The importance of directors and officers liability insurance
By Lucian Carciumaru
Camargue Underwriting Managers (Pty) Ltd
There has been an international trend toward increased liability and accountability of company directors. It seems that there has been an increased tendency for courts and society to hold directors accountable – when company stakeholders sustain a loss, the board of directors is often the first obvious place to recoup. Further, as a result of the increased complexity of the modern economic world there is an increased possibility of director error and fraud.
Let us first look at the new Companies Act No. 71 of 2008 (the Act). This Act has followed suit with international standards of personal liability for directors, as well as a continuing increased standard of conduct. There are numerous Sections which look at director accountability, liability, as well as duties.
Section 76 codifies the existing common law duties of directors towards the company. These duties are known as the fiduciary duty and the duty of care and skill. A codification does not necessarily increase liability but it does increase the awareness of potential plaintiffs. It is also more effortless to use legislation than common law in order to claim.
Section 157 introduces the concept of class actions into South African law. This means that any class of persons mentioned in the Act or affected by the company will be able to potentially claim against a director.
Section 218 (2) has introduced civil remedies. Any person who contravenes the Act will be liable as a result to any other person who suffers a loss as a result of the contravention. This Section potentially opens up directors’ liability exponentially to indeterminate persons.
Section 76 (4) does introduce a defence otherwise known as the Business Judgement Rule for directors that have acted in good faith, in the best interests of the company, according to their duty of care, skill and diligence, and have avoided conflicts of interest. It is the view of some law academics that if these requirements have been carried out, the director would have complied with the common law duties. Therefore it seems that this new ‘defence’ has not added any new protection for directors.
According to the third King Code of Corporate Governance (the Report), a new Governance Code was required in South Africa as a result of the Act, as well as transformations in global governance trends. The modern business world is now developing at an exponential rate, especially in the midst of Information Technology (IT) usage. The Code applies to all companies, regardless of the type of incorporation, which includes private and non-profit companies. This is in contrast to King 2 which applied only to listed companies, financial institutions, and public companies. Therefore a wider range of directors are now affected by the Report.
Compliance with the Report will be on an ‘apply or explain’ foundation. This is dissimilar from the United States approach to the Sarbanes-Oxley Act, which follows a ‘comply or else’ approach. In this case there would be legal repercussions for nonconformity. According to the Report, corporate governance should not be based only on compliance, but the consideration of the manner in which principles and recommendations can be applied. Therefore directors acting in the best interests of a company should consider whether or not a recommendation in the Report should be applied and to what extent. Compliance eventuates in the explication of how the Report was applied or not. Therefore the stakeholders of the company will be able to judge whether business has been carried out in accordance with the corporate governance principles of fairness, accountability, responsibility and transparency.
The Report is based on principles of leadership, sustainability and corporate citizenship. It is not necessary to go into details, as the Code is self-explanatory. What is important is that business must be carried out in a sustainable manner which looks out for economic, social, and environmental factors. This interconnection must be managed and reported on by the board of directors.
One must comprehend the relationship between corporate governance and the law from a director’s point of view. Directors have two common law duties (which are now legislated in the new Act) toward the company; the fiduciary duties and the duty to act with care and skill. When judging whether or not a director has acted with the appropriate standard of care, the application of corporate governance practices, codes and guidelines will be considered.
Courts will consider the application of corporate governance codes as a criterion for meeting the required standard of care. In this manner, a director may be held liable at law even though corporate governance codes are not actual legislation. Such is the relationship between corporate governance and the law, that failing to apply or explain the principles in the Report, may result in a director being held liable under common law or the new Act. Bear in mind that as per international standards, directors’ common law duties have now been included in the Act. It can thus be said that corporate governance codes can have the effect of increasing the expectations of directors’ duties. An increase in duties will equal an increase in potential liability.
The Report takes a ‘stakeholder inclusive’ approach – the board of directors must consider the genuine interests of all stakeholders (not only shareholders) into account. This consideration must be made in the best interests of the company. According to the Report, when considering contradicting and synergetic interests of stakeholders, this must be done on a case by case basis. The decision must be made with the company’s best interests in mind.
The Report also includes Practice Notes on fundamental and affected transactions, which were dealt with in the preceding King Reports. Directors must be aware of their duties during mergers and acquisitions. Another principle which directors should familiarize themselves with is that of Business Rescue. The idea is to save economically viable companies that are struggling financially.
One of the new subjects dealt with in the Report is IT governance. It is important that the board of directors uses IT not only as a means of operations, but also as a tool in order to gain a competitive advantage. Therefore it is necessary to manage IT risks, as well as to create business opportunities in the best interests of the company. There are increased risks involved in making payments online, as well as safeguarding client confidential information. Directors must be aware of the increased risk and implement strategies for security. This once again relates to the director’s duty of care – a director that has not taken reasonable steps to mitigate IT risks could well be held liable at law, if the company suffers a loss.
Another new principle in the Report which is in line with international standards is alternative dispute resolution (ADR). The Report recommends that ADR clauses should be inserted into business contracts. According to the Report, mediation should be used as a management tool as well as a dispute resolution instrument. ADR allows for fast and cost-efficient settlements, which protect a company’s reputation before matters go to the Courts. Here is another way in which the bar will be raised on directors’ duty of care. The board of directors should ensure that disputes are resolved efficiently, inexpensively and without media attention – this is in the best interests of the company. The Institute of Directors (IOD) and Arbitration Foundation of Southern Africa have created an ADR clause which should be placed in contracts as per the Practice Notes.
Along with the existing corporate Camargue Underwriting Managers Directors and Officers Liability Insurance (D&O), we have also introduced a SME scheme option. This is because no company in South Africa should be without D&O, in light of the new legislative and governance changes. The SME option is extremely easy to sell and quick to underwrite with a simplified proposal form. The costs of defending legal actions may exceed the net worth of a small company’s assets. A judgement against a director of a private company could lead to major financial losses. Complicated conflicts of interest could arise due to the intertwined responsibilities which may exist in SMEs.
Camargue Underwriting Managers has taken this view for many years now. In fact, all of our products are wrapped-up in risk management services, which include director membership of the IOD and access to dispute resolution services from TOKISO. It is important that the company’s reputation is protected and that matters are dealt with swiftly and inexpensively.
Camargue Underwriting Managers (Pty) Ltd
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