A Company does not make decisions. It appoints a Board of Directors, Officers and Managers to make decisions on its behalf. In making these decisions the Directors and Officers not only place the company at risk from actions by an aggrieved party, they also place themselves personally at risk.
A Director's personal liability is unlimited. All his assets are at risk. Unlike the Company, he cannot hide behind limited liability.
Directors are jointly and severally liable. The actions of one Director are the legal responsibility of his fellow Directors.
It is the Directors who manage the assets and control the Company's day to day affairs. They act as trustees of the Company's assets and because they determine the activities of the Company they have a legal obligation to ensure that their actions are bona fide and for the benefit of the Company.
Directors are liable personally to pay losses suffered by the Company following an act which is either illegal, outside the Company's authority, beyond their power, or which evidences insufficient skill and care in managing the Company's affairs.
LIABILITY - HOW IT ARISES
A Director or Officer is liable in the event of a breach of:
i) fiduciary duty to the company
ii) duty of skill and care to the company
iii) contract
iv) statutory duty
v) duty to shareholders
vi) common law
THE DIRECTORS - THEIR MAIN EXPOSURES
Directors and Officers are particularly exposed to claims when serving in Companies which:
- are publicly quoted
- have subsidiaries with outside shareholders
- are involved in joint ventures
Their exposure increases still further when their Company:
- publicly raises additional capital
- arranges a private placement of debt or equity
- acquires new entities
- sells all or part of any subsidiary
- merges itself or any subsidiary
- undertakes any major restructuring
AREAS OF GREATEST RISK
The risk of litigation against Directors increases still further when the Company accesses international capital markets, particularly in the USA, by means of
Private Offerings
Whether these are by a private placement, or by a private placement under Rule 144 (A) or by a debt/bond issue, the Directors are exposed both to claims from investors who are prone to litigate and from the dangers and uncertainties inherent in USA litigation.
Public Offerings
Here the dangers of litigation increase dramatically whether the Company is seeking a full US exchange listing, or arranging a sponsored ADR programme, or an unsponsored ADR programme.
All of these transactions require the Directors and Officers to comply with the full registration and reporting procedures imposed by The Securities Act of 1933 and The Securities and Exchange Act of 1934. The obligations imposed by these Acts are extremely onerous.
The legal environment surrounding such transactions is characterised by:
- a very high duty of care imposed on the Directors and Officers
- a minimal burden of proof for litigants
- the common occurrence of costly class actions being brought by professional plaintiff attorneys
The keystone of The Securities Act is 'disclosure'. A Director or Officer is held liable for any material misrepresentation or omission in the registration statement of a Company seeking to raise capital.
Under The Securities Act, damages awarded to litigants are based on the difference between the value of the litigant's shares at the time of the public offering and the value of the same shares at the time the suit is filed.
Under The Exchange Act, damages are calculated on the difference in the declared value of the investment at the time of the public offering as against its actual value at the same time.
The burden of proof placed on litigants is such that they are not even required to show that at the time of making their investment they relied on the information which they now claim to be inaccurate! For a suit to be successful, there is no need even to prove that a loss was suffered or that there was intent to defraud!
To further compound the dangers of litigation to Directors of Companies subject to SEC regulations a recent court ruling allowed a European Company to be sued in the USA by another European Company simply because the defendant Company had arranged an ADR programme in the USA. The litigation was successful despite the fact that the litigant had acquired their equity not through such ADR programme, but directly on a local non-USA stock exchange.
Another high risk area is when foreign investors acquire equity in the Company, whether this is directly in the holding company or in a subsidiary company.
Finally, a significant area of risk is where the Company internationalises its business by:
- opening branches/subsidiaries overseas, particularly in the USA
- entering into strategic alliances with overseas companies, particularly in the USA
- establishing relationships with non-domestic clients, again, particularly in the USA
WHO CAN BRING AN ACTION AGAINST THE DIRECTORS AND OFFICERS?
1. The Company - for actions which are in breach of the Director's and Officer's duty to the Company. If the Company fails to take action then a minority shareholder may enforce the Company's rights by an action on behalf of himself and all other shareholders. This is known as a Derivative action.
2. Shareholders - they may bring an action in their own names if their rights have been injured. This injury may arise if a Director is negligent when acting as an agent for a shareholder or where the loss is suffered as a result of a misstatement in a company prospectus, as well as in circumstances mentioned in 1. above.
3. Employees - for wrongful dismissal or discrimination.
4. Governmental or Regulatory Authorities - for breach of regulations.
5. The Official Receiver - in all types of winding up actions he may apply for permission to examine the conduct of Directors and Officers, both past and present, and pursue litigation against them.
6. The Company Liquidator - as in the case of the Official Receiver, a Liquidator may bring an action against the Directors and Officers.
7. Creditors - in the event of a Company going into liquidation and/or failing to pay its creditors, they may bring an action against any or all of the Directors, both past and present.
8. Others - Anyone suffering a loss as a result of a breach of warranty of authority to contract on the Company's behalf. Also third parties dealing with a Director or Officer without the knowledge that he is acting only as a company agent, may sue the Director or Officer for any loss which has been sustained.
WHAT ARE THE CONSEQUENCES?
There is an increasing tendency on the part of those who suffer loss to seek redress by litigation. Investors, creditors, banks and customers are no longer prepared to write off losses simply because a Company suffers financial difficulty. More and more frequently they demand reimbursement from the Directors who run the company.
In a recent survey of over 500 shareholder class actions, the average settlement cost was in excess of US $8 million.
In most of these cases the legal action was settled out of court. The settlement and defence costs of those actions which proceeded to court were on average US $20 million.
These sums indicate that if a Director or Officer is forced into litigation without the protection of a Directors and Officers Liability Policy he is likely to be bankrupted.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
