Directors facing more personal liabilities

Company directors in Australia are facing a more onerous personal liability environment, which is discouraging risk-taking and innovation, the Australian Institute of Company Directors has warned.

While most of the actual laws relating to the responsibilities of directors haven’t changed in recent years, there is increased expectation and scrutiny from the public and from regulators in the wake of the global financial crisis, says Lysarne Pelling, Senior Policy Adviser at the AICD.

“It is in an environment where there is an increased scrutiny of boards, expectations from the community increasing, activist regulators that are keen to guide forwards and drive what they perceive as improved performance,” she says.

Her colleague Louise Petschler, General Manager Advocacy at the AICD, agrees, stating ‘the liability environment for directors under Australian law is particularly onerous.’

“We believe that it actively encourages a risk aversion in decision-making that’s counterproductive to innovation and growth and that we don’t have the extensive defences that we believe should be provided for in a law.”

Directors have several fundamental duties set out in the Corporations Act, including to act with the same care and diligence a reasonable person would be expected to show in the role; to act in good faith in the best interests of the company; to not improperly use their position to gain an advantage; and to not improperly use the information they gain in the course of their director duties to gain an advantage.

If these laws are breached then in some circumstances the directors can be personally liable, such as for debts incurred by the company, for legal action by investors or others who allege the breach caused the losses, or for fines or other penalties imposed by the regulators.

Directors also have other duties under state and federal based laws, such as competition law, occupational health and safety, environmental law and taxation, as well as specialised laws governing specific industries. As with the Corporations Act, they can be held personally liable for breaches.

Taken together these laws mean directors can be held liable for debts incurred when the company is insolvent, company losses caused by a breach of directors duties, breach of a company’s disclosure obligations and unpaid superannuation entitlements, to name just a few.

Adding to the risks for directors is the rise of the litigation funders – companies which cover the legal fees for people to take class actions against companies in exchange for an eventual share of the class action proceeds. Directors say this has led to many more class actions against them.

When the AICD takes aspiring directors through its directors course, it explains that the penalties for breaching their duties can be very serious.

“There is a range of criminal, civil sanctions, along with disqualification under the Corporations Act but also the state legislations or other forms of legislation. So, it is a serious business with serious penalties for failing to uphold those duties that is very important to emphasize,” says Pelling.

Oliver Jankowsky, a partner at corporate law firm Hall & Wilcox, says the tougher environment has introduced a note of caution among potential directors and company secretaries.

“For directors, before they join the board or be made secretary, they certainly have a think about it and possibly even rearrange their affairs by making sure that they don’t have too many assets in their own name,” he says.

“Professional directors themselves have become more cautious and want to do due diligence on the company, want to have very good insurance protection, want to have the benefit of the deed of indemnity, that if something goes wrong, they get reimbursed.”

These liabilities are covered by directors’ & officers’ liability insurance, or D&O insurance as it is generally known. Usually the insurance is taken out and paid for by a company on behalf of their directors.

D&O insurance covers the cost of defending a claim against a director as well as any financial loss that arises as a result of the claim. It also covers class actions by investors.

However, as with most insurance policies, it does not cover criminal, intentionally non-compliant or fraudulent acts.

Stuart Davies, national practice leader, finance and professional risks at insurance broker Arthur J. Gallagher says D&O insurance has become increasingly important.

“Certainly, if you look at your suite of insurance policies for any given company, it has to be one of the number one considerations and I think from a D&O insurance perspective, there are increased exposures, whether that’s more aggressive litigation strategies, whether there’s increased regulatory scrutiny,” he says. “We have seen more significant D&O insurance claim activity over the years.”

Davies says that in recent years there has been an increase in legal actions arising from listed companies’ continuous disclosure obligations, which require them to reveal significant company information to investors when they receive it. Some directors have taken action against companies, alleging they made losses because they had not been given all of the relevant information.