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Is your directors' liability insurance still fit for purpose?

05 May 2011

This article first appeared in the May 2011 issue of Boardroom magazine.

Have you looked at your liability policies lately?  Now would be a good time to check that your D&O and statutory liability policies are fit for purpose.

Not only do our regulators have more weapons at their disposal but they seem much more assertive about using them; more ‘trigger-happy’, if you like.  Two recent examples – both from the now disestablished Securities Commission – demonstrate this cultural shift: the use of the “freezing” power in the context of the Hanover investigation, and the injunction obtained by the Commission to stop settlements of share transactions instigated by Bernard Whimp.
The Commission was replaced on 1 May by the Financial Markets Authority, which has substantially greater powers than the Commission enjoyed and – early indications are – has a keen appetite to use them. 
These new powers include:
  • the right to sue, on behalf of investors, a wide range of financial markets participants, including directors, auditors and experts.  Controversially, the FMA can pursue claims dating back in time, subject only to legal limitation periods, and
  • broader search and surveillance powers, including the supposedly important power to search a bicycle.  At least Parliament cannot be criticized for skimping on detail on that score. 

Put those powers together, and grind them through the media mill, and you get this reportage from the Sunday Star Times (27 March), based on an interview with the chief executive of the FMA, Sean Hughes:

“Kiwi investors have been screwed for more than $3.5 billion in company collapses and failed finances – but the man who is set next month to step into the job of the country’s top financial cop says he will have the power to turn back time and chase compensation from firms that have gone under.”

The drive toward tighter and more aggressive regulation is part of the fall-out from the finance sector failures, but it has been reinforced by the trans-Tasman harmonisation agenda.  So it is worth noting that the chairman of the Australian Securities Investment Commission, Tony D’Aloisio, is beginning to question whether Australian law is now imposing too many obligations on directors. 

He told The Australian last month:

“As I look at it as a former lawyer, the duty of negligence does look like a very high standard when you consider that board members are advisers and that they are not really involved and don’t have the knowledge that management has...
“There are concerns out there as to whether or not it is going to discourage good people from becoming directors, particularly for the medium to small enterprises.  And if it does do that, there is an economic concern that, longer term, if those entities don’t get top board representation, their ability to put pressure on the big companies may be reduced”.  

Mr D’Aloisio’s comment followed a survey by the Australian Institute of Company Directors last year in which more than half of the respondents said they knew of people who had declined an offer of a directorship or resigned from a board because they were concerned at their potential legal vulnerability.

Health check for directors

Assuming that you still want to be a director in the face of a legion of regulators and regulations, how well are you protected by insurance from the otherwise severe personal economic consequences that can follow from a regulator’s investigation?  A useful health check might include:

  • reviewing the company’s indemnity to you.  You might consider whether it is broad enough to cover an investigation and the ancillary powers that might be used against you in an investigation
  • asking your broker to advise you whether the policies you have will respond to the costs of complying with broad regulatory requirements
  • thinking about what your biggest personal and business risks are, and ensuring that you have made informed decisions about whether you have cover for these risks
  • understanding who your insurers actually are, and what their track records are like in paying legitimate claims.  Many people confuse their brokers with their underwriters – a big mistake, and
  • being wary of promises of premium savings at renewal time, especially if there are competitive bids for your company’s insurance business.  Not all policies are the same.  An attractive (cheap) premium offered to you might reflect limited scope of cover, rather than a good deal.

Adam Ross is a partner in Chapman Tripp’s litigation department.