Crypto Execs require legal responsibility insurance coverage
When it comes to regulation and necessities like banking, crypto entrepreneurs haven't always had the easiest time.
Recently, I discovered that some of my crypto clients are struggling to get an important business planning tool: directors and officers' liability insurance (D&O). As I will explain, a combination of "event-driven" COVID-19 litigation, uncertainties about crypto regulations, and a misunderstanding of crypto by some insurance companies makes securing crypto entrepreneurs a critical service.
Matthew Burgoyne is a corporate and securities law partner at McLeod Law LLP in Calgary, Alberta. He has been advising cryptocurrency clients since 2013 and is chairman of McLeod Law's cryptocurrency and blockchain group.
Many countries, including the United States, impose fiduciary duties on directors and / or officers that they owe either to shareholders or to the company. Depending on the case law, the law can stipulate a “duty of care”, a “duty of loyalty” or a “duty to promote the company's success”.
However you define it, it means these individuals are subject to the highest legal standard of due diligence when a breach of the fiduciary duty of directors or officers can result in heavy sentences, often including imprisonment.
There are important political reasons why directors and officers should be protected from liability. Directors should arguably be at liberty to conduct the business, operations and affairs of a corporation in a decisive manner without fear that actions they take could result in personal liability. Limitation of liability encourages healthy management risk taking, which hopefully leads to economic benefits for a company. This is supported by the fact that under the laws of many jurisdictions, corporations are legal entities separate from their stakeholders.
To protect directors and officers from liability, company statutes often require the company to indemnify directors and officers from costs if they are sued, provided directors and officers perform certain duties.
Cryptocurrency companies are suffering from some sort of storm that makes it difficult to get D&O insurance.
In other words, the company is paying to defend and pay damages to directors and officers who are sued for their work alone.
A company may also enter into a compensation agreement with a director or officer that provides for a similar type of comprehensive compensation as that contained in the company's articles of association. A key difference between a statutory compensation and an internal compensation agreement is that the latter cannot be unilaterally terminated without the consent of the other party. On the other hand, the Articles of Association can be changed by a company at any time, provided that the appropriate approval of the director and / or shareholders is obtained.
Why is D&O insurance necessary given the above protective measures? Insurance is critical because it can be used to both reduce risk and reduce costs. If directors and officers are sued, there is a possibility that the company could also be sued and the company may not have sufficient resources to defend itself and pay the directors and officers legal expenses. Finally, the interests of the director or officer may not entirely coincide with those of the company and to avoid a conflict of interest the director or officer may need to seek their own independent legal counsel.
Crypto top executives may want to pay special attention to D&O insurance, especially given the cybersecurity risks that platforms like crypto exchanges face and given the immature state of crypto law.
Based on conversations with insurance brokers and feedback from clients across different parts of the cryptocurrency industry, I believe that cryptocurrency companies are suffering from some kind of storm that makes it difficult to get D&O insurance.
First, because of COVID-19, insurance companies are reluctant to offer D&O coverage in general because of concerns about "event-driven" litigation with COVID-19. Many companies, especially those in the travel, entertainment, and restaurant industries, barely stay afloat in the face of ongoing lockdowns and social distancing. Stakeholders seek to hold companies and their management responsible for loss and damage resulting from layoffs, reduced dividends, and corporate bankruptcies.
Second, there is the current bleak state of the law regulating cryptocurrency. Regulators continue to review the rules to address issues and provide added security. Because of the uncertainty surrounding the law related to securities, there is an increase in litigation and people turning to the courts to rule on the matter.
See also: This blue-chip crypto insurance consortium is missing one thing – a sizeable loss
There have been a number of lawsuits against companies in the cryptocurrency space over the past eight months. As Kevin M. LaCroix writes in The D&O Diary, April 3, 2020 was a pretty big day for class action lawsuits in the United States. On April 3, 2020, a total of 11 cryptocurrency-related securities lawsuits were filed in a single day, which is probably unprecedented. The lawsuits were all filed in the southern borough of New York and were directed against four crypto exchanges and seven token issuers.
According to LaCroix, each of the complaints is directed to certain directors and officers of the defendant companies in addition to the defendant companies.
Third, I've been told that some members of the insurance industry don't understand cryptocurrency and are more likely to dismiss it as a scam or too risky to insure. A colleague recently shared a story in which he spent almost an hour debating with an insurance broker why Bitcoin is not a Ponzi program.
I hope that as crypto enters the mainstream, critical industries like insurance will better understand and warm up the technology. When a crypto business starts operations, it ideally has adequate D&O insurance in place. In the absence of a proper D&O insurance policy, crypto entrepreneurs can nonetheless mitigate their risks through properly drafted statutes or a compensation agreement.