"Accidents" do happen and a prudent director should ensure they appropriately protect themselves from such an eventuality. Insurance is a key tool for managing this risk and this article is aimed at providing some guidance on Directors & Officers Liability Insurance.
Directors have a "duty of care" to numerous stakeholders. In New Zealand these legal responsibilities are encapsulated in statute under the Companies Act 1993. If a director is alleged to have breached his or her duty of care, this can result in significant personal financial liability.
It is important to be aware that the dollar clock starts ticking long before any breach is actually proven. The legal defence of such allegations is usually drawn out over a number of years. Even if the director is ultimately exonerated, it may run into hundreds of thousands, sometimes millions of dollars, and this is before taking into account any actual settlement or judgment, in the event the breach is proved. In addition to the direct financial loss, there are non-financial issues to consider such as reputational damage and the personal stress and heartache that a legal battle can cause.
Whilst many may consider New Zealand a non-litigious country, the awards by the courts have been significant.
* South Pacific Shipping--The company went into liquidation in 1998 and the case was heard in 2004; the High Court found reckless trading in breach of s135 of the Companies Act 1993 and ordered the director to pay $8.4 million to liquidators.
* Cellar House--The company was placed in liquidation in 1999 and in 2004 the managing director was ordered to pay $1.75 million by the High Court for reckless trading under the Companies Act 1993.
* Tranz Rail--In 2007 the Securities Commission settled a long-running insider trading case for $20 million, the highest insider trading settlement in Australasian history. The directors, Richwite and Fay, have always maintained their innocence.
* Feltex Carpets--The company was placed in receivership in 2006. The matter is far from finalised but the liquidators have put the directors on notice that they could face legal action in excess of $20 million. There has also been speculation that shareholders are planning a joint recovery action claiming up to $250 million, which would be the first class action in New Zealand.
These are only the cases that get into the press. There are other multimillion-dollar matters which are privately settled. Overseas, such litigation is commonplace and significantly more catastrophic. You only need to look at some of the current cases in Australia; there's the GIO case which settled in 2003 for A$97 million and a number of ongoing class actions such as that against AWB (A$25 million), Multiplex (A$100 million), Aristocrat (A$100 million), Downer EDI (A$100 million). There is talk of a new A$300 million shareholder class action against Centro Properties Group. Further afield in the United States, it is even more disturbing. Over the 10 years to 2006, there was an average of 194 securities class actions filed each year and in 2007 the average settlement paid to shareholders was US$32.2 million (Source: NERA Economic Consulting 2007).
Legal claims can and have been made against directors by numerous parties including creditors, shareholders, employees, regulators like the Securities and Commerce Commissions and other third parties such as commercial business partners, clients and competitors.
There is no doubt that the level of litigation in New Zealand is on the increase and it is also clear that it is not only directors of public companies that can come into the firing line as clearly shown in the South Pacific Shipping and Cellar House cases. Therefore how does a prudent director protect his or her interests? The simple answer is Directors and Officers Liability Insurance (which is commonly available in New Zealand). …