LIABILITY OF DIRECTORS & OFFICERS
The position of director or officer in a company brings with it responsibilities, as well as rewards. In today’s corporate climate one might well be excused for thinking that the risks are beginning to outweigh the rewards. Directors and officers may be held personally liable for failure to carry out their duties properly, which could mean financial ruin.
Just as traditional professionals, like accountants and lawyers, can be held legally liable for errors or omissions in the conduct of their business, so too can directors and officers in any organisation be held accountable for failure to carry out their duties properly.
How did Directors liability arise?
The concept of the limited liability company was developed to protect the shareholders in a venture from being exposed to creditors or others whose legitimate claims for payment could not be satisfied by the trading entity usually as a result of its insolvency Without such limitations of liability to the extent of their shareholding, it would be much harder to attract investors to finance business ventures.
Initially shares in companies were usually held within a close knit group, typically members of a family or local community As companies grew in size, shareholdings became larger and more widespread, thus losing the close relationship and opportunity for personal knowledge of the affairs of the enterprise. Management and direction of companies became separate from ownership; operational control became the responsibility of paid representatives of the owners, the directors and officers of the company.
It is only fair that such custodians of the corporate entity should be held responsible for the way in which they discharge their duties. If an ordinary employee fails to perform as required, he or she may be reprimanded or dismissed. If a senior officer or director fails in their duty, they may also be dismissed or voted out of office. However, if some other party can show that they have suffered injury or damage in consequence of the acts or omissions ofsuch officers or directors, then that plaintiff may bring a legal action against them personally for damages. The potential cost of such a claim, or just the legal costs incurred in defending it, can be very substantial.
Who can claim directors liability insurance?
As society becomes more inclined to litigation and legislation is expanded to impose greater controls on corporate activities, the risk exposure for directors and officers increases.
Potential claimants could include:
- Shareholders - in relation to incorrect prospectus information, or other breachers of duty as directors.
- Regulators - such as the Australian Securities Commission, Trade Practices Commission or Australian Taxation Office, for breaches of legislation.
- Competitors - arising from unfair trading activities.
- Creditors - in relation to debts incurred when the company was known to be unable to meet its commitments.
- Customers - for misleading conduct.
- Employees - in connection with unfair dismissal, breach of equal opportunity requirements, or sexual harassment.
Is the problem increasing?
Yes, it certainly is! Community standards are becoming more stringent; the public is demanding that directors be held responsible for the consequences of their actions.
Greater public awareness of consumers rights has placed pressure on government to clarify and expand the obligations of directors. This has resulted in tougher legislation and court decisions that reflect higher community expectations.
Claims against directors and officers are expected to increase significantly over the next few years.
Who can be sued?
Any director or executive officer is exposed to claims, irrespective of the size or nature of the company concerned and we are not just talking about public companies.
It makes no difference whether you are a non-executive director, or are only involved with a private company, charity or non-profit organisation. Anyone in a position of corporate authority or with management responsibility, is fair game these days. You are not only responsible for your own actions, but can also be held liable for the actions of fellow directors.
What can you do?
Directors and officers should try to reduce their exposure by ensuring that certain practical measures are undertaken to minimise risk. They should ensure that they are fully briefed on their areas of responsibility, so that all decisions may be taken on an informed basis. Larger companies should establish audit committees, to check on the conduct of the business and compliance with all statutory requirements.
Directors & Officers Liability insurance should be arranged in addition to, rather than in place of such precautions. It should be considered as a safety net, but is no substitute for careful, prudent conduct. Remember, it will only cover damages and legal expenses, not fines and penalties; that would be against public policy.
What director/officer liability insurance is available?
We are not talking here about liability for physical injury or damage involving third parties, that is the province of Public or Products Liability risk. What we are concerned with is liability for purely financial loss, which may be equated to the errors and omissions exposure faced by people like accountants or lawyers, only in relation to company officials — that is why it is called Directors & Officers Liability insurance.
Cover is provided only in relation to liability arising from corporate activity in a general, managerial sense. There is no indemnity for errors and omissions relating to specialist professional responsibility to clients, in areas like law, medicine or accountancy.
The cover is written in two parts, a company reimbursement policy on legal expenses, and a personal indemnity policy on damages plus legal expenses. This is done to comply with Australian legislation, which forbids companies from indemnifying their directors. The overall premium is generally split, with the company paying around 90% and directors paying the 10% balance.
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