Canada: Increase In Claims Against Directors And Officers A Major Challenge For Insurers

Last Updated: February 27 2017
Article by Catherine Tyndale

Over the last 20 years, we've seen a steady increase in claims against corporate directors and officers (D&Os) in Canada. Because Canadian courts apply a relatively low threshold to the certification of securities class actions and are generally reluctant to dismiss them at an early stage, there has also been a trend toward higher settlements in an environment where plaintiffs are more confident they can "hang in" and bargain for more.

These trends are likely to continue in 2017 for a number of reasons, some of which are detailed below, and will pose challenges for D&O liability insurers.

Securities regulators and whistleblower programs

Securities regulators in Canada, particularly in Ontario, Quebec, and Alberta, have shown an increasing enthusiasm for investigating companies and their executives.

The last year also saw the launch of two new whistleblower programs, one in Ontario and the other in Quebec. In both provinces, individuals now have added incentive to come forward to report wrongful conduct by D&Os.

Both programs offer anti-reprisal and confidentiality protections to whistleblowers. In Ontario there are monetary rewards, representing a percentage of sanctions paid up to a maximum of $5 million, in exchange for useful information; even whistleblowers involved in the wrongdoing can be eligible. Quebec's securities regulator has opted not to offer financial incentives.

Of interest to insurers would be the issue of whether whistleblowers who participated in the wrongdoing would trigger the policy's prohibition against admission of liability, thus putting themselves in a position where their good faith effort to report wrongdoing has had the unwanted consequence of putting themselves outside of coverage.

Litigation funding

A second factor is the emergence and acceptance of third-party litigation funding which, after some initial resistance from the courts, is now considered a promising growth area in Canada, as funders tailor their offerings to the market. A 2011 Ontario Superior Court1 ruling recognized the legitimacy of the practice as a means to overcome financial barriers to access to justice for people who would otherwise be discouraged from taking legal action. A handful of decisions have followed which have endorsed the availability of litigation funding arrangements, subject to certain safeguards. Canada is following a global trend that started in Australia, allowing claimants to launch class action lawsuits while transferring to the litigation funder their exposure to any costs awarded against them, in exchange for a percentage of any settlement or judgment in their favour.

This last point is important, particularly in relation to claims by security holders against D&Os for misrepresentations in the secondary market. Indeed, litigation funding would in large part eliminate one of the safety measures considered by the provincial legislators in introducing secondary market liability to Canadian provinces, namely the "loser pays" rule generally applicable in civil matters in Canada, whereby the unsuccessful party is liable for the other party's costs. When the introduction of secondary market liability was being considered in the 1990s, in particular by the Allen Committee chaired by securities litigator Thomas Allen, one of the concerns raised was the risk of importation into Canada of U.S.-style class action securities litigation, which the Committee viewed as something to be avoided. The prevailing view, however, was that the "loser pays" rule would help attenuate that risk. Now, plaintiffs (and their counsel) who avail themselves of third-party litigation funding arrangements no longer face any personal exposure to costs awards and there is no financial downside to initiating a securities class action.

It is unclear whether this trend has, in fact, contributed to an increase in the number of securities class actions being brought in Canada, but the possibility certainly exists. Some have argued that because the litigation funders are sophisticated investors, they will only choose to finance truly meritorious actions, since the frivolous ones will face early dismissal and a corresponding loss to the funder. However, as discussed earlier, it has been difficult (although not impossible) to convince Canadian courts to dismiss securities class actions at an early stage, and the potential payoff to the funder can be considerable.

The economy

Another factor is the current economic climate in Canada. Low commodity prices are weighing down resource companies, leading to a rise in insolvencies. That, in turn, is contributing to an uptick in claims against D&Os for mismanagement of corporate affairs, as well as claims involving liabilities imposed on directors by statute, such as for unpaid employee wages, unremitted source deductions and certain taxes. As to the mismanagement claims, the status of the party bringing the claim against the D&Os will often lead to disputes between insurers and insureds as to whether the claim is being brought "on behalf of" the company and therefore potentially excluded from coverage.

Environmental liability

Ever since the case of Northstar Aerospace, an insolvent Ontario company whose directors were held personally liable by the Ministry of the Environment for ongoing cleanup costs (a settlement was ultimately reached in which the directors paid $4.75 million to the Ministry), Canadian D&Os and their insurers have been very concerned about environmental liability. Traditional D&O policies do not cover that exposure, as the potential risk can be prohibitive, and insureds and their brokers have been active in seeking, with some success, to obtain non-traditional coverage.

Until recently, the property (contaminated or otherwise) of a dissolved corporation devolved to the Crown in right of the province in which it was located, and the province and its taxpayers would be stuck with the cleanup bill. However, Ontario has recently introduced legislation (the Forfeited Corporate Property Act, 2015 together with amendments to the Ontario Business Corporations Act) which imposes absolute liability on the former directors of a dissolved corporation, holding them personally liable for the costs to remediate forfeited corporate property. Other Canadian provinces are increasingly seeking to hold prior owners accountable for cleanup costs, regardless of fault, either through environmental orders or the introduction of legislation similar to the FCPA.

While the tendency in recent years has been to eliminate or attenuate the D&O policy's "pollution exclusion", given these statutory developments, insurers will have to give careful consideration to granting such coverage to those insureds which operate in industries susceptible to the risk of environmental liability.

Conclusion

Together these emerging risks are likely to have a significant impact on the Canadian D&O landscape, and insurers will have to take a closer look at their cover. The reality in the Canadian marketplace, however, is that an abundance of capacity together with the entry of new players with no loss history mean that D&O insurers are hard pressed to get in front of emerging risks. They have been waiting a very long time for a turn in the market, and all signs are that they will continue to wait for some time yet.

Footnote

1. Dugal v. Manulife Financial Corporation, 2011 ONSC 1785

Increase In Claims Against Directors And Officers A Major Challenge For Insurers

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