“Accidents” do happen and prudent director should ensure they appropriately protect themselves from such an eventuality. Insurance is key tool for managing this risk and this article is aimed at providing some guidance on Directors & Officers Liability Insurance.
Directors have “duty of care” to numerous stakeholders. In New Zealand these legal responsibilities are encapsulated in statute under the Companies Act 1993. If director is alleged to have breached his or her duty of care, this can result in significant personal financial liability.
It is important to be aware that the dollar clock starts ticking long before any breach is actually proven. The legal defence of such allegations is usually drawn out over number of years. Even if the director is ultimately exonerated, it may run into hundreds of thousands, sometimes millions of dollars, and this is before taking into account any actual settlement or judgment, in the event the breach is proved. In addition to the direct financial loss, there are non-financial issues to consider such as reputational damage and the personal stress and heartache that legal battle can cause.
Whilst many may consider New Zealand non-litigious country, the awards by the courts have been significant.
• South Pacific Shipping – The company went into liquidation in 1998 and the case was heard in 2004; the High Court found reckless trading in breach of s135 of the Companies Act 1993 and ordered the director to pay $8.4 million to liquidators.
• Cellar House – The company was placed in liquidation in 1999 and in 2004 the managing director was ordered to pay $1.75 million by the High Court for reckless trading under the Companies Act 1993.
• Tranz Rail – In 2007 the Securities Commission settled long-running insider trading case for $20 million, the highest insider trading settlement in Australasian history. The directors, Richwite and Fay, have always maintained their innocence.
• Feltex Carpets – The company was placed in receivership in 2006. The matter is far from finalised but the liquidators have put the directors on notice that they could face legal action in excess of $20 million. There has also been speculation that shareholders are planning joint recovery action claiming up to $250 million, which would be the first class action in New Zealand.
These are only the cases that get into the press. There are other multimillion-dollar matters which are privately settled. Overseas, such litigation is commonplace and significantly more catastrophic. You only need to look at some of the current cases in Australia; there’s the GIO case which settled in 2003 for A$97 million and number of ongoing class actions such as that against AWB (A$25 million), Multiplex (A$100 million), Aristocrat (A$100 million), Downer EDI (A$100 million). There is talk of new A$300 million shareholder class action against Centro Properties Group. Further afield in the United States, it is even more disturbing. Over the 10 years to 2006, there was an average of 194 securities class actions filed each year and in 2007 the average settlement paid to shareholders was US$32.2 million (Source: NERA Economic Consulting 2007).
Legal claims can and have been made against directors by numerous parties including creditors, shareholders, employees, regulators like the Securities and Commerce Commissions and other third parties such as commercial business partners, clients and competitors.
There is no doubt that the level of litigation in New Zealand is on the increase and it is also clear that it is not only directors of public companies that can come into the firing line as clearly shown in the South Pacific Shipping and Cellar House cases. Therefore how does prudent director protect his or her interests? The simple answer is Directors and Officers Liability Insurance (which is commonly available in New Zealand).
What is Directors & Officers Liability Insurance?
Broadly Directors and Officers Liability Insurance is an insurance policy that covers directors (and other officers of company) for the legal liabilities that they incur through an alleged or actual breach of their obligations as director (or officer). Some policies also cover certain other defined events such as attendance at inquiries, defence costs for breaches of certain legislation such as Occupational Health & Safety laws and the publicity and crisis containment costs surrounding the curtailment of reputational damage.
How does Directors and Officers Liability Insurance work?
The first thing to understand is that this insurance is generally purchased for the directors by the company they are appointed to. This means that the company pays the premium, on behalf of the director.
Directors should execute deed of indemnity with the company. This usually states that the company will indemnify the directors for certain liabilities incurred by the director in their capacity as director of the company. Directors and Officers Liability Insurance aims to reimburse the company for any indemnity it has to grant to the director but, most importantly, it will indemnify the director individually in the event that the company will not or is unable to indemnify the director. There are number of instances where this can occur including:
• The company becomes insolvent – When company becomes insolvent, the indemnity provided to the directors by the company becomes effectively worthless. It is at this time that directors are most vulnerable as usually the liquidators will scrutinise directors’ actions to determine whether they are able to bring claim against the directors to recover money owing to creditors.
• Alleged fraud or dishonesty – Company indemnities will not extend to allegations of fraud/dishonesty and other criminal acts. Whilst you as director may be entirely innocent, you will still need to go through lengthy legal proceedings in order to defend yourself and prove your innocence.
• Company/director disputes – If there is dispute between the director and the company, the company can refuse to indemnify the director, leaving the director to face the costs of the dispute.
Common Pitfalls
Directors and Officers Liability Insurance policies are like cars – there are low cost budget models which can be prone to mechanical failure and there are Rolls Royces which go on and on forever. The key priorities are to ensure that the policy is appropriate to the needs of the directors and it is provided by reputable and financially sound insurer.
• Make sure the Deed of Indemnity is adequately drafted and allows purchasing of Directors and Officers Liability Insurance – typically deeds of indemnity have provision for the purchase of this insurance by the company for the benefit of the directors. Ensure that this provision is in the deed and make sure it is enforced.
• Make sure the limit of indemnity is sufficient – policies cover multiple directors and some policies also cover the company itself which can result in the insurance being eroded by variety of directors and officers claims and the director being left without cover. If there is dispute over who gets access to the policy first, the company will usually win. The best way to prevent this occurring is to buy limit which is sufficient for all parties under the policy.
• Make sure the insurance is provided by financially sound insurer – Directors and officers claims can drag on for many years. Therefore you need to be sure that your insurer will still exist when the matter is finally resolved, otherwise the director will be left to pay personally.
• Have input into the insurance purchasing process – many directors delegate the purchasing of Directors and Officers insurance to others within the company. This can lead to conflict of interest as others may be more focused on price rather than coverage. It is in director’s interest to take an active role in the purchasing of this cover as the policy could be the only thing betw
