if an insolvency administrator of the policyholder has become the insurer’s interlocutor.


Executive compensation by the company instead of benefits with insurance coverage

If there is a possibility of rescission or recourse by the insurer, the time has come to look at the possibilities of claim satisfaction under various contracts, such as the service contract, retirement benefits, pensions and indemnities. As a rule, D&O insurance conditions will also contain notification obligations which, if not fulfilled, could result in the insurer refusing to pay benefits. The business manager concerned will then consider whether he could not set off on the grounds of insufficient but promised insurance cover – i.e. a breach of duty on the part of the company?


The insurer formulates quite charmingly when the opportunity arises – in order not to be dependent on recourse after the service has been rendered – “so, dear company, we have various possibilities …”. This now leads to the fact that, in place of genuine severance payments to deserving employees, the company nevertheless digs deep into its pockets and pays millions in severance payments (officially known as severance payments for early termination of employment contracts or severance payments for a bAV).

In public, this then appears as a “golden handshake” – in reality, however, this severance payment already includes the recourse against the managing director or board of directors. In practice, this represents a deductible or loss sharing between the D&O insurer and affected companies. The managing director or board member will then ultimately pay “his” settlement to the D&O insurer, and thus the managing director is “clean”, as they say in the industry. Sometimes the preservation of a good reputation for the company dictates that a high insurance benefit and a high settlement are only presented to the outside world – in reality the D&O insurer effectively spends nothing economically, especially if it actually does not have to pay at all.


Rarely good coverage via D&O insurance for residual risks

At best, every manager should take out and pay for a D&O insurance policy for himself, corresponding to a pecuniary damage liability insurance policy – which, however, would usually be considerably more expensive. At the very least, a rescission would be precluded for policies of bona fide directors. As a policyholder, he can no longer suddenly find himself in the role of a pawn in delicate questions of recourse, as is the case with a merely insured person, but is part of the proceedings or master of the situation and not an outsider.



On a different note: Anyone who looks into their D&O insurance will almost certainly discover, after the most careful examination, that their “own” policy may contain quite considerable gaps in coverage which, in the event of a claim, could endanger the existence of the company. To recognize this only in the case of damage, means to trust blindly any advertising statements, which one will be able to call later unfounded hopes. There is currently no watertight D&O insurance on the German market. For those who do not want to believe this, a confirmation of conformity can be obtained from our press office and can then be presented to your insurer for signature.


The fact that such a product can be purchased represents the swan song of entrepreneurship, to be responsible for one’s own actions. However, this powerlessness also implies that the clarity of business processes is not very clear, and so the question may be raised as to what companies have been given by laws such as KonTraG, BilMog, the Product Safety Act or standards and certifications (such as ISO, ISO -TS) or regulations such as the Ordinance on Industrial Safety and Health. Boards often make it clear at the same time that while everyone is obligated to report irregularities from their area, such a report will result in a “special unit” immediately “dealing” with the reporter to solve the problem until the reporter can report the problem as solved or, better yet, as non-existent. Then already times also again the sun turns around the earth. Board members have also complained that after written notifications they can no longer say that they did not know anything about it – and it is not uncommon for the board secretary to collect unwelcome notices from all the addressees of a distribution list. Insurers have not yet penetrated these issues at all in claims settlements.


by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm


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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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