The ‘failure to prevent fraud’ offence
In June 2022, the U.K. Law Commission published a paper with the aim of ensuring that large corporations could effectively and more easily be held to account for committing serious crimes. The Commission’s paper resulted in the creation of the Economic Crime and Corporate Transparency Act 2023, and pursuant to section 199, it created the new corporate criminal offence of failure to prevent fraud. The offence comes into force on 1 September 2025. Although this is a U.K. law offence, it has global reach, and can impact corporate policyholders based outside the United Kingdom. The new offence should therefore be taken into account by global corporate organisations renewing or placing D&O insurance.
The common law identification doctrine, which required commission/omission relating to an offence to be attributed to an individual who was, at the relevant time, the ‘directing will and mind of the company’ has been extended by the statute to include ‘senior managers’. This means that a greater number of employees, not just board members and the most senior officers of a company, are now likely to be relevant for the purposes of assessing corporate criminal liability. From an insurance industry perspective, once the offence comes into force next year, notifications under D&O policies are expected to increase significantly.
Directors’ & Officers’ insurance
D&O cover provides directors and other senior individuals of corporates with reimbursement for legal costs and expenses incurred in relation to investigations and/or in defending claims brought against them personally for alleged wrongdoing (acts and/or omissions) during the course of their duties. It usually also provides reimbursement for settlement amounts or monetary awards resulting from such claims.
The failure to prevent fraud offence, which includes false or misleading representations or statements, and failures in disclosure, is likely to give rise to increase the incidences of Side A, B or C claims under D&O policies.
It is expected that regulators will be more heavily focused on senior management failures with a view to holding corporates to account, which also means that the insurance market is braced for an increase in D&O claims from both individuals and from corporates.
Rising costs
Although the market has been ‘soft’ in recent years, with many insurers competing for D&O business, the expansion of corporate offences and accountability is expected to lead to an increase in claims and a hardening market. In turn, insurers are expecting to face larger exposures, which will necessarily result in higher premiums for policyholders. In relation to the failure to prevent fraud offence, sections 199(4) and (5) of the 2023 Act set out that relevant organisations will have a defence if they have reasonable procedures in place to prevent fraud, or if they can demonstrate that it was not reasonable in all the circumstances to expect the organisation to have any prevention procedures in place. Guidance suggests that fraud prevention frameworks should be informed by principles such as top-level commitment, processes for risk assessment, proportionate risk-based prevention procedures, due diligence, communication (including training), and monitoring and review.
Going forward, insurers may require policyholders to demonstrate that ‘reasonable procedures’ have been put in place to mitigate risk. Companies with good practices and procedures already in place should find it easier to negotiate lower premiums and broader terms of coverage.
Limits of liability
Policyholders will need to assess whether limits of liability for different sections of cover need to be increased in light of the new failure to prevent fraud offence, e.g. cover may need to be increased for investigation costs, defence costs and PR/crisis costs cover.
When it comes to erosion of D&O policy limits, cover for individual directors and officers is usually eroded on a first come first served basis, so it is in senior managers’ own interests to familiarise themselves with the scope and terms of cover.
Terms of cover
Policyholders should check the way in which terms operate, e.g. warranties and/or conditions precedent. Other claims conditions should also be considered since these will be especially important if claims arise; claims control conditions will be relevant to policyholders who wish to retain a high degree of control over the conduct of any defence, including the ability to decide who should be retained to act for them. Dealing with policy terms before inception or policy renewal will mean policyholders are better placed to negotiate suitable terms.
Exclusions
Policyholders should seek advice from specialist brokers and lawyers so that the operation and breadth of exclusions are carefully reviewed and negotiated. A projected increase in D&O claims in 2025 and beyond, including securities claims and class actions, may contribute to narrower coverage and broader policy exclusions.
The way forward
Insurers are often able to deny cover for otherwise covered claims due to breaches of policy terms, often linked to late notice. Given the increased risk that the government will seek to impose corporate criminal liability linked with acts and omissions of senior managers, it will be critical for companies (and the individuals themselves) to understand which senior individuals are performing roles that could expose the company (and individuals) to criminal liability.
In the current climate, D&O insurance will be increasingly important to companies to help protect their balance sheets and assets. Shareholder and class actions, regulatory investigations and/or criminal prosecutions can span many years and legal costs relating to them can easily run into the many millions of pounds. Companies should be prepared. Boards, general counsel, and risk managers should be looking closely at the D&O cover. Relevant training should take place internally and all senior leaders within a company should be fully informed as to the scope of D&O cover.
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