A recent German legislative action creates some interesting requirements for and limitations upon insurance for German corporate director liability. These legislative changes are designed to try to ensure greater director exposure to personal liability, as a deterrent to corporate misconduct. However, the legislative changes are susceptible to circumventions that may limit their intended effects.
As reflected in a July 1, 2009 memo by Anthony Menzires and Dr. Gunbritt Kammerer-Galahn of the Taylor Wessing law firm entitled “D&O Insurance in Germany – The New Legislation Arrives” (here), on June 18, 2009, the Bundestag enacted the new Act on the Adequacy of Managerial Salaries.
Among other things, this new Act will impose a new requirement that German Stock Corporations (Aktiengesetz) purchasing D&O insurance for their executives must impose a personal deductible to be borne by the directors in an amount equivalent to at least 10% of the relevant loss, up to an annual cap. Comments accompanying the Act specify that the annual cap must be set at not less than one and one half the annual fixed remuneration of the director.
These requirements are applicable to all stock corporations, whether listed or publicly owned.
The requirements will to into effect immediately following the Act’s ratification by the Bundesrat on July 10, 2009, with immediate effect on all D&O insurance policies formed after that date and with a further requirement that all existing policies must be amended to bring them into compliance by July 1, 2010.
According to the law firm’s memo, these new statutory requirements codify long-standing German governance guidelines that had encouraged companies to structure their D&O insurance with a deductible to be borne personally by the directors as a way to “motivate them to avoid claims arising.” The memo observes that many German corporations “circumvented” these voluntary requirements.
The elevation of these provisions into statutory mandates represents an apparent legislative attempt to try to use the threat of personal liability to deter corporate misconduct. The German legislature’s action raises a couple of questions: Will the statutory requirement be effective? And will other countries follow?
As for whether the requirement will be effective in deterring corporate misconduct, there are certain aspects of the statutory requirement that are worth considering. The first is that that under the German two-tier system of board governance, the requirements apply only to D&O insurance for the management board (Vorstand) and not to the non-executive supervisory board (Aufsichtsrat). At a minimum, then, the deterrent effect, if any, is limited solely to the management board and would not reach the supervisory board.
The other aspect of the statute that may affect its effectiveness is the fact that the Act does not prohibit the acquisition of separate insurance for the individual director’s deductible exposure, which presents a rather obvious new product opportunity for German D&O insurers. And while the premium cost would have to be borne personally by the director, there is, as the memo notes, nothing to prevent each director from “seeking a commensurate uplift in their remuneration to cover the outlay.” Furthermore, there apparently is no existing requirement that would compel the corporation to disclose this type of compensation arrangement.
Whether other countries might follow the German legislation and enact similar statutory requirements may depend on whether the German requirement proves to be effective in deterring corporate misconduct. While the results from the statutory requirement remain to be seen, the apparent ease with which the personal exposure could be insured may well limit the deterrent effects.
The obvious logical step, then, might be to suggest that other countries considering the German requirement add further specifications that the director cannot acquire separate personal insurance to protect against the required liability exposure. My own view is that there are several critical considerations that should be taken into account before these kinds of prohibitions are imposed.
The first is that directors ought to be able to defend themselves, and so there should be no prohibition for the insurance providing defense expense protection. The second is that fundamental fairness requires that the barriers should apply only if an adjudication has determined that the director actually violated liability standards, and accordingly the statutory prohibition should only apply to judgments.