‘Insured capacity’ is a frequently visited subject and continues to be a central aspect in many discussions around the scope of D&O policies. Often conjoined with this is the area of personal guarantees. Given the potential complexity of D&O cover, it’s never wise to be prescriptive, but there are a few common observations that can be made.
In general terms, for cover to be triggered under a D&O policy, any supposed loss must arise from wrongful acts that were allegedly committed by an insured person whilst discharging those duties for which they have been retained, appointed or employed by an organisation (their ‘insured capacity’). Potential complications arise when directors (or partners/members) may also be shareholders or owners of the organisation, or certain activities may be considered to be outside of the scope of that insured capacity. Straightforwardly, activity as a shareholder, as opposed to a director, shouldn’t expect to be picked up under what is clearly defined as a policy for management (as a shareholder, a person is an owner/investor in an organisation, not one of its managers). On a parallel level, disputes over partnership/LLP agreements wouldn’t be funded by a D&O policy (or derivatives of D&O forms calibrated to those types of organisation). However, where more surgical analysis might be required is where disputes involve multiple allegations. Supposed losses may be incurred by the same individual but arise from his/her capacity as a shareholder (i.e. in a personal capacity) or as a director (i.e. in an insured capacity). In these circumstances, insurers and insureds must rely on the D&O policy’s allocation provisions in order to agree what is and is not covered.
This point on insured capacity is a vital ingredient in understanding the position on personal guarantees. A typical requirement of these is that the directors’ guarantee jointly and severally the performance of the company’s financial obligations under such an agreement. Critically, however, an organisation is liable for its debts, the directors are not. Therefore, by agreeing to assume an obligation to guarantee performance of a company’s debts, the directors are consenting to something they are not required to agree to as directors. And whilst they might only have provided these guarantees because they were the directors of the company, that potential liability under a guarantee that secures the indebtedness of the organisation, is not taken on in an “insured capacity”, but in their personal capacity. And, if you think about it, if the execution of the guarantee was in an official capacity, this results in the organisation guaranteeing its own indebtedness, negating the very purpose of the exercise (effectively, directors are being asked to perform, under the terms of a contract, the obligations of the company where the company is unable to do so).
Complications can also arise because of the requirement for a ‘wrongful act’ policy trigger. So, putting aside the issue of whether they were acting in an insured capacity, and notwithstanding whether the guarantees were, or were not, personal in nature, there is often nothing specifically alleged that would pull such a trigger.
The central premise of D&O insurance is to protect individual directors and officers, but that cannot extend to everything those individuals might do. Although the lines of demarcation between actions undertaken in an official capacity and actions undertaken in a personal capacity may not always be bright, it is necessary to separate the motivation from the action. Signing a guarantee obligates the individual, not the organisation, and this is a separate, personal undertaking, often evidenced by the fact that guarantees are frequently secured against personal assets. For that reason, repayment of such a personal contractual obligation does not generally present as a loss under a D&O insurance policy. It might also explain, and have contributed to, the emergence of specific personal guarantee insurance.