Alarming insolvency statistics: strategic protection for board members

According to official ASIC statistics, August 2023 recorded the greatest number of companies that entered into external administration or had a controller appointed (918) – more than any other month in the past 6 years. One third of those companies were in the construction sector.

We set out below current risks for company boards and strategies to transfer that risk to protect directors’ and officers’ personal assets, beyond the annual corporate D&O policy.

During the 22/23 financial year, there were 7,942 companies recorded, a 61% increase compared to the previous financial year. Of those, 28% were construction sector followed by 14% in accommodation and food services.

The impact of insolvencies on companies often results in claims brought against company boards and individual board members personally as regards the management of the company. Liquidators may bring actions for breaches of the Corporations Act – where this occurs, board members look to their Directors’ and Officers’ Liability insurance policies for coverage.

The increasing rates of insolvencies have resulted in insurers attempting to reduce their exposure to losses by applying insolvency and financial mismanagement exclusions on D&O policies. They are also being more cautious in underwriting methodologies prior to removing the application of such exclusions.

In these cases, boards can be left exposed to potential claims for which there may be little or even no insurance coverage to protect individual directors and officers. This is a major cause of concern for directors.

Typical insolvency exclusions apply to limit insurers’ liability for claims arising out of, or in connection with, administration, insolvency, bankruptcy, liquidation or the failure of a company to meet its debt obligations as and when they fall due. The breadth of the exclusions extends also to preclude payment of legal costs to defend these claims, irrespective of the merits of the case.

Claims against company boards typically follow insolvency events, however, how wide the operation of these exclusions can be cast depends on the allegations made and the conduct giving rise to the action.

In the 2019 Kaboko (AIG Australia Limited v Kaboko Mining Limited [2019] FCAFC 96) case, the Full Federal Court found that an insolvency exclusion in a D&O policy did not apply to exclude claims brought against directors and officers of a company under external administration.

While insolvencies are one major concern for some boards, the current corporate climate presents numerous exposures that may limit the coverage available under a corporate D&O programme or translate to claims that result in damages payouts and defence costs that erode more of your policy limit than expected.

This is where boards can benefit from a Side A Difference in Conditions insurance policy.

A Side A Difference in Conditions insurance policy (Side A DIC) provides coverage to directors and officers under a policy that is not shared with the company (as is the case in the annual D&O policy), does not have a deductible/excess and is not subject to cancellation by the insurer (except for non-payment of premiums). Side A DIC can be procured alongside a company’s annual D&O policy and operate to ‘drop down’ where the annual policy limit is exhausted or coverage is declined.

Another benefit of this coverage is that companies can attract and retain qualified board members who seek broader personal coverage to ensure their personal assets are not at risk when taking positions on company boards.

To read more about Side A DIC coverage and Directors’ and Officers’ Liability, see our article here. If Side A DIC is of interest, please contact an expert advisor at Bellrock.