Indemnification challenges for Web3 Directors and Officers

By 12 September 2023Blog

A Directors and Officers Liability (D&O) insurance policy provides coverage for defence costs and damages arising from civil/criminal/regulatory actions (referred to as an ‘action’ in this article) brought against a company’s directors/officers as well as in certain scenarios against the company itself. A D&O policy comprises three parts:

  • Side A covers the directors/officers personally (i.e. protects their personal assets) if the company can’t or won’t indemnify them in the event an action is brought against them.
  • Side B covers the legal costs incurred by the company when defending directors/officers from an action.
  • Side C covers security-related actions against the company.

In this article, we’ll focus on protecting directors/officers if an action is brought against them for actual or alleged wrongdoing when managing a Web3 company, and we’ll explore the concept of presumptive indemnification and its impact on a D&O insurance policy. 

New company – standard articles?  

When an action is brought against a director/officer by internal parties (other directors/officers or employees) or external parties (investors, regulators, suppliers, customers for non-service-related issues and any other third party), an action can often result in personal liability which subjects directors/officers personal assets to potentially significant loss if a company is unable/unwilling to defend the director/officer.

Web3 firms are especially vulnerable to actions due to an evolving regulatory landscape, fast burn rate of capital, volatile business models and high staff turnover. There is little (but rapidly growing) legal or regulatory precedent in actions and investigations in the running of Web3 firms.

Because the industry is developing at a rapid pace and, in some cases, still finding its feet, some of the most common actions are for deceptive or false advertising, misrepresentation, breach of contract, and non-compliance with money laundering and securities regulations. Actions are often brought simply because a firm has not reacted fast enough to changing business conditions.

Given the volatility of the marketplace, the financial performance of Web3 firms can fluctuate widely, and the presumption of wrongdoing can be more prevalent. Therefore, the directors and officers should ensure their articles of association or equivalent provide specific indemnification provisions to protect them in this fast-paced environment.

In some cases, Web3 directors/officers can find themselves with little protection from their company to the extent that they will only be indemnified by the company if after final adjudication they are found innocent of the accusation. This leaves Web3 directors/officers in an uncertain position, as they may have to defend the action themselves which could expose their personal assets.

What is presumptive indemnification in D&O insurance?

This clause assumes that a company will indemnify its directors/officers to the “fullest extent permitted by law”. In other words, it does not matter what the company actually states in its articles of association indemnification provisions, insurers expect the company to go beyond that to the maximum extent permissible.

With this clause in place, when a claim is made, the D&O insurance only covers claims relating to matters where the director/officer was indemnified by the company or where the company was able to indemnify the director/officer, leaving the directors/officers exposed to significant personal liability if the articles of the company do not require the company to defend the director/officer.

Web3 directors/officers need to be aware of any limitations in the indemnification provided by their company. Any ambiguity or omissions could lead to uninsured liability in the event of a claim, and without maximum protection permissible under law, Web3 directors/officers could face a large, uninsured loss because of presumptive indemnification clauses.

Some D&O insurance policies will include a presumptive indemnification clause. The example here requires the company to indemnify the Director/Officer even if the articles may state the opposite:

“The Named Insured and any other Company agree to indemnify the Insured Persons, including the advancement of Claim Expenses incurred by the Insured Persons to the fullest extent permitted by law or the functional or foreign equivalent.”

Side A D&O will protect directors/officers when they are not indemnified by their company. Scenarios where indemnification might not be available to a director/officer include bankruptcy, regulatory proceedings, criminal allegations, and acts of ‘bad faith; however, in circumstances where the company can indemnify a director/officer and chose not to, then the director/officer may find there is limited access to coverage.

As Web3 grows in popularity and becomes more mainstream, it is crucial for Web3 firms to maintain and monitor sufficient levels of D&O coverage. Elmore strongly encourages any firm, whether operating in Web3 or not, to be aware of indemnification clauses both in their company articles and in insurance and ensure that the right level of protection is in place.

For further advice and information on Elmore’s D&O services, please contact the Elmore Fintech Team: ElmoreFinTechTeam@elmorebrokers.com

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