Trouble at the top
8 October 2007
4 November 2013
28 October 2013
29 January 2013
13 May 2013
UAE: the standard of care for special care objects and equipment and the extent of liability of its custodian
20 May 2013
As in so many things, the leading market for directors' and officers' (D&O) insurance protection historically has been the US, where directors of publicly quoted companies can expect to find themselves at the wrong end of shareholder litigation with even the slightest whiff of boardroom wrongdoing. US investors have enjoyed zealous shareholder rights since the federal securities legislation of 1933 and 1934, itself a backlash from the 1929 stock market crash, and this has combined with an aggressive and often political plaintiffs' bar to bring the pursuit of shareholder claims to an industrial level.
In the UK, by contrast, the director's life has always been seen as rather less perilous, leading many to question whether D&O insurance is really necessary here at all. Take-up was also impeded for a long time by a widely held (if questionable) belief that D&O insurance was prohibited in the UK by virtue of the embargo against companies extending indemnities to directors for their own liability. Any apprehensions should have been put to rest by the Companies Act 1989, which specifically sanctions D&O protection for most types of liability, and more recently by the Companies (Audit, Investigations and Community Enterprise) Act 2004, but still there remained a lingering reluctance to take up the product.
As recently as 2003, the Office of Fair Trading published a report revealing that some 65 per cent of companies with an annual turnover of at least £100m had bought D&O cover; but that still left a surprising 35 per cent that did not. Among companies with sub-£100m turnover, take-up was just 10 per cent. While there has been further development since then, there is still no compulsion on the part of UK companies to purchase D&O insurance. In the case of fully listed companies, the Financial Services Authority's Combined Code on Corporate Governance suggests they should. Many companies still do not.
Things may be about to change. Recent focus on the Companies Act 2006 has placed UK D&O insurance centre stage for the first time, and has caused many corporations, particularly small and medium-sized enterprises, to think about whether D&O is still a discretionary purchase. A good deal has been written about the act, some of it at times hyperbolic when it concerns the litigation that UK directors might now be about to face.
Whatever else one might say about rights of action under the new statute, they do not come close to replicating the US Federal Acts of 1933 and 1934, not least because claims initiated by shareholders under the UK legislation remain derivative in nature, and so any damages recovered accrue to the company, not the complaining shareholders themselves.
In short, class action shareholder claims are unlikely to be coming to a boardroom near you any time soon, but neither is it true to say that the act simply codifies the existing law. The eyes of the D&O insurance market have focused on the new duty to be found in Section 172. It requires directors to act in a manner that they, in good faith, consider likely to be in the best interests of the company. This sounds innocuous enough, but it then goes on to require them, in so doing, to have regard to six factors, including: the consequences of any decision in the long term; the interests of the company's employees; and the impact of the company's operations on the community and the environment.
Critics of Section 172 - and there have been many - are quick to point out its apparent contradictions. Can a director realistically have regard at the same time to each of the factors listed, when as often as not they will be in conflict? It is in the economic interests of tobacco manufacturers to sell more cigarettes and for airlines to sell more flights, but one harms the health of its customers and the other, we are told, damages the environment.
While Section 172 is unlikely to spawn a welter of claims from conventional shareholders, the greater fear is infiltration by eco-shareholders, political activists busily acquiring equity in large corporations in an attempt to force them continued #to change course. "We'll have teetotallers taking over the brewery," was one colourful observation attributed to Professor Dan Prentice of Oxford University, in The Economist last year.
The concerns are further heightened by what was described in the House of Lords debate as the "double whammy" - new duties in Section 172 coupled with the relaxation of the threshold for the bringing of derivative actions against directors. The former test of 'fraud on the minority' is swept away and in its place is Section 260(3), under which a derivative action can lie for any actual or proposed act of negligence or breach of duty to the company.
This has inevitably led to concerns about increasing D&O claims, both in frequency and size, and in some quarters the worry that the D&O market might find itself at the wrong end of the food chain in the event of some major loss.
Take the example of an escape of some noxious substance from an industrial plant, which causes loss and damage to neighbouring third parties. The company's public liability insurers settle the third-party claims on their insured's behalf, but it then transpires that the leak was the result of a breach by certain directors of their duty to the company to have regard to the impact of its operations on the environment. The company has suffered loss, namely the incurring of liability to the third parties, by reason of the directors' breach, a loss for which it has been indemnified under the liability policy.
On the face of it, the company's claim for loss and damage against its directors ticks all the boxes for a subrogated action at the behest of the liability insurers, and if the company declines to cooperate in the bringing of such an action (as well it might), will a single willing shareholder not do just as well?Such a claim would face serial obstacles, the most obvious in the present example being that many D&O policies exclude pollution liabilities.
However, the same principle could apply in other, non-excluded, scenarios in which the company's insured liability was caused by the directors' negligence or other breach of duty. In many cases, the directors will be shielded from such subrogated claims by virtue of their being listed as co-insureds under the liability policy, or at any rate will benefit from a waiver of subrogation in the policy, but again that will not always be so.
Ultimately, the court may well conclude that a subrogated action for the benefit of the company's insurers, like the eco-shareholder's complaint about greenhouse gas emissions, is one asserted in the pursuit of interests or causes extraneous to the company and not, in fact, a claim that would be pursued by a person motivated only to promote the success of the company itself (Section 263(3)). That said, if and when a suitable case comes along, the point is bound to be put to the test.
The relevant sections of the act came into force on 1 October 2007, so companies and their D&O insurers might not have to wait too long for that to happen.
Anthony Menzies is a partner at Clyde & Co