The directors and officers of a company have a statutory and common law duty to their company, shareholders and employees. Gary Meggitt, Louise O'Reilly and Sheona Wood explain the insurance implications
Despite the increasing number of claims made against company directors by competitors, employees, shareholders, trade unions and government regulators, a recent survey found that of the 3.5 million small to medium enterprises (SMEs) less than one in five have directors' and officers' (D&O) cover.
In the middle to large company sector (with turnover of more than £1m) only 18% of respondents had arranged D&O cover and 39% had never heard of it. The reasons for this seem to be a general lack of understanding about the type of claim that might be brought and also the nature of cover available.
Who are directors and officers? Directors are defined by the Companies Act [1985] as: "Any person occupying the position of director by whatever name called."
As for officers this includes "a director, manager or secretary". There are several types of director:
There is, however, no distinction in law between the different categories of director. Each director has specific duties and if he or she fails to discharge them properly, they may incur significant (and sometimes unlimited) personal liability.
Director's duties
The Department of Trade and Industry (DTI) is undertaking a wholesale review of company law. According to a recent DTI press release the review is likely to result in a new Companies Act in 2004 or 2005. Any new legislation is likely to include a statutory statement of directors' duties. In the meantime directors' duties can be divided into three categories:
Common law: liability may arise at common law out of a director's lack of care and skill in the performance of his or her duties. For example, giving negligent advice or making a misstatement, or negligent supervision of delegated responsibilities.
Traditionally the standard of care has been subjective; the director has to show the degree of care reasonably to be expected from a person of his knowledge and experience.
More recent case law means the standard of care is to be both subjective and objective and considered by reference to a reasonably diligent person having the general knowledge, skill and experience that may be reasonably expected of a person carrying out that director's functions. In addition, reference is made to the director's general knowledge, skill and experience.
Both the Law Commission and the DTI's company law review agreed that this dual subjective/objective standard of care should be incorporated in future legislation concerning companies.
Fiduciary duties: a director must act honestly, in good faith and in what he or she considers to be in the best interests of the company in all dealings with it, or on its behalf.
Statutory duties: there is a continuously expanding range of specific duties imposed on directors by various statutes. Examples are: the Insolvency Act [1986] s214 under which personal liability contributes to creditors if the company carried out "wrongful trading"; the Environmental Protection Act [1990] and Environment Act [1995] which introduce personal liability for various "pollution" offences; and the Financial Services & Markets Act [2000] s90 which imposes a liability to compensate buyers of shares for loss suffered as a result of untrue statement in listing particulars.
Some statutes such as the Environmental Protection Act [1990] and the Health & Safety at Work Act go so far as to impose criminal sanctions on directors who are in violation of the statute.
Due to the restrictions placed by s310 of the Companies Act [1985] on the ability of a company to provide indemnity to its directors, D&O cover is conventionally arranged as a two-part policy. The first part provides that the insurer will reimburse the company to the extent that the company actually indemnifies the director for losses arising from claims for wrongful acts in his capacity as director, as required or permitted by law or as may be agreed by the company.
For example, "wrongful acts" may include actual or alleged breach of trust, breach of duty, misstatement or omission.
The company's losses usually cover the amount the company is required or permitted to pay to a director, including: awards of damages or costs against him; his own legal costs, including those incurred at an official investigation and the amount the company is required to pay to a third party in respect of the costs incurred by him, where the court makes an order against the director.
The second part of the policy is usually similar in scope to the first. It will indemnify the director on a direct basis, where he cannot look to his company for indemnity.
Cover usually embraces the whole board of directors and can be extended to cover the directors of subsidiary companies and executive officers of any company in the group.
D&O cover does not usually cover any personal guarantee or warranty given by the director or any loss caused by dishonesty, fraud or malicious conduct of the director.
The usual exclusions apply, such as where the risk is more properly the subject of other insurances, and any breach of professional duty. Clearly there is still some way to go in getting the message across. Directors and officers need to consider the risk management issues associated with their business. They also need to understand their own personal responsibilities; the fallout from the collapse of Enron may provide continuing education for those in any doubt.
Question 1
Which of the following is not a type of director
a De jure
b Shadow
c Echo
d De facto
Question 2
Can a director ever face liability for lack of supervision taken when delegating responsibility?
a Yes
b No
Question 3
In which of the following circumstances might a director face criminal charges:
a Forgetting to submit company accounts on time
b Allowing a health and safety hazard to go uncorrected, resulting in injury to an employee or member of the public
c Employing an individual without checking their references thoroughly, who later turns out to have a criminal record for fraud, only discovered after they have stolen from the company.
This CPD page is edited by RW Associates, specialists in training, competence and compliance.
Email: ruy.lopez@rwassociates.co.uk
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