Crypto executors need liability insurance

When it comes to regulation and necessities like the banking sector, cryptocurrency entrepreneurs haven’t always had the easiest time.

Recently, I’ve found that some of my crypto clients are having a hard time getting an important business planning tool: Directors and Officers Liability Insurance (D&O). In my opinion, as I will explain, a combination of “event-driven” COVID-19 litigation, regulatory uncertainty about cryptocurrencies, and a misunderstanding of crypto by some in the insurance industry, is making security difficult for crypto entrepreneurs an important service.

Many countries, including the United States, impose a fiduciary duty on directors and / or executive officers that they owe to shareholders or the company. Depending on the jurisdiction, the law may impose a “duty of care”, a “duty of loyalty” or a “duty to promote the success of the company”.

How you ever define it means these individuals are held to the highest legal standards of care, where a breach of fiduciary duty by directors or officers can expose them to heavy penalties, which often include prison sentences.

There are important political reasons why directors and officers should be protected from liability. Arguably, directors should be free to manage a company’s affairs, operations, and affairs in a decisive manner without the fear that any action taken could lead to personal liability. Limitation of liability promotes healthy risk-taking by management, which, hopefully, leads to economic benefits for a company. This is supported by the reality that in the laws of many jurisdictions, companies are separate legal entities and separate from their stakeholders.

In an effort to protect directors and officers from liability, corporate bylaws often dictate that, as long as directors and officers perform certain duties, the company will indemnify them from the costs if they are sued.

In other words, the company will pay to defend and pay damages granted against directors and officers who are sued simply for doing their job.

A company may also enter into a compensation agreement with a director or officer, providing a type of general compensation similar to what may be contained in the company bylaws. One of the main differences between indemnification under the statute and an internal indemnity agreement is that the latter cannot be terminated unilaterally without the consent of the other party. The articles of association, on the other hand, can be amended by a company at any time, provided that the approval of the appropriate director and / or shareholders is obtained.

Why is D&O insurance necessary in light of the above protections? Insurance is critical because it can be used to mitigate both risk and costs. When directors and officers are sued, the company is also likely to be sued and the company may not have sufficient funds to defend itself and pay the attorney fees of the directors and officers. Finally, the interests of the director or officer may not be fully aligned with those of the company and, in order to prevent a conflict of interest, the director or officer may need to use their own independent consultant.

The management of cryptocurrency companies may want to pay special attention to D&O Insurance, especially in light of the cyber security risks facing platforms such as cryptocurrency exchanges and considering the immature state of the cryptocurrency law.

Based on the conversations I have had with insurance brokers and the feedback I have received from clients in different parts of the cryptocurrency industry, I believe that cryptocurrency companies are suffering from some sort of perfect storm, which makes it difficult to get D&O Insurance.

First, due to COVID-19, insurance companies are reluctant to provide D&O insurance in general due to a concern over the “event-driven” COVID-19 litigation. Many companies, particularly in the travel, entertainment and catering industries, can barely stay afloat amidst the constant blockages and social distances. Stakeholders are seeking to hold companies and their management accountable for losses and damages resulting from employee layoffs, dividend cuts and corporate insolvencies.

Secondly, there is the current obscure state of the law governing cryptocurrency. Regulators continue to review regulations to address issues and provide more certainty. Due to the uncertainty surrounding the law in the context of titles, there is an increase in disputes and people turning to the courts to decide matters.

See also: This blue-chip crypto insurance consortium is missing one thing: a sizable loss

In the past eight months, there has been a flurry of lawsuits against companies active in the cryptocurrency industry. As Kevin M. LaCroix writes in The D&O Diary, April 3, 2020 was a pretty important day for class action lawsuits in the U.S. On April 3, 2020, there were 11 lawsuits in total related to cryptocurrencies in only one day, which is probably unprecedented. The lawsuits were all filed in the Southern District of New York and targeted four cryptocurrency exchanges and seven token issuers.

Significantly, LaCroix says, in addition to the defendant companies, each of the complaints is directed at specific directors and officers of each defendant company.

Third, I am told that some members of the insurance industry do not understand cryptocurrency and tend to dismiss it as a scam or too risky to insure. A colleague recently told a story in which he spent nearly an hour arguing with an insurance broker about why Bitcoin is not a Ponzi scheme.

My hope is that when cryptocurrencies enter the mainstream, we will see critical industries, such as insurance, better understand and move closer to technology. Ideally, when a cryptocurrency company begins operations, it will have an adequate D&O insurance policy. But in the absence of a proper D&O insurance policy, cryptocurrency entrepreneurs can still mitigate their risks through a set of properly drafted company statutes or an indemnity agreement.