Scaling the heights

Company directors have always had responsibilities, as compliance with common and statute laws, and a variety of court rulings have created many areas of accountability.

However, recent corporate scandals have raised major questions globally among governments, regulators and the media as to the performance and activities of company directors. This has been compounded by the increasingly litigious nature of society as well as the downturn in economic conditions, which has led to a greater number of company failures. This, in turn, has contributed to an increase in the amount of legal action taken against directors.

In addition, the introduction of new legislation and changes to corporate governance to regulate companies and the actions of their directors has placed a greater personal onus on directors and officers.

Many company directors, especially those that run small to medium-sized companies, are unaware of the personal risks they face. They fail to understand the implications of changes in legislation and society trends as well as their personal liability. The insurance industry needs to do more to get the message across.

Insurers and brokers need to improve how they communicate the financial risks senior company employees face for the actions of their companies.

Of course, directors' and officers' cover, by providing insurance against court costs and civil damages, can protect those individuals against those risks. However, as insurance premiums continue to rise in most insurance classes, company directors may not think it is a good time to buy additional products.

Gross negligence

Company directors can face financial ruin, or even prison, as a result of their actions. A particularly high-profile case at present is the Hatfield train crash enquiry. The derailment of a high-speed train due to a broken rail left four dead and dozens injured. Six rail managers are up for prosecution facing charges of gross negligence, manslaughter and a health and safety offence. If found guilty they could face life imprisonment and the two companies involved (Network Rail, successor to Railtrack, and Balfour Beatty, maintenance contractor) could be ordered to pay unlimited fines.

Proving corporate manslaughter has been notoriously difficult in the past. It is hard to prosecute the directors or senior managers of large companies, even though there may be some serious failures on the part of the company or individuals.

Corporate killing

This will change, however, with the new offence of corporate killing that the UK government is planning to enact. This offence would allow any employing organisation to be prosecuted for causing death as a result of a serious management failure, making it easier to prosecute a company for homicide offences.

About 350 people a year are killed in work-related accidents, according to the Royal Society for the Prevention of Accidents, but the debate on whether the law should remain one of corporate manslaughter (in which directors are personally prosecuted) or one of corporate killing is not over. If corporate manslaughter wins, this will further raise the issue in the public eye. Directors may yet get pinned to the wall, paving the way for future successful prosecutions.

In reality, corporate manslaughter is rarely used to bring claims against company directors and has little effect on the demand or need for D&O cover. More common areas include health and safety, employment legislation, libel and slander and regulatory claims. Company directors should take careful note of other recent legislative changes, which could impact them adversely.

Lack of understanding

At present, most large companies buy D&O cover out of necessity, especially if they have US operations. However, many SMEs still think of it as a nice-to-have rather than a necessary cover. A recent Zurich UK Commercial survey found that 33% of SMEs did not understand D&O cover nor the need for it, while more than four in 10 (45%) had no D&O cover.

An SME can be qualified as a private company with an annual turnover less than £75m, and as such they make up the vast proportion of the UK business community and it is often seen to be easier to identify a director responsible for a claim in a smaller company.

One of the myths surrounding D&O cover is that it is shareholder-driven.

While this may be the case in the US, in the UK it is far more difficult to bring about shareholder claims. In the UK, employment-related claims against directors are far more common.

There is also a lack of understanding about who can be termed a director or an officer. Although there is no comprehensive definition of director, the Companies Act 1985 states that the term includes "any person occupying the position of a director, by whatever name called". Therefore, directors are identified by their duties and not their titles.

The law does not distinguish between an executive and non-executive director and both face personal liability for their own wrongful acts. Officers also have personal liability for their actions under various statues but the term is less well defined than director. The Act states that an officer "includes a director, manager or secretary". It can also mean "a person who is managing the affairs of a company as a whole".

Company directors cannot be held jointly and severally liable for their actions in the same way as partners or trustees. The fact that one director is liable for a breach of duty to the company does not mean that their fellow directors are also automatically liable.

Directors and officers have responsibility to police their fellow senior colleagues, including non-executive directors. All senior personnel have a duty and responsibility to make sure that they are fully aware of what is going on. However, senior personnel cannot always rely on their companies to protect them and their own personal liabilities can be on the line.

Prison term

Successful prosecution means directors can be made to pay for damages, sent to prison or disqualified from being a director for up to 15 years.

Fundamentally, D&O cover for large corporates and SMEs is the same but there are some essential differences. At the top end of the market, cover tends to be more sophisticated and is usually tailor-made to take into account large corporates' additional and more unusual exposures, such as dealing on the US stock exchange. These bespoke programmes generally cater for the FT 100 companies and are priced individually, depending on the company's risks and where it is traded.

D&O cover for SMEs tends to be a more off-the-shelf product and is often bundled with other covers such as entity and corporate cover. The idea is to make it a more affordable and attractive package for SMEs.

The current hard market has led to pricing increases and capacity shortages in the D&O market. SMEs have experienced average rate increases of between 20-30% for a reasonable risk profile. Larger companies with added exposures have seen far greater increases, some up to 250% due to the capacity shrinkage.

Many insurers are reluctant to provide D&O cover now due to the US corporate scandals. The changing nature of, and increase in, large corporates' fundamental exposure has also created a great deal of uncertainty.

SME competition

For SMEs this is actually good news. As insurers become more circumspect about large D&O risks, competition is increasing in the SME area. Providers are currently aiming to expand their D&O business by getting a bedrock of SMEs with lower exposures, which has resulted in the lower rate increases for this sector. They are also offering SME D&O cover online, cutting administration costs and, therefore, prices.

But unfortunately many companies and their directors still do not understand D&O cover. It is often confused with employers' liability, a legal requirement for all companies, and public liability cover. However, possession of even the most comprehensive EL and PL policies could still leave senior personnel vulnerable to a number of personal liabilities.

D&O cover looks set to become an essential rather than a luxury buy for all companies, large or small. Insurers and brokers must pass the message on to their clients.

LATEST LEGISLATION

- Enterprise Act 2002: This law revolves around trade practice - cartel and price-fixing where directors can be prosecuted and disqualified for up to 15 years.

- Financial Services & Markets Act 2000: This is a broad act within which there are issues that affect directors and officers, particularly around a company making a listing on the stock exchange or of securities. Company directors can be liable for making false, misleading or even ambitious statements on company prospects.

- The government is also keen to rewrite the Companies Act 1985, which will increase shareholders' rights and make directors and officers more accountable.

COMMON CAUSES OF CLAIMS

Claims can arise from any of the following:

- shareholders or other directors may bring a claim against them if they consider they have acted improperly in their capacity as company director - they may consider that their actions have caused the company's value to reduce, for example.

- employees can hold their managers and directors personally responsible for acts that range from dismissal to harassment to contravening the Data Protection Act.

- competitors, regulators or the police (for criminal offences).

- receivers/administrators on behalf of creditors alleging wrongful trading.

- libel and slander can be a source of claims in acrimonious disputes.

- takeovers and disposal of companies can produce allegations of mis-representation as to the value of a company.

- floating a company or raising additional capital through share issues exposes directors and officers to public shareholders who are looking for a return on their investment.

- any warranties or statements made on future performance can be challenged if poor performance materialises.