Can Director’s Liability Insurance (D&O) become an ‘all-purpose shield’ against management risks?

Recently, the number of cases where corporate executives are at the center of legal disputes is increasing due to the strengthening of the Severe Accident Punishment Act, the implementation of amendments to the Commercial Act, and the spread of shareholder activism. The ‘individualization of risk’ is accelerating, such as claiming compensation for damages or holding individual executives criminally liable.

Accordingly, the size of the directors' liability insurance (D&O insurance) market is steadily growing every year. This product is a system that guarantees damages and litigation costs when financial damage occurs to shareholders and third parties due to an executive's professional negligence or failure to fulfill obligations. According to the Financial Supervisory Service, this year's D&O contract size is expected to increase by about 15% compared to the previous year to approximately 62 billion won by September. The prevailing assessment is that the insurance is still in its infancy compared to countries where such insurance is active, such as the United States, the United Kingdom, and Japan, but this proves that the sense of legal crisis felt by management is increasing.

However, when an accident occurs, insurance payments are often denied, or fierce legal battles break out between insurance companies and executives over the scope of compensation. So what are the legal issues in D&O insurance that corporate managers must be aware of?

First of all, you must clearly understand the scope of 'damage' covered by D&O insurance. The core of this insurance is to compensate for the resulting damages when an executive becomes legally liable for damages to a third party due to an unfair act committed while performing his or her duties. The unfair act referred to here is a broad concept that encompasses business negligence, negligence, mistakes, and omissions. This works in conjunction with the scope of responsibility of executives established by law, such as Article 399 (responsibility to the company) and Article 401 (responsibility to third parties) of the Commercial Act.

The problem arises immediately after an accident occurs, at the stage of interpreting the insurance company's disclaimer clause. Since many executives have purchased insurance, we believe the majority of legal costs will be covered. However, the insurance terms and conditions state that damages caused by ‘intentional or criminal acts’ are not compensated. Even if you are found guilty in a criminal case, no insurance money will be paid. In other words, if an investigation is initiated on charges of embezzlement, breach of trust, or violation of the Capital Markets Act, it is very likely that the insurance company will judge this as a reason for exemption and withhold or refuse insurance payment.

Many clients knock on the door of law firms when faced with these situations. In this case, the lawyer's assistance does not stop at simply criminal defense against the investigative agency. Legally proving from the early stage of the investigation that the charge is a negligence in management judgment rather than an intentional crime is a key judgment standard when disputing immunity during the insurance payment process in the future. Only by proactively responding from the investigation stage, when the charges are not confirmed, can you prevent insurance payments from being rejected in the future.

As important as insurance payment is the issue of litigation costs. Typical damages lawsuits take several years until the Supreme Court makes a final decision, and it is virtually impossible for individual executives to cover large amounts of attorney fees and litigation costs until a decision is made. For this reason, it is necessary to utilize the 'advance payment clause for defense costs' in the terms and conditions to ensure that legal costs are paid in advance by the insurance company even before the judgment. However, for risk management purposes, insurance companies tend to be reluctant to pay out before the judgment is confirmed. This is because there is a possibility that the money already paid may not be returned if the grounds for exemption are recognized in the results of a future trial. Accordingly, it is important to persuade the insurance company through a letter of assurance that prepaid expenses will be returned when the grounds for exemption are confirmed.

In this way, D&O insurance is more than a simple financial product, but is a complex legal contract directly related to the survival of executives. The structure is such that insurance companies try to minimize payments by imposing strict terms and conditions, and executives must prove the legitimacy of their management activities and request defense. In the end, D&O insurance is an economic safety device that supports active management activities, but signing up does not automatically resolve all legal risks. True risk management is completed by establishing a compliance management system and responding to a crisis by closely analyzing insurance terms and conditions and commercial law responsibilities with legal experts from the beginning when a crisis occurs.
 

Small Business Team

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