Company debt and the implications on insurance

Renewing the quantum of debt in UK plc in 2009 is going to be challenging. If debt is not available to the extent required, and additional equity equally hard to find, then company directors may face some hard questioning from their auditors.

It is becoming clear that auditors may be forced to qualify the report and accounts of heavily debt-ridden businesses whose facilities renew in 2009 for not being able to sign off a “going concern” statement. Leading accountants have recently commented that for a business to have an unqualified report and accounts, they need to see appropriate financing is in place for the next 12 months.

If accounts are qualified, the company is exposed to potentially significant implications with its business banking facility. Many facilities have covenants, which require unqualified accounts. If these covenants are broken, the banks may request repayment, which inevitably could be more costly or just unavailable to the company.  

A business’s ability to raise and/or afford the debt is key. For those less fortunate or robust, insolvency looms and/or directors risk either way increases.

According to our head of directors’ risks, Mark Burden: “While the qualification of the report and accounts is not directly a directors and officers [D&O] issue, the consequence of such may lead to a extremely difficult period for the company and its directors in which to operate. The implications of these changes can create potential gaps in a D&O policy if the correct level of cover is not being provided.”

Company directors can be exposed for a number of reasons. These include:

Change of ownership

When faced with a crippling amount of debt, a company may find itself forced into a debt for equity swap. The likely impact to the D&O cover is a triggering of the transaction clause, converting the policy to prior acts cover only (run-off cover), and exposing the directors for claims for ongoing acts. Shareholders will have suffered a significant loss of investment and may look to hold directors accountable, which could be excluded from the D&O cover if the policy contains some form of shareholder exclusion.

Insolvency

In the event of insolvency, the largest risks faced by directors are claims by liquidators for misfeasance or wrongful trading. D&O policies are likely to cover such actions as a carve back under the insured versus insured clause and will provide defence costs for allegations of dishonesty until a finding of guilt. It is important that the policy provides cover up to final adjudication but it should be noted that at this point insurers are generally entitled to reimbursement of the cost they have advanced and depending on the wording, this can be sought not just from the guilty individual, who will likely be stripped of their assets, but more likely from the company.

Asset of the estate

One issue relating to the D&O policy is whether directors of a bankrupt corporation will be able to access the proceeds of the corporation’s D&O policy. While the general intent of D&O insurance is the protection of the directors and officers, most policies provide company reimbursement and, on occasion, securities entity, which has meant courts have not taken a consistent approach on the issue of whether the D&O policy is actually an asset of the estate.  

Policies offering protection for individuals when no indemnification is available have become increasingly popular with directors especially when the company is facing financial difficulty. These policies do overcome the uncertainty of whom the policy ultimately benefits.  

Non disclosure

For D&O insurers the above issues would be deemed material facts and failure to disclose as part of the D&O renewal process could constitute a material non-disclosure. Depending on the policy wording, this may entitle the insurer to void the policy. While most policies contain severability clauses, it may be difficult for a director to argue that they were not aware of the true position of the company given their level of involvement into the affairs of the company.  

In the current economic climate the strength of a company’s internal controls and accounting practices are vital and will be one key areas insurers will scrutinise throughout 2009. The financial health of the company will be under the microscope especially on the company debt maturity profile.

*Alan Pratten is head of major accounts at insurance broker Heath Lambert. Related articlesReal Business/CBI FDs’ Excellence Awards.Ten tips to keep your business going in a pandemicBudget leaves entrepreneurs paying for the mistakes of othersUK recession worsensPicture source

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