2011 was another interesting year for directors, officers and their insurers. While the trends identified in recent years continued, some new issues arose both in judicial decisions and regulatory changes. One case, Bridgecorp (see page 43), had underwriters immediately reaching for their pens to enhance existing cover.
The claims environment remained active. In that regard, many long tail claims following the credit crunch and the Global Financial Crisis are still progressing through the system. The various agri-investment class actions are but one example. We have continued to see a rise in employment practices claims against companies and their directors, including for unfair dismissal, harassment and bullying.
The regulatory supervision to which directors are subject continued to increase with the introduction of new legislation and regulations. Regulators are vigilant and willing to investigate and prosecute.
From an insurance perspective, capacity for Directors and Officers (D&O) risks continued to increase and broader cover is being provided at more competitive prices. There have been a number of new entrants into the market.
We have also witnessed the rise and rise of the management liability insurance policy, catering particularly for risks associated with small-to-medium enterprises.
Two particular cases grabbed the headlines, causing ripples across the industry for their potential impact.
Many are still scratching their heads about the New Zealand High Court's decision in Steigrad & Ors v BFSL 2007 Limited & Ors (Bridgecorp decision), not necessarily because of the decision itself but wondering why it has taken so long for this issue to be raised.
The Bridgecorp decision involved the New Zealand equivalent of Section 6 of the Law Reform (Miscellaneous Provisions) Act 1946(NSW) (Section 6). The Australian Capital Territory and Northern Territory have similar sections.
Section 6 provides that a statutory charge attaches to insurance moneys payable in respect of a claim, in practice allowing the third-party claimant to sue the insurer directly in the event that the claimant is unable to pursue the insured (eg if the insured is in liquidation).
In the Bridgecorp decision, the relevant D&O insurer was prevented from advancing defence costs to the directors, on the basis that the various Bridgecorp claimants had asserted a charge over all of the available insurance moneys under the D&O policy. On the basis that their potential claims exceeded the available limit under the policy, nothing was available to advance to the directors by way of defence costs.
The directors relied too heavily and, in fact, completely on the processes in place and their advisers.
The Bridgecorp decision is currently being appealed to the New Zealand Supreme Court. Although it has not yet been considered in an Australian court, it has caused significant concern to directors and their insurers. The Bridgecorp decision has far-reaching implications for directors, given the often significant costs required to defend claims or investigations by regulators.
Insurers have moved quickly to develop solutions to "ring fence" defence costs to avoid the potential implications of the Bridgecorp decision. The industry will be watching the New Zealand Supreme Court appeal closely. For further commentary on the Bridgecorp decision, please see Crossley Gates' article on page 43 or visit out Insurance Flashlight blog at www.insuranceflashlight.com.
ASIC v Healy (Centro decision) is about a company's financial reporting and the role and responsibilities of directors in relation to that task.
The case concerned the board's approval of the 2007 financial statements of two companies within the Centro Group. Middleton J found that the financial statements failed to disclose significant matters, in particular:
- Centro Properties Group failed to disclose $1.5 million of short-term liabilities by classifying them as non-current liabilities instead of current.
- Centro Properties Group failed to disclose guarantees of short-term liabilities of an associated company of about US$1.75 billion.
- Centro Retail Group failed to disclose $500 million of short term liabilities that had been classified as non-current.
The issue arose out of a change in reporting standards. The new standards required that short-term debt only be classified as non-current if the company had an unconditional right to defer settlement of the liability for at least 12 months after the reporting date. The significance of this change in reporting standards to a corporate group such as Centro, which relied on bridging finance that would ultimately be rolled into longer term debt, was profound.
The integrity and bona fides of the directors was not in issue and questions of credit did not arise. The central question was the extent to which the directors were entitled to rely on advice given to them by senior managers of the company and its auditors. While Middleton J acknowledged that directors are entitled to rely on others and commented that "there was no suggestion in this proceeding that the reliance on others was not warranted", he found that directors cannot substitute reliance upon the advice of management for their own attention and examination of an important matter that falls specifically within the board's responsibilities as with the reporting obligations. They cannot delegate or abdicate that responsibility to others.
In this case, Middleton J found that the directors relied too heavily and, in fact, completely on the processes in place and their advisers.
This case has and will cause many directors and their insurers some concern. While the principles enunciated in the decision are not new, the circumstances of this case served as a stark warning that directors, at the apex of the company's management structure, have the overarching duty to ensure that a company's financial records are accurately reported. While many of their responsibilities may be delegated, they cannot completely absolve themselves of their obligations.
Ultimately, the penalties awarded were much lighter than those agitated for by the Australian Securities and Investments Commission (ASIC). In his reasons, Middleton J had regard to the fact that the directors were intelligent, experienced, conscientious and honest.
Other cases of note include:
- Smart v Westpac Banking Corporation  FCA 829. This case considered whether the statutory duty of good faith under section 13 of the Insurance Contracts Act 1984 (Cth) extended to an "insured person" under a D&O policy. Jagot J of the Federal Court affirmed that the statutory duty does not extend beyond the parties to the contract.
- Buzzle Operations Pty Limited (in liq) v Apple Computer Australia Pty Limited  NSWCA 109. This case considered circumstances under which a creditor of a company might be a shadow director.
- The High Court's granting of special leave to Andrew Forrest to appeal ASIC's successful prosecution of him for misleading and deceptive conduct and breaching the disclosure laws in relation to statements about various contracts between his company, Fortescue Metals, and Chinese entities. Together with the James Hardie appeal, which is also likely to be heard in 2012, the High Court will now consider two cases in 2012 that deal with market disclosure issues. This is anticipated to be agenda-setting.
Some of the major legislative developments impacting on directors and officers that have been introduced in 2011 include the following.
Australian Consumer Law
The Australian Consumer Law commenced earlier this year, revamping consumer and trade practices law in Australia. This law introduced new liabilities for directors and officers, particularly in relation to consumer protection.
ASIC or the Australian Consumer and Competition Commission will now be able to seek orders disqualifying directors and managers if they breach these consumer protection provisions. They also face significant fines if they are "knowingly concerned" in breaches of the legislation.
The Australian Consumer Law introduces new prohibitions against a company indemnifying a director for pecuniary penalties and legal costs if they are found personally liable for contraventions of consumer protection provisions. Nothing prevents an insurer from indemnifying a director for these penalties and costs.
Harmonisation of occupational health and safety
Progress has also been made in the harmonisation of occupational health and safety laws around Australia, including in New South Wales following the election of the Liberal Government earlier this year. With the exception of Western Australia, laws based on the harmonised Model Law will commence around Australia in early 2012.
While the Model Law removes strict liability for directors, it imposes a new positive due diligence obligation and increased penalties on directors.
Carbon emissions trading scheme
The Federal Government has introduced its carbon emissions trading scheme, which was passed in Federal Parliament in 2011. The Clean Energy Act 2011 (Cth) and associated legislation will commence on 1 July 2012. The scheme will cover emissions from the statutory energy, industrial processing, resources and waste sectors.
For directors, this will introduce new liabilities, along with expanded obligations to comply with their existing duties, such as reasonable care and diligence and their duties around disclosure.
THE YEAR AHEAD
The agenda for directors, officers and their insurers in 2012 is likely to be dominated by the fallout from the sovereign debt crisis in Europe and the impact that could have on the availability of capital worldwide. It seems unlikely the claims trend will reduce next year, but it remains to be seen whether global events will cause the D&O insurance market to contract and premiums to finally start to rise.
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