In the following guest post, Peter C. Fischer and Burkhard Fassbach explore the reasons why board members of German companies would be well-advised to negotiate a clause in their service agreements requiring their companies to procure D&O insurance, as well as the preferred terms and provisions that the D&O insurance should incorporate. Peter is a Professor of Law at the University of Applied Sciences Dusseldorf and Burkhard is a D&O lawyer in private practice in Germany. A version of this article in German previously was published in the law journal GWR. I would like to thank Burkhard and Peter for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.

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In view of the severe rules for the liability for board members under German law such board members should ensure that the company signs and maintains D&O insurance for them. A so-called D&O procurement clause (Verschaffungsklausel) in the service agreements of executive directors offers security. Ideally, a corresponding clause for non-executive members) should be anchored in the articles of association.

This publication, which was originally published in German (GWR 8/2024), lines out what to pay particular attention to when drafting contracts from the perspective and on behalf of executive directors. Finally, this article provides a sample clause for service agreements of executive directors as a guideline. It goes without saying that such clause cannot replace an individual legal advice.

The readers without a German legal background should note that German Stock Corporations follow the two-tier board system consisting of a board of management with executive directors on the one hand (Management Board) and a non-executive board with non-executive directors on the other hand (Supervisory Board). A German closed corporation (German Limited Liability Company) has usually only executive directors (Managing Directors) unless a Supervisory Board has been established mandatory under the German Co-Determination laws or voluntarily. Since members of the Supervisory Board do not have a service agreement a D&O procurement clause can only be inserted into the articles of association.

I. Severe liability of Directors as the reason for the Necessity of a D&O Procurement Clause

Board members, whether executive or non-executive, who fail to fulfill their duties are liable without limitation with their complete private assets even in cases of slight negligence. Furthermore, in liability proceedings the burden of presentation and proof for their dutiful conduct and lack of fault lies with the management board members (cf. section 93 II 2 German Stock Corporation Act). the so-called ARAG doctrine of the German Federal Court of Justice (is another driver of directors’ liability under German law: According to the ARAG-doctrine, the Supervisory Board is generally obliged to assert claims for damages against members of the Management Board.

Traditionally, D&O claims are characterized by the fact that the company sues the (former) members of the Management Board – by way of a so-called hostile claim – for damages. A more recent trend is the so-called Direct action. The D&O cover claim can be assigned from the (former) board members to the company it and then the company can directly sue the D&O insurer. The direct action has been recognized by the German Federal Court of Justice. According to the latest (albeit not uncontroversial) case law of the Higher Regional Court of Cologne, the statutory reversal of the burden of proof applies analogously in direct proceedings. This strengthens companies in direct disputes with their D&O insurers.

The existence of D&O insurance cover should be contractually guaranteed in the Service Agreement of the executive directors by means of a D&O procurement clause. Such a clause is just as important for executive directors as the D&O insurance itself. For Members of the Supervisory Board, a corresponding clause should be included in the articles of association. According to the rules of competence under the German stock corporation law, the Supervisory Board has to decide on the granting of entitlement for D&O insurance cover for the Members of the Management Board, and the shareholders have to decide on this for the Members of the Supervisory Board. The D&O policy must then be taken out by the Management Board. The following issues should be considered when drafting a detailed D&O insurance clause for the Employment Agreements of Managing Directors in case of a German Limited Liability Company in the Managing Directors and Members of the Management Board in case of a German Stock Corporation. members of the Management Board Service Agreements

II. Parameters for high-quality D&O Insurance Cover

1. Sum insured

In D&O claims with several insured managers, it can happen that their claims for cover exceed the contractually agreed sum insured. According to the Higher Regional Court of Hamm, it is appropriate and in the interests of the parties to divide the sum insured in equal shares   in accordance with section 430 German Civil Code.

In general, the D&O procurement clause should always include a claim by the manager against the company for replenishment of the sum insured. This presupposes that the D&O insurance conditions contain the option for the policyholder to acquire a new full sum insured – for further insured events for breaches of duty not yet known at the time of replenishment (so-called “reinstatement”).

In the case of so-called “total losses”, the amount of the asserted claim for damages often corresponds to the D&O sum insured. If the insurer and company reach a settlement in the amount of the sum insured or if the court awards the amount in a judgment, the D&O insurer will pay compensation less the costs already incurred. The defense costs are offset against the sum insured. In these cases, supplementary pecuniary loss legal expenses insurance can cover the costs remaining after the D&O sum insured has been exhausted, so that full compensation is possible. In addition, directors can also take out a personal D&O policy for their own account.

2. Entitlement to the Provision of the D&O Policy

A D&O procurement clause should oblige the company to provide the manager with a copy of the current D&O policy and its terms and conditions. This is important because many companies still regard the D&O policy as a so-called “treasury policy”.

3. Quality of the D&O Insurance Conditions

The general terms and conditions of D&O insurers differ greatly from one another. As the D&O market is constantly changing, the annual policy renewals should be reviewed with regard to the quality of the insurance conditions. Particular attention should be paid to the following:

a. Fee Guarantee Clause

Lawyers specializing in directors’ and officers’ liability usually charge on an hourly rate basis and not in accordance with the German Lawyers’ Fees Act. The D&O insurance conditions should therefore stipulate that there is no need for coordination with the insurer regarding the choice of lawyer and the fee agreement if the lawyer is arranged via a lawyer panel accepted by the insurer.

b. Arbitration Clause

For complex claims, D&O insurance conditions should offer the option of institutionalized arbitration. The advantage of this is that liability and cover can be bindingly clarified in a uniform procedure. Arbitration proceedings – without a court of appeal – are dealt with more quickly than proceedings before the ordinary courts and are also not associated with a court hearing. As a potential disadvantage, it should be noted that it is generally not possible to issue notices of dispute to third parties in arbitration proceedings.

c. Insurance cover for operational Activities

The Higher Regional Court of Zweibrücken ruled that the Managing Director sued for damages in the specific case had acted with slight negligence, but had not breached any duty that she was subject to in her capacity as Managing Director. The case concerned a bank transfer. In the opinion of the appellate court, this was usually the task of the accounting department; the company management was not affected. For such activities, which could just as well have been carried out by a third party and which were only carried out on the occasion of the management, the court ruled out the liability of the Managing Director, inter alia with reference to a literature opinion. As no further appeal to the Federal Court of Justice was lodged, the fundamental question remains unresolved on the highest federal level. Therefore, operational activities (as in this case) should be expressly covered by D&O insurance.

d. Continued salary Payments and severance Payments

In D&O claims practice companies often attempt to offset their alleged claims for damages, which would be insured under the insurance terms and conditions, or to assert rights of retention against claims of executive directors under their employment contracts, in particular salary claims and claims arising from termination and severance agreements. The personal consequences for executives are then often liquidity problems. For this reason, high-quality D&O policies include clauses that allow continued salary payments and also cover severance payments within a sub-limit. D&O insurance cover also extends to the assumption of costs arising from the assertion of claims.

e. Continuity Guarantee

If the insurer demands exclusions of cover as part of the annual D&O policy renewal – for example for corruption, antitrust violations or due to cum-ex – and possibly reduces the sum insured at the same time, then this limited insurance cover applies retroactively for any breach of duty and subsequent claims for damages are excluded from D&O insurance cover due to the claims-made principle. The continuity guarantee in the D&O insurance conditions excludes this cover-destroying retroactive effect, so that reductions in the sum insured and insurance exclusions only apply to the future and possible “legacy claims” remain insured.

f. Extended Notification Period

If the insurance relationship ends, insured events that occur after the end of the contract within the extended notification period remain insured if the corresponding breaches of duty were committed within the term of the contract or the period of agreed retroactive cover. It should be noted that the special limitation period for claims against directors begins to run when the claim arises as an objective circumstance, the claim may only arise many years after the possible breach of duty when the facts of the case are investigated during the tax audit and the first onerous tax assessment notices are issued. The mere passage of time, which is determined entirely by the course of business of the tax authorities and, in some cases, the public prosecutor’s office, increases the risk of the directors to a considerable extent. It is therefore important that the insurance relationship is maintained or, in the event of termination, that sufficiently long extended notification periods are ensured.

g. Criminal Law Protection Module

It is not uncommon that a breach of duty of directors is a potential criminal act and therefore the proceedings are initiated by prosecutors, even pre-trial detention may be ordered. The D&O insurance conditions should therefore include a criminal law protection module.

The Higher Regional Court of Hamm has recently ruled on a D&O insurance policy with included criminal legal protection that if the insurer has promised “provisional cover” in favor of the insured Managing Directors in the event of disputed knowledge of the breach of duty until the court has established knowledge, the insurer cannot successfully counter its provisional claim that the insured person prosecuted under criminal law has violated information obligations, because he did not allow himself to be “questioned” by the insurer about the accusations, did not allow the insurer to inspect the criminal case file or did not allow the insurer to inspect the defense file and it was therefore not possible for the insurer to prematurely convict the insured person of “knowing breach of duty”.

In view of the regulatory practice of D&O insurers, a D&O contract legal protection policy does generally make sense. This covers the costs of coverage claims against the D&O insurer. These costs can be as high as the defense costs in civil damages proceedings, meaning  that the directors are exposed to a double risk of litigation costs.

h. PR Expenses

If media coverage of an insured event threatens to damage the director’s reputation, the D&O insurance cover should grant public relations costs as part of the defense costs and cover the costs incurred for the fees of a public relations consultant commissioned to mitigate or prevent the reputational damage.

III. Sample D&O-Procurement Clause

The following sample D&O procurement clause for the Service Agreements of Managing Directors of a German Limited Liability Company or members of the Management Board of a German Stock Corporation in favor of the executive directors is intended to provide guidance in light of current case law (cf. the sample clause by Fassbach/Fleck, MANAGEMENT-BLOG of Wirtschaftswoche from December 18, 2013). However, as already stated above, the model clause can under no circumstances replace individual legal advice and contract drafting for individual purposes.

(1) The Company undertakes to take out D&O insurance for the Managing Director/Member of the Management Board or to maintain existing D&O insurance cover. For this purpose, the Company shall commission a market-recognized D&O expert to assess the tenders, the renewal offers, the insurance conditions, the rating and the settlement behavior of the insurers as well as the appropriateness of the amount of cover in advance of the contract placement and as part of the annual contract renewal. The Company shall provide the Managing Director/Member of the Management Board with a copy of the expert opinion. [Alternatively: The Company must inform the Managing Director/Member of the Management Board immediately if the Company does not follow the expert’s recommendations].

(2) The obligation to procure in accordance with paragraph 1 relates to a D&O insurance policy with an option to replenish the sum insured (“reinstatement”). The Managing Director/Member of the Management Board is entitled to claim that the Company exercises its reinstatement option vis-à-vis the D&O insurer and acquires a new full sum insured for further insured events for breaches of duty not yet known at the time of reinstatement.

(3) The obligation to procure in accordance with paragraph 1 includes D&O insurance with a criminal law protection module. A sublimit of [__] % of the sum insured, up to a maximum of EUR [__], applies to the criminal law protection module.

(4) At the time of the commencement of the employment contract, the insurance cover shall apply to the extent of the D&O policy and the insurance conditions, which are attached to this employment contract. The Company undertakes vis-à-vis the Managing Director/ Member of the Management Board not to fall below the insurance cover defined in the annex as a minimum standard (sum insured, general and special insurance conditions) for the term of the employment contract and after termination of the employment contract for the term of the limitation period for directors’ and officers’ liability claims. The Company will expand and optimize the insurance cover, taking into account the annual recommendations of the expert opinion in accordance with paragraph 1 above. [Alternatively: The Company intends to expand and optimize the insurance cover in accordance with the annual recommendations of the expert opinion pursuant to paragraph 1 above]. If the defined minimum standard cannot be maintained or expanded in the future due to a tougher D&O market, the Company shall – taking into account the expert opinion – provide the optimum insurance cover possible in a tougher D&O market.

(5) In order to flank the D&O insurance cover, the Company concludes pecuniary loss legal protection and D&O contractual legal protection policies as supplementary legal protection contracts.

(6) The Company shall provide the Managing Director/Member of the Management Board with a copy or a digital copy of the current D&O policy and its terms and conditions as well as the pecuniary loss legal protection and D&O contractual legal protection policies and their terms and conditions.

(7) If the Managing Director/Member of the Management Board leaves the Company – for whatever reason – the Company undertakes to acquire a sufficient extended notification period corresponding to the limitation period for directors’ and officers’ liability claims and to provide the managing director/executive board member with corresponding proof or to maintain the insurance cover for the corresponding period.

IV. Summary

1. Given the severe rules for the liability of directors under German law, Managing Directors of a German Limited Liability Company and members of the Management Board of a German Stock Corporation should ensure that the Company undertakes to take out and maintain D&O insurance for them in their employment agreement. A corresponding clause for the Members of a Supervisory Board should be included in the articles of association. A D&O procurement clause for directors is under German law just as important as the D&O insurance itself.

2. Parameters for high-quality D&O insurance cover are Sum insured, entitlement to receive a copy of the D&O policy, fee guarantee clause, option of institutionalized arbitration proceedings, insurance cover for operational activities, cover for continued salary payments and severance payments, continuity guarantee, grace periods, criminal law protection module and assumption of PR expenses.

3. The D&O insurance cover should be flanked by supplementary D&O contractual legal protection and legal protection insurance against pecuniary loss.