15 Mar 2010
It is estimated that there are at least 10,000 actions against directors and/or officers of companies around the world underway at any one particular point in time. On average, each claim may take seven years to settle, irrespective of whether any grounds are actually found for the original action.
While a claim is proceeding, a lot of management time will be absorbed in defending the allegation and legal costs can soar. This is before considering any indemnity payouts, where claims are found to be upheld.
In this increasingly litigious society, more and more people are taking legal action against the directors and officers of a company. The list includes: employees, customers, suppliers, bankers, creditors, regulators, shareholders, fellow directors and pressure groups. Directors and officers can be held legally accountable in their own personal capacity for unlimited amounts. Furthermore, they can be called to account for the actions of management and of other board members.
The marked increase in the personal liability of directors is driven by ongoing changes in legislation in the areas of corporate governance, employment law, health and safety and the increasing powers of regulators. Shareholders receive a constant supply of accurate corporate data and are increasingly likely to sue if they do not receive it or feel that it is inaccurate, particularly in the US. This has increased the likelihood of actions against directors.
Whether the accusation is of profligate spending, contracting a bad deal or laying a company open to a claim under the new ELD (Environmental Liability Directive), large private companies, charities, financial institutions, pension funds and all executive and non executive directors need to consider the risks. The fact that there are now professional litigators in the US, demonstrates the significantly increasing risks particularly for directors of listed companies. These individuals or firms purchase single shares of all listed companies, then monitor performance against expectations. Any unusual performance (for example, a stock drop of 20 percent) may lead to an investigation and the formation of class action. A typical class action costs around US $5m to defend and an average indemnity payout may reach over $35m.
Made more challenging by difficult economic conditions
Directors and officers personal exposure is further increased by the current shortage of credit and consequently heightened risk of bankruptcies. In the case of insolvency there is no entity left to indemnify the directors, who then have to rely entirely on insurance policies to defend themselves and their assets. It requires some detailed planning and advice to extend cover corporately without eroding directors.
The current action against the Stanford Financial directors as well as previous high- profile actions such as Enron and the Nat West trial show the importance of carefully calibrated, up-to-date insurance arrangements.
Mitigating the risk
With the increase in D&O claims and the global economy becoming more electronic with intercontinental trading, there is now an increased obligation and responsibility on directors of large corporations and small to mid-sized businesses to purchase suitable insurance. As covers broaden, it is also becoming more important to consider buying standalone cover to protect directors personal exposure from a host of issues including pollution, insolvency of insurers, bodily injury and many others. Directors and Officers insurance, or D&O, covers company directors and officers in the event that they are accused of being engaged in wrongful acts whilst conducting company business. This type of policy will reimburse company directors and officers in such an eventuality. The D&O market in the UK alone is estimated to have grown from £445m in 2007 to over £500m in 2009, as measured by gross written premium (GWP).
It’s not all bad news: insurance can make transactions happen
The mood at the recent WEF meeting in Davos could not have been viewed as entirely optimistic. But there was an emerging feeling that several viable corporate transactions, that had been shelved because of the economic conditions, might now be set to move again later in the year.
Some dealmakers are beginning to take advantage of increasingly innovative insurance solutions to help deals go through, either by insuring warranties and indemnities in private transactions or more broad-based prospectus covers (including advisors/brokers) for public offerings. When a company decides to undertake a significant transaction, it generates a comparatively high level of risk exposure for the directors and officers of the company and its advisors. The prospectus itself makes numerous and detailed comments about the health of the company and its future prospects, upon which potential investors rely.
Investors might subsequently make a claim against its directors should circumstances cause the business to under-perform. Hence it is essential for a company to ensure that appropriate and specific cover is provided and that these losses do not impact on the ongoing D&O protection, if it wants to ensure that deals proceed.
In addition, for certain large transactions, historic tails of liability may be insured away, to make sure that the seller achieves an appropriate/undiscounted sale price. This technique may actually help enable transactions complete, by de-risking the deal for potential purchasers and sweetening the price for the sellers.
What D&O should I buy?
D&O is a complex product, with a wide variation in the breadth of cover from different providers. Company directors are facing increasingly onerous responsibilities as shareholders demand higher standards of corporate governance and financial transparency. In a rapidly changing claims environment and an increasingly litigious world, have you reviewed the breadth of cover, adequacy of limits and programme design?
Many policies are inadequate and often poorly sold and accordingly it is worth searching out professional advice from a specialist intermediary, to give you advice appropriate to your particular needs and circumstances.