Directors and officers liability: The heat is on
Jo McIntosh, New Zealand Tree Grower August 2019.
Most of you will have seen the papers and the recent high profile Mainzeal case. This judgment has thrown directors and officers liability insurance back in the spotlight. At the same time, there are other pressures on this type of insurance such as the rise of class actions and litigation funding in New Zealand.
The Mainzeal case was brought by the liquidators on behalf of unsecured creditors who sought awards of between $32.8 million and $75.3 million from the four former directors. After consideration, which included assessing damages using estimated losses then applying discounts for other factors that courts felt contributed to the loss, the court ultimately awarded a total of $38 million.
Three of the directors were found liable for $6 million each namely Dame Jenny Shipley, Peter Gomm and Clive Tilby and the fourth director Richard Yan liable for the total of $36 million. The judgment was made on 26 February this year. It is understood, that Mainzeal held a directors and officers liability insurance policy with a $20 million limit. This case raises several questions regarding −
- Under insurance
- Adequacy of policy limits
- Inclusion of defence costs and priority of access to policy limits and if you have a claim larger than the insurance limit then who pays what?
The judgment is being appealed and the insurance market awaits the next decision with great interest.
The rise of class actions
Notable in the Mainzeal case is that the liquidators used litigation funders to pay for this case. It may surprise you that New Zealand laws are quite open to such arrangements. The world of class actions has seemed to be something which happens in America or Australia.
Our laws allow such actions, and there is the opportunity, as we have seen, with litigation funding specialists moving in. Currently there are seven litigation funders operating in New Zealand with four from Australia and one from the United Kingdom.
The way our New Zealand law currently works is through representative actions. These allow one person to represent others where the proposed group of plaintiffs have the same interest. The main requirement is that the plaintiff group has a common interest. To date these representative actions in New Zealand have been opt in class actions which require people to knowingly elect to participate in the action.
When you have one of these class actions there will generally be a funding arrangement which is effectively structured as loans from the funder to the funded claimant. A typical arrangement might be −
- If the claim is successful, the funder will be reimbursed the cost of funding and a percentage of awards
- If the funding is unsuccessful, the funders do not recover any of the funding payments and are required to pay costs award on behalf of the unsuccessful claim.
You can see how appealing this would be to a claimant, but all the above should be ringing alarm bells for company directors to ensure that they have adequate directors and officers liability insurance.
What is directors and officers insurance?
For many of you establishing a business, choosing the structure of that entity is an important decision and hopefully one you will get some advice on from your accountants and lawyers.
Many New Zealanders choose to establish a limited liability company. A company, in a legal sense, is separate from the people who own it – the directors and shareholders.
There are financial benefits in operating a limited liability company rather than an alternative structure such as a sole trader or partnership but there is more regulation. Directors and officers need to understand their responsibilities under the Companies Act and other risks involved in becoming a director. For directors and officers of limited liability companies, directors and officers liability insurance transfers some of that risk to insurance.
Directors and officers liability insurance is often misunderstood. This product is designed to protect directors, officers and employees who are involved in the management of a limited liability company from personal loss resulting from legal claims made against them while undertaking their duties on behalf of the company.
If you look at the Mainzeal example above, the claim against the directors was that they were trading recklessly while the company had been insolvent over a period of years. A directors and officers liability insurance policy covers −
- Damages or judgments including settlements negotiated with the insurer’s prior written consent
- Legal costs and expenses awarded against a director or officer
- Defence costs.
Claims may come from several directions such as −
- Investigations, examination or prosecutions by regulatory authorities, notably the Commerce Commission, Financial Markets Authority or WorkSafe
- Claims from competitors alleging anti-competitive trade practices
- Claims from insolvency, allegations of reckless trading, trading while insolvent.
- Claims from employees, unfair dismissal, wrongful discrimination, sexual harassment
- Claims from investors claiming misrepresentation in a product disclosure document, in the old days known as prospectus but now generally known as product disclosure statements.
Other things to consider
Directors and officers liability insurance is a claims made policy. You must have insurance in place at the time the claim is made. By nature, liability claims are ‘long tail’, meaning a claim can arise years after the decisions or events that trigger that claim. Directors must be sure that if they stop being a director, that cover remains in place after they have departed. If selling or winding up a business, it is recommended you purchase run-off cover to ensure any future claims are covered.
For those who sit on multiple boards you may want to consider personal directors and officers liability. This is available to company directors who wish to supplement their corporate directors and officers’ policy.
With rising claims costs across most insurance and increased risk in liability insurance, insurers are closely reviewing directors and officers liability insurance terms. Liability insurers are closely reviewing company costs and will be particularly interested in structures involving parent companies, local companies and funding support.
Generally, insurers are being more cautious about the capacity and terms they offer. Allianz, who are one of the world’s largest insurers, have made significant change and removed themselves from this market.
Allianz Global Corporate and Specialty will cease underwriting long-tail risks in Australia and New Zealand from September following a strategic review of the business. Allianz Global Corporate and Specialty says it will also close its operations in New Zealand with lines such as engineering, property, energy, entertainment and alternative risk transfer to be written out of Australia in future.
Board member and chief regions and markets officer Sinead Browne says it is no longer sustainable to continue offering long-tail risk coverage, with corporates exposed to an ‘alarming increase’ in class action lawsuits and litigation funders. The rise in legal funders and the ultra-challenging legal environment which drives extraordinary claims levels in our sectors have made it untenable for Allianz Global Corporate and Specialty to continue offering long-tail business in the Pacific.
Manage and reduce risk
The good news is you can manage and reduce your risks. Having good governance in place is a good start. However, you cannot avoid all risk and for that reason a directors and officers liability policy is recommended.
Make sure you get good advice on adequate limits, place the cover with well rated, trusted insurers and allow plenty of time for negotiation and placement of your policy. Make sure you read and understand the cover, in particular any endorsements that might limit the cover offered. With good governance in place and appropriate directors and officers liability insurance you can minimise some of the challenges that directors and officers currently face.
Jo McIntosh is an Executive Director of Aon and specialises in insurance for forestry and horticulture.