Corporate Directors and Officers Personally Liable for Insufficient Insurance Coverage, D&O-Insurace counts

The verdict from the German Higher Regional Court in the city of Kiel dated February 26, 2024, Case No. 16 U 93/23, casts a spotlight on the essential duties of corporate management within the framework of operational risk prevention and insurance management. In a world where companies are increasingly exposed to complex risks, from natural disasters to cyber-attacks, this verdict holds particular significance. It concerns not only the specific situation of a bakery that suffered considerable damage from a fire but also the fundamental question of how meticulously directors and officers must review and adjust their company’s insurance coverage.

What Happened?

The case revolved around a lawsuit from a bakery operating company against its D&O insurer for assigned rights. After a fire caused significant damage, it became apparent that the existing insurance sums – for content, business interruption, and building insurance – were insufficient to fully cover the incurred damages. The manager failed to regularly review and adjust the insurance sums according to the actual value of the fixed assets and the company’s risks. This negligence led to a coverage gap that significantly hindered the company’s financial recovery from the fire event. Notably, the bakery’s ovens, not considered an essential part of the building, were significantly damaged. Over time, the content insurance was not adjusted for new acquisitions and value developments. Even with an insurer change and a site visit, the extent of coverage was not adequately clarified. The manager merely assumed the ovens were sufficiently insured against damage or loss.

The holding company, as the sole owner of the operating GmbH, had taken out a D&O insurance in favor of the operating company’s management. After the operating company’s general meeting decided to personally hold the management liable for insufficient insurance coverage for damages arising from the undercoverage under § 43 Paragraph 2 GmbHG, the manager assigned his exemption claims against the D&O insurance to the operating company.

The initially called Kiel Regional Court had ruled in favor of the D&O insurance as requested. The insurance appealed, raising a multitude of insurance law objections regarding the basic insurance relationship of the building, content, and business interruption insurance. It accused the manager of intentional action to reject a liability obligation based on its own AGB-legal principles and ultimately raised the statute of limitations defense because a timely claim interrupting the statute of limitations was not filed against the affected manager but only against the D&O insurance.

The D&O insurance lost on all counts.

How Is the Decision to Be Evaluated?

Since more than 80% of the cases regulated by D&O insurances are settled by a compromise between the claimant and the insurance, it is welcome from the perspective of legal practitioners that a higher court had the opportunity to express itself relatively detailedly on reasons for liability, damage calculation, and procedural nuances of claim assignment.

The court unequivocally places the responsibility for ensuring adequate insurance coverage for the company under the purview of the executive management. This conclusion is likely applicable to the duties of corporate directors under § 93 AktG (German Stock Corporation Act), akin to the responsibilities of directors and officers in U.S. corporations.

The court found that the executive’s breach of this duty of care could fundamentally give rise to a liability claim under § 43 Paragraph 2 GmbHG (German Limited Liability Company Act), paralleling director and officer liability under similar U.S. corporate governance laws.

According to the court, the breach of duty clearly resulted in damages to the company in the form of uncovered material damage and operational interruption losses, as the company’s operational assets were not fully available for a certain period.

The D&O insurance’s defense of intentional misconduct was dismissed by the court as unsubstantiated, as the insurance, bearing the burden of proof for this claim, failed to provide sufficient evidence.

Furthermore, the court was not persuaded by the statute of limitations defense. The indemnification claim of the executive against the D&O insurance transformed into a payment claim of the company against the insurer upon assignment. This assignment is interpreted as a performance to be fulfilled and not as fulfillment itself, meaning the company is barred from pursuing the executive as long as it seeks compensation from the insurer. From the underlying agreements, it is inferred that the company must pursue the insurer. Implicitly, the shareholders and the executive have entered into what is known as a “pactum de non petendo,” which suspends the statute of limitations for the liability claim against the executive for the duration of the claim pursuit against the insurer.

Practical Implications from the Decision

From the ruling, vital practical recommendations for executive management and corporate directors can be derived. Primarily, the regular review and adjustment of insurance sums are critical to avoid underinsurance. Companies should also thoroughly understand the terms of their insurance contracts and seek expert advice when necessary. The verdict further highlights the significance of D&O insurance as a risk mitigation tool for corporate leaders. The complex interaction between various insurance policies and internal agreements necessitates careful planning and communication within the company and with external partners.

In conclusion, it is critiqued that the verdict underscores the high demands on executive management and directors regarding risk management and insurance matters specifically, but also in relation to their general duties. The decision sends a clear message that ignorance or neglect in insurance matters can lead to severe financial consequences. This may pose a challenge especially for smaller companies or startups, where the executive management often has to juggle multiple roles simultaneously. At the same time, the verdict reflects the societal expectation that companies should not only manage risks effectively but also build a certain resilience to unforeseen events.