In India, the directors of a company are considered the persons responsible for managing the affairs of a company or organization. They are appointed by the shareholders of the company and they are expected to act in the best interests of the company. Directors play a critical role in managing the affairs of the company and are responsible for making important decisions that impact the company's growth and success.
However, with great power comes great responsibility. In India, directors of a company can be held personally liable for their actions in certain situations. Understanding the circumstances under which directors can be held personally liable is essential for them to fulfill their responsibilities and avoid potential legal liabilities. In this article, we will discuss the situations under which directors of a company can become personally liable in India and go for D&O insurance to save yourself from potential lawsuit costs.
When do Directors of a company Become Personally Liable?
Here are some circumstances under which directors of a company may become personally liable-
- Breach of Fiduciary Duty
Directors of a company owe a fiduciary duty to the company and its shareholders. They are expected to act in the best interests of the company and not for their personal gains. If a director breaches his fiduciary duty, he can be held personally liable for his actions. For example, if a director of a company sells the company's assets to his own company at a lower price, he can be held personally liable for breaching his fiduciary duty.
- Fraudulent Activities
If a director of a company is involved in fraudulent activities, he can be held personally liable for his actions. For example, if a director of a company misrepresents the financial statements of the company to the shareholders, he can be held personally liable for fraud.
Directors of a company are expected to exercise reasonable care and skill in the management of the affairs of the company. If a director fails to exercise reasonable care and skill, he can be held personally liable for his actions. For example, if a director of a company fails to take necessary steps to prevent the company from incurring losses, he can be held personally liable for negligence.
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- Environmental Damage
Directors of a company can be held personally liable for environmental damage caused by the company. The Indian government has implemented various laws to protect the environment and directors of a company can be held personally liable for violations of these laws. For example, if a company discharges pollutants into the environment, its directors can be held personally liable for the damage caused.
- Tax Evasion
Directors of a company can be held personally liable for tax evasion by the company. The Indian government has implemented various tax laws and directors of a company are expected to comply with these laws. If a company evades taxes, its directors can be held personally liable for the tax evasion.
Directors of a company can be held personally liable for the insolvency of the company. If a company becomes insolvent, its directors are expected to take necessary steps to ensure that the assets of the company are distributed among its creditors. If the directors fail to do so, they can be held personally liable for the insolvency of the company.
How can directors protect themselves from personal liability?
If you are a director in a company, you would agree that company management often needs to make important and seemingly unpopular business decisions on the spot. Such decisions made during the day-to-day business operations can make you extremely vulnerable to possible lawsuits from regulators, customers, competitors, shareholders, employees, and Government bodies (just to name a few!). You may also face claims and lawsuits related to discrimination, harassment allegations, alleged violations related to employment practice, cost of regulatory investigations, defending and settling claims, paying compensation, and so on. A costly lawsuit can have a severe impact on your personal fortunes.
Directors’ & officers’ insurance or D&O insurance can come to your rescue in such situations. It is a policy created to protect the directors, board members, and other employees who serve in management or supervisory roles- from potential legal obligations. This insurance coverage safeguards the directors' and officers' personal assets and pays for the settlements and legal costs associated with such lawsuits and disputes.
However, it excludes costs originating from intentionally dishonest & fraudulent acts, claims related to intentional omissions, errors, and negligence while providing professional services, deliberate acts of violating a law, contract, or regulation, cyber threats, etc. It is also essential to understand that having D&O insurance does not provide a guarantee against financial loss and the coverage offered may be subject to policy exclusions and limitations. As a result, before acquiring a D&O insurance policy, it is a good idea to thoroughly read the terms and conditions.
Directors of a company are responsible for managing the affairs of the company and they are expected to act in the best interests of the company. However, in certain situations mentioned above, they can be held personally liable for their actions. To avoid personal liability, it is important for directors of a company to be aware of their responsibilities and to comply with the laws and regulations in India.
Frequently asked questions ( FAQs)
- What does D&O Insurance not cover?
A D&O Insurance policy typically excludes the following –
- Data breaches and cyber attacks
- Fines and penalties resulting from intentionally fraudulent and malicious acts committed by the directors and officers. However, well-devised exclusions are there for those who were unaware of such fraud.
- Claims related to negligence, omissions, and errors while offering professional services.
- Third-Party Injury or damage
- infringement or misappropriation of patents/trade secrets
- Exposures related to mergers & acquisition
- Deliberate acts of violating a law, contract, or regulation
2. Is D&O Insurance a claims-made or occurrence policy?
A D&O policy is typically a claims-made policy. This implies that it only applies to claims that occur and are reported when the policy is in force. In general, the date of claim notification and the alleged occurrence date is always emphasized in a Directors' and officers’ insurance policy. To avoid problems, you need to inform the insurer of the potential claim as soon as you become aware of it.
3. What does D&O Insurance cover?
A D&O Insurance policy includes (but is not limited to)-
- The costs related to the investigation, defense, negotiation, and settlement of a covered claim. This includes attorneys’ fees, court attendance costs, bail, and bond costs, etc.
- Subsidiary coverage
- Pecuniary Penalties
- Coverage for outside directors
- Crisis Communication Costs
- Kidnap & Response Costs
- Employer-Employee Disputes
- Cover for damage to reputation
- Public Relations Expenses
- Emergency Costs
- Coverage for Retired Directors and Non-Executive Directors
- Severability coverage