Corporate scandal, stricter corporate governance and the increase in the number of claims against directors and officers of UK companies mean that many companies view the purchase of directors' and officers' (D&O) insurance cover, as increasingly important. D&O cover is designed to protect directors and officers from any claims that arise in relation to the discharge of their duties. Companies are permitted to purchase and maintain D&O cover for their officers and auditors under Section 310 of the CompaniesAct 1985.

According to recent press reports, the cost of D&O cover has increased significantly over the past two years (up by a 50% average in 2003 and estimated to be rising by 20% this year). In the US, the increase of securities litigation and class action lawsuits mean that UK companies who raise money in the US, either through stock market or private placements, are particularly hard hit by soaring costs of cover.

Increasingly, current directors and other advisers may not be willing to accept a position on the board or to take on an assignment unless appropriate and sufficient insurance cover is in place. Should the company move into financial difficulties, directors will need protection to cover potential claims against them personally for wrongful trading, in addition to claims for breach of their ongoing common law fiduciary duties.

In practice, key D&O issues which may need to be considered by companies and their directors and advisers alike are: a) Who is covered by the policy? and b) What acts/omissions are covered, and in particular is wrongful trading covered?

Who is covered?

The terms of the policy itself need, in each case, to be carefully reviewed. Routinely, policies will be expressed to cover legally appointed directors and officers, past and present. Such cover may be considered too narrow and may raise concerns for those occupying a de facto or shadow director role.

A de facto director can usually be quickly identified (being a person who has not been legally appointed but who openly acts as though he has been appointed); and if appropriate, steps may be taken to formalise their appointment. Going forward they may expect to receive D&O cover as a legally appointed director. As regards past acts, the D&O policy will, however, have to be carefully construed to check for coverage.

Identifying a shadow director can be more difficult, being someone who makes decisions or gives instructions upon which the board is accustomed to act, as a matter of regular practice, over a period of time. In the case of a company in financial difficulty, it is possible that external advisors instructed by the board to assist in the formulation of its strategies may, unwittingly, take on this role. The fact that the directors act on the basis of such professional advice does not make those consultants shadow directors.There may, however, be situations in which the adviser's role, particularly if extended, does or may amount to that of a shadow director. Ultimately this may be a case of degree and the D&O policy will need to be carefully reviewed to establish whether the advisers are covered.

What acts/omissions are covered under the policy?

Again, the scope of the policy will depend on its individual express terms which will need careful review. One of the issues, now quite commonly raised in practice, is whether a D&O policy can give effective protection against claims for wrongful trading, the legal shorthand for a claim against a director under S214 InsolvencyAct 1986.

D&O policies are often expressed to provide protection for directors against liability for'wrongful acts'. While some policies are silent on what constitutes a wrongful act, others provide a definition, such as'breach of duty, neglect, error, misstatement, misleading statement, breach of trust, breach of warranty, etc'.

Pending any judicial determination, the general view within the insolvency profession is that as a question of construction wrongful trading would generally be covered by the definition of wrongful act. Arguments to the effect that compensation payments or other orders made in wrongful trading proceedings should not be covered by D&O policies, on grounds of public policy, are unlikely to succeed. This is because wrongful trading is intended to operate as a vehicle to provide compensation to creditors rather than as a penalty to directors, and so public policy arguments should have no place.

Owing to the increasing importance of D&O policies, we may in future see some of the above points clarified by the court. In the meantime, directors should carefully consider these issues and review the terms of their policy.

Elaine Nolan is an associate in the business, finance and restructuring department at Weil Gotshal & Manges.