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COVID and Insolvency: A booster for your D&O cover

When Covid hit in March 2020 and the country went into lockdown with an associated dip in economic activity and consumer confidence, the viability of many small and medium sized enterprises was called into question. Many directors will have had cause to consider their obligation to place their company into an insolvency proceeding in order to insulate themselves from personal liability, and in particular liability for wrongful trading (continuing to trade when they knew or ought to have known there was no reasonable prospect of the company surviving).

If corporate insolvencies had happened at scale across the economy, a slowdown could have snowballed into a crisis. To stop this and to encourage corporates to trade through the pandemic, the government suspended liability for wrongful trading with effect from 1 March 2020. That suspension (apart from a brief hiatus in September/October 2020) came to an end in July 2021.

For any corporate insolvencies since 1 March 2020 in which directors are pursued for wrongful trading, it seems that they cannot be held liable for worsening finances during the suspension period. This is likely to throw up significant evidential issues, giving directors a basis for defence to claims made by liquidators to claw money back from them. This is where directors and officers insurance (“D&O”) comes into its own: it is essentially a legal expenses cover which is there to make sure directors can pay for the best possible legal team to put up the best possible defence, including obtaining the best advocates to make sure directors avail themselves of the full benefit of the Covid suspension where applicable.

Wrongful Trading

A claim for wrongful trading under s214 of the 1986 Insolvency Act brought against a director by the liquidator of a company is exactly the sort of claim that D&O insurance is there to protect a director against. Such a claim allows a liquidator to ask the court to declare that the director should make a personal contribution to the assets of the company to compensate for continuing to trade when they ought to have known that the company would not avoid insolvency, thereby generating further losses for the company and its creditors. A typical D&O policy should respond to such a claim by doing two things for a director:

  1. Funding his defence to avoid an order for a contribution (a defence the director might not otherwise be able to afford); and
  2. If the defence does not succeed, funding the contribution order made by the court.

Fraudulent Trading

A much more serious claim that a director may face as a result of insolvency (and one against which the covid suspension affords no protection) is a claim by a liquidator for fraudulent trading under s213 of the 1986 Insolvency Act. This is a claim in which the director is alleged to have carried on trading despite inevitable insolvency in order to deceive and defraud customers and creditors. There is a basic problem for insureds under any policy of insurance: it is a principle of law that you cannot insure yourself against liability for your own fraud (D&O policies normally gild this lily by having an exclusion to the same effect). However, a good D&O policy is still there to help because you can insure yourself against the costs of defending yourself against an allegation of fraud (since you are innocent until proven guilty) and the fraud exclusion in a decent D&O policy will normally be worded to take effect only once fraud has been determined by a court or tribunal or has been admitted by the director. This means that most D&O policies will expressly provide that they will fund a defence to a fraud allegation until fraud is established (the “Defence to Fraud Extension”).

Doubt about D&O cover for costs of a defence to fraud allegations (such as Fraudulent Trading)

There is a question, however, as to whether insurers will always honour a Defence to Fraud Extension. If an allegation of fraud is made, insurers can get jumpy and become suspicious. They do not like helping suspected fraudsters and may be inclined to make a judgment of their own before a finding of fraud is made. This is what happened in an Australian case about a Defence to Fraud Extension in a D&O policy. The case was called Onley -v- Catlin. The insured directors faced criminal proceedings relating to fraud on the Australian Revenue and called on D&O insurers to pay for their defence in accordance with the policy’s Defence to Fraud Extension which gave the insured directors the right to funding for their defence costs until fraud was established. Insurers rejected the claim saying that the alleged dishonest conduct had begun before the policy incepted and, on that basis, ought to have been disclosed to insurers as part of the insureds’ duty of disclosure. On that basis the insurers avoided the policy.

The insureds did not accept this, saying that it undermined the Defence to Fraud Extension and that their defence costs should be met by insurers until the fraud allegations were proved. They argued that the insurer’s right to avoid and the Defence to Fraud Exclusion clashed with each other and that allowing the insurer to rely on the alleged fraud to avoid deprived the Defence to Fraud Extension of meaning and effect. The parties must have intended, they said, that the avoidance right be suspended in favour of the insureds’ right to be funded to defend the very allegations the insurers were making a judgment about before the allegations were tested in court.

The Australian court disagreed with the insured directors and found that the right to avoid was a basic right of the insurer and the Defence to Fraud Exclusion did not cut across it or affect it in any way. While the principle underlying the Defence to Fraud Exclusion was that of “innocent until proven guilty”, no such principle applied to the insurer’s right to avoid for alleged fraudulent disclosure.

The insured directors argued that this deprived the Defence to Fraud Exclusion of meaning if it was susceptible to a declaration of avoidance by insurers in relation to the same allegations. Not so, said the court. If the facts underlying the fraud allegation only occurred during the policy period, no issue of disclosure could arise and the insureds could call on the policy to pay their defence costs.

The case is a significant one and may be seized upon by insurers in England. The insurers’ avoidance was not based on proof of fraud. They were entitled to make a declaration of avoidance for fraudulent non-disclosure where they had substantial grounds. In the Onley -v- Catlin case the fact that a prosecution had been commenced was sufficient grounding for a declaration of avoidance. This was bad news for the insured directors. They would have to fund their own defence to the fraud allegations and sue the insurers to challenge the avoidance.

While there can be no sympathy for fraudsters when insurance does not respond, it is a different matter when the allegation of fraud is as yet unproven and the point of D&O (to fund legal defence costs in dealing with contested allegations) is defeated by the contested allegation itself.

Dispelling the Doubt

Is there anything insureds can do to deal with this problem? There is. Assuming that the duty of fair presentation cannot be dispensed with (this is legally feasible but an unattractive risk management issue for insurers), the right to avoid for fraudulent breach of the duty of fair presentation can be brought into line with the Defence to Fraud Extension. What is needed is wording to the effect that the insurer has no right to avoid until breach of the duty of fair presentation duty has been proven (by a court or tribunal or admitted by the insured). That links the fair presentation duty and the Defence to Fraud Exclusion so that they are both regulated by the “innocent until proven guilty” principle. This wording is attainable and already exists in the market in the better D&O policies.

If you have a dispute under a D&O policy, do get in touch with John Curran at for a free, no obligation discussion about how Indemnity Legal may be able to help.

John Curran
Indemnity Legal
7 December 2021

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