NSW Supreme Court Chief Justice Tom Bathurst told the AILA conference in Sydney there was “a significant lack of clarity about circumstances in which directors and officers cannot access insurance for reasons of public policy”.

In a keynote presentation, CJ Bathurst said liability insurance played several essential roles. “It insulates defendants from the potentially devastating financial consequences of a moment of carelessness, for example while driving. Particularly in the commercial sphere, liability insurance also plays an essential role in encouraging productive economic activity.

“By protecting individuals financially against the consequences of failure, insurance allows company officers, investors and others in the commercial community to take risks that are necessary for successful entrepreneurship and, in turn, economic expansion,” he said.

“The rationale for providing such insurance is clear. In its absence, capable and talented individuals may be unwilling to join boards of directors, particularly as non-executive directors, or may become excessively risk averse on boards, to the detriment of the individual company and the broader commercial community. D&O insurance also recognises that company officers may become personally liable in circumstances where they have scant moral responsibility, for example where uncertainty in the law means that, while company directors may subjectively believe they are acting in accordance with their duties, they are later found not to be.”

 CJ Bathurst said it could also be argued D&O insurance provided too much insulation from risk, “creating a moral hazard by removing any chance directors will have to meet liability from their personal funds”.

“In this way insurance can be argued to subvert public policy, encourage unscrupulous directors to pursue questionable activities and dull the incentives of honest directors to be attentive to their duties and act in the best interests of the company,” he said.

The judge said there were ever-increasing obligations on company directors and advisers and, in particular, auditors.

“It does not seem to me unreasonable that directors should be able to protect themselves from liability for civil penalties as well as liability to third parties. The deterrent effects of disqualification and the significant loss of reputation that inevitably flow from such a finding remain. One has only to remember the opprobrium directed towards the James Hardie directors to appreciate this.

“What is undesirable however is the lack of clarity around these issues. At the moment, the market’s best guess seems to be that insurance for criminal penalties is likely to be deemed illegal or unenforceable by the courts, and it is not clear if a similar situation applies in relation to civil penalties.”

CJ Bathurst said the need for certainty in legal rules applicable to commercial activity was “acute”.

“Directors and officers need to know whether their policies are enforceable and will protect them against the risk of personal liability and possible bankruptcy. Insurers need to be able to properly assess variables to accurately price risk. ASIC needs to assess how insurance may affect its corporate regulation strategy. At present, it is questionable whether sufficient clarity exists to enable those assessments to be made satisfactorily.”

 

Litigation a business

Litigation against directors is no longer just to punish wrongdoers, it’s now a business, says AIG’s Jeremy Scott-Mackenzie.

In a separate Harbour Lights session, he told the AILA conference the advent of litigation funders, whose motivation was returns for shareholders, meant litigation was “just a business for them”. ASIC, having had “a few high-profile losses” against directors, was now “looking for scalps”.

Non-executive director Naseema Sparks agreed, saying class actions were in funders’ interests. Directors faced a plethora of legislation, including the Corporations Act 2001, federal statutes and more than 750 state and territory laws.

Directors and management were becoming risk averse because of the potential for personal liability. “There must be regulation around company management, but most directors are hardworking, honest people,” Ms Sparks said. Many were no longer prepared to face the potential financial and reputational risk exposures.

Time directors spent on compliance had increased in the past 12 months and that was at the expense of thinking about strategy, future business growth and performance. ASIC was “peering over directors’ shoulders” much more than in the past. ASIC “wants to be at the board table, to see draft releases and forecasts, and get more involved in the process. I sympathise with them, but it doesn’t make it easy to run a business”, Ms Sparks said.

“It’s not a good place for Australian business if people are not willing to serve on boards and lend their expertise.” She said a survey showed one third of directors had declined a board position because of the fear of personal liability. Directors “feel besieged by corporate governance requirements”.

Mr Scott-Mackenzie warned defence costs could be crippling, but said D&O insurance was not just for financial protection. “It provides expertise to level the playing field when you’re sizing up against an aggressive regulator or funder.”

He said a “great” claims manager could be “the lynch pin in protecting a director’s reputation” as they had panels of experts, including public relations advisers. Claims managers were “a treasure trove of information in developing risk management frameworks”.

Mr Scott-Mackenzie warned too few insureds considered contingency planning. “Has your response plan been stress tested? How do you respond if ASIC’s on the phone or a plaintiff lawyer gets in touch?”

He advised directors to use good risk management, including contingency planning; have the claims manager as part of their ‘inner circle’; buy D&O cover sufficiently broad to cover their risks; and have access to advice and expertise.

Asked whether the existence of insurance helped directors better focus on strategy, Mr Scott-Mackenzie said directors were now more specific about the type of cover they wanted in place. “It’s not just ‘I’ve got insurance – tick’.”

Asked about personal D&O cover, he said the industry “has no compelling solution” and “must get a handle on that”. It was difficult to underwrite because insurers lacked information on companies as directors moved from board to board. The cost of D&O cover was prohibitive for individual directors.

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