The blame game

Directors' liability insurance may not be as big as predicted, but as Gareth Chadwick reports, it is lurking at the threshold

Directors' and officers' liability (D&O) was supposed to be the new rock 'n' roll. In the aftermath of the Companies Act 1989, professional indemnity (PI) insurers and insurance lawyers were predicting an explosion of D&O work. Company directors and officers, we were told, would no longer be allowed to scuttle quietly out of the boardroom after business failures, as the auditors and other professional advisers faced the mob clutching their PI policies.
You only need to look at the US, it was explained, where every share price blip results in a shareholder action, to see the morass of D&O work that would soon be hitting the desks and cramming the corridors of insurance law firms across the country. But the deluge never came; and now, 10 years after the unstoppable wave of D&O work was first predicted, and with Enron, WorldCom, Equitable Life, Independent Insurance and others casting their shadows, we are still waiting.
“It's difficult to know what caused such high expectations of masses of D&O work,” says Edward Smerdon, one of six partners in Reynolds Porter Chamberlain's D&O unit. “I suppose it was more of a hope than an expectation. Things have moved gradually towards a culture of claims against directors, but there hasn't been anything like the explosion that commentators talked about.”
So what happened? A closer look at the D&O market would have indicated that such a radical increase in claims was never likely. D&O policies were a relatively new product and as such there was always going to be a bedding down period as underwriters, brokers and boardrooms got used to the idea.
No one had a model for a 'typical' D&O policy, which meant that everyone had their own interpretation and often borrowed from the US. Coverage limits were low at around the £5m mark, and policies tended to be narrow, with a raft of exclusions, such as the 'insured v insured' exclusion, meaning that directors could not be sued by fellow directors. With no history of claims to point to and limited coverage, brokers were left trying to sell D&O policies to a sceptical market. Even if a potential action did arise, the low coverage limits were a disincentive to go through the costly and lengthy exercise of mounting a claim against a director. In 1994, the total premium income for D&O cover was estimated at £75m – a considerable increase on the £5m of 10 years previously, but still far short of the hundreds of millions that had been predicted.
The structure of company law in the UK also lessened the likelihood of a rush of claims along US lines, with it still being quite difficult in this country to directly sue a director as a private individual. Roger Stewart QC of Four New Square explains: “There are all sorts of occasions when liabilities are imposed on directors, such as health and safety at work, financial services regulation or competition regulations. Most of these claims, though, if they lead anywhere, lead to a criminal prosecution or the imposition of fines and penalties, or to a liability to the company rather than directly to a third party.”
Where a claim is an option, the ingrained culture in the UK of going after the auditors and professional advisers mitigates against a claim. According to Francis Kean, one of two partners actively engaged in D&O at Barlow Lyde & Gilbert: “Directors tend to be quite low down the pecking order when claimants are casting around as to who to blame when something has gone wrong. They traditionally aim for the professional advisers and don't regard the directors as a deep pocket that's worth pursuing.”
It is an attitude that many in the industry believe is finally changing, which, in tandem with other developments, is leading to speculation that the long-heralded D&O upsurge could finally be on its way.
“I'd given up prophesying that D&O claims were going to start flooding through,” says Kean. “But over the last few months there's been a marked increase in notifications to insurers of circumstances which could give rise to a claim.”
High-profile failures such as Enron, WorldCom and, closer to home, Equitable Life and Independent Insurance have played a part, highlighting the often dubious role played by directors and officers in many corporate failures. Chris Lowney, a consultant in the 12-strong insurance group at Richards Butler, believes a backlash has begun and that there is “a public perception that directors are getting away with it” and are “ramping up share prices illegally and making money on the back of false accounting”. Kean agrees, noting a growing awareness of the role of directors and their responsibilities and an increasing readiness to take action against them. He also cites the growing army of claimant lawyers using conditional fee arrangements to generate support for shareholder class actions against directors.
Smerdon points to changes in the legal environment as an indication of the way the market is heading. The law on minority shareholder actions in particular could have a significant influence. The Department of Trade and Industry has already approved recommendations for a new minority shareholder right, enabling minority shareholders to compel the company to bring an action against the directors.
Smerdon also believes that the increased amount of regulation on companies will have a bearing on the number of claims. The Financial Services Act in particular could be a rich source of work as tighter regulations lead to more investigations. The high-profile scandals, corporate failures and shareholder actions may have the glamour, but claims from directors seeking to defend themselves against investigations by a whole host of regulatory bodies already constitute a substantial proportion of D&O claims.
The lawyers are also getting involved in increasing amounts of advisory work, advising companies and the insurers themselves on policy issues and potential liabilities. Marcus Campbell, a partner and one of three D&O specialists at Beachcroft Wansbroughs, believes that the initial focus on actions between directors and shareholders came at the expense of a broader appreciation of the type of work that D&O cover was generating. “One mistake people made was that they presumed it was all about shareholder actions, because in the US shareholder-driven actions are huge; but there are aspects of English law that meant that was never going to happen here,” he says. Stewart agrees, saying that he has yet to work on a high-profile courtroom, directors-in-the-dock D&O case, but that he is doing a lot of work advising companies and insurers about their liability and policy coverage.
It is far from the explosion of work that was anticipated, but the work is gradually coming in and the amount has increased significantly over the past six months. With the hype out of the way, D&O is becoming an accepted part of most insurance practices. “We're on the way to it becoming an established facet of the insurance and litigation landscape,” says Campbell. “People looked across the Atlantic in 1990, where there's a mass of D&O-related litigation, and predicted similar levels here within about five years. That was naïve. But if you look five years ahead from now, while I'm not predicting a flood, the whole climate has given rise to a greater degree of responsibility on directors and officers. People see them being highly paid and expect that, when things go wrong, they should carry the can.”
There is a widespread belief in the D&O industry that it would only take one high-profile case to be brought to court successfully for the implications and sums of money involved to act as the catalyst for a huge rise in claims. All that is required is a high-profile corporate scandal to act as a trigger. On recent performances, we should not have too long to wait.