The “blame culture” targeting directors is here to stay


Author: Marc Sosnow


The “blame culture” targeting directors is here to stay: Some practical steps to protect directors from litigation

Over the last decade the business world has changed forever. Corporate scandals on a considerable scale, amendments to securities regulations worldwide, increased shareholder awareness and extended rules on corporate governance have made being a company director in the 21st century an increasingly difficult task.

Directors have always been bound by many duties arising under jurisdictional laws and even from imputation of personal liability solely due to their position. The difference in today’s world is that stakeholders have far greater forms of remedy against directors and more of a “blame culture” has developed, increasing the appetite for litigation.

This article recommends some practical steps that directors, and those guiding them, can take to ensure they fulfil their duties and protect themselves.

Directors’ duties

Directors owe statutory duties to their companies. The nature and scope of these obligations are set out in the Companies Act 2006 (2006 Act). They are:

  • to promote the long-term financial success of the company for the benefit of its members;
  • to exercise reasonable care, skill and diligence;
  • to act within the powers conferred by a company’s constitution;
  • to exercise independent judgement;
  • to avoid conflicts of interest;
  • not to accept benefits from third parties; and
  • to declare an interest in a proposed transaction or arrangement.

Companies will wish to take practical steps to ensure that directors:

  • are aware of their duties (in particular, their obligation to promote their company’s long-term financial success for the benefit of its shareholders);
  • can be seen to be considering them and complying with them – the more important the decision, the more important the thinking and the paper trail;
  • are suitably trained;
  • have adequate directors’ and officers’ (D&O) insurance for the benefit of the company’s directors;
  • review and align company strategy, policies and processes with shareholder concerns; and
  • seek letters of support from shareholders setting out why they agree with the important decision taken.

Claims by companies against directors

Where a company is performing badly, there is an increased likelihood that there will be major changes to the composition of the board, potentially as the result of public outcry or shareholder pressure (and more recently activist investors). In these circumstances, there is clearly the potential for directors of old boards to become the target of the criticism and, potentially, claims by new boards, even where the directors of the old board may have left and their involvement in the company has entirely ceased.

The upshot of this is that a director who has subsequently taken office in a different company or retired may find himself the target of a claim against him for conduct when in a previous office. Such a claim may be extremely costly to defend and, if made good against him, could lead to his financial, as well as reputational, ruin.

In certain limited instances, a company’s shareholders may bring proceedings to enforce the obligations of a director to his company. The route available to such disgruntled shareholders is the “shareholder derivative action”. Because the director owes his duties to the company, this involves the shareholder bringing an action against a director on the company’s behalf, which the company itself has not chosen to pursue.

Any shareholder(s) may bring claims against a director(s) for any act or omission, either actual or proposed, by the director involving his negligence, breach of duty or breach of trust. The shareholder need not be in possession of his share at the time of the wrong complained of: in other words, it is possible for him to acquire a share expressly for the purpose of being able to launch a derivative action.

Crucially, however, before proceeding with his claim, a shareholder must first seek the permission of the court. The court will decide, by reference to a number of factors, whether to grant the shareholder permission to continue with his claim.

A major factor in the lack of appetite for using class actions in the English courts is that, under our current legal system (unlike that in the US), the losing party is generally liable to pay the winning party’s costs, which, at present, serves as an effective deterrent.

Among the most valuable protections for a director faced with claims against him will be an indemnity from his company and/or D&O insurance.

The 2006 Act provides, in broad terms, that provisions purporting to exempt a director from his liabilities in respect of his company are void. Exceptions to this general rule are that in certain circumstances, a company can indemnify its directors, and that a company can purchase D&O insurance.

D&O insurance

The D&O policy is, in a sense, an unusual form of insurance because, whilst it is bought by the company it is the director who benefits from it. Claims against directors are often very costly to defend and, if made out, frequently lead to sanctions other than damages, such as fines, disqualification and even loss of liberty. Given the nature of claims against directors, perhaps the greatest value of the D&O policy is therefore as a fighting fund.

English D&O policies will generally provide some cover to the director for the costs of defending the following actions:

  • claims by his company;
  • shareholder derivative claims and other shareholder actions;
  • FCA investigations and enforcements; and
  • claims by liquidators on insolvency.

Most D&O insurance policies provide cover for former and current directors of companies. There is no obligation on a company to provide D&O insurance for its directors, although many will consider it best practice to do so.

The effect of this is that directors, particularly retired directors, will not be in a position to influence whether insurance is obtained, and may well not even know if there is D&O insurance available to protect them. Directors would therefore be well-advised to acquaint themselves fully with the D&O provision obtained by their companies, and retiring directors may wish to explore the potential for agreement that D&O cover will be maintained for the future.

It is particularly important in the current climate that companies and their directors give careful thought to the issue of whether the company will indemnify its directors and, if so, on what terms, and whether D&O insurance will be bought by the company.

Indemnities

A company may also indemnify its directors in respect of proceedings brought by third parties, including certain legal costs and certain judgments against the director. A company may also pay directors’ defence costs (even in an action brought by the company itself, provided that the director will be liable to repay these costs to the company if the defence is unsuccessful).

Importantly, however, a company will only be able to provide its directors with an indemnity within the rules if:

  • its memorandum and articles of association permit this;
  • the indemnity is evidenced in a written agreement between the director and his company; and
  • the agreement for indemnity does not contravene the 2006 Act.

Any indemnity provided to the director by his company will only be as good as the covenant that the company is able to provide. As discussed, many claims against directors arise on insolvency, and the company will be in no position to protect its director by an indemnity in those circumstances. This is one area, therefore, where the availability of D&O insurance may be particularly important.

This article is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact:

Marc Sosnow, Partner, Fladgate LLP (msosnow@fladgate.com)

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