Protecting directors: Get the details right – It can be a risky business being a director of a UK company these days and we all know the common myth that the limited liability status protects directors personally against being sued – from action by shareholders, employees, clients, suppliers, regulators, or just about anyone else who believes that they have suffered loss because of something they believe the company has done or should have done.
Recently acts have been passed increasing the exposure of directors to legal action personally –
- the Health and Safety at Work Act 2004,
- the Environmental Liability Directive 2009,
- the Corporate Manslaughter and Homicide Act 2007 and
- most recently, the Bribery Act 2010 to name but a few (penalties for individuals under the Bribery Act include imprisonment for up to 10 years and an unlimited fine).
A company can reduce the effects of a director being sued by either taking out insurance (‘Directors and Officers ‘(D & O) Insurance’) and/or by indemnifying the director.
Insurance
s233 Companies Act 2006 (CA) specifically allows a company to insure directors against those risks that either the company cannot indemnify against or chooses not to (for example, where the company itself brings a claim). D&O Insurance policies are not cheap but are now fairly commonplace particularly for private limited companies that have a number of non-executive directors or where the company’s activities are conducted in the USA.
Indemnity
Indemnity is allowed for legal costs incurred for proceedings against ‘any negligence, default, breach of duty or of trust by a director’ but only in cases specifically brought by third parties. (s232 CA 2006).
The legal costs covered are for:
•civil claims even if the judgment goes against the director
•damages made against the director
•criminal proceedings but only if the director is acquitted
•civil proceedings brought by the FSA
The Companies Act Model Articles allow for the indemnity (at article 52) but it is not an automatic benefit for a director – the company can choose to indemnify or not as the case may be. Specific shareholder resolution approval is not required but a separate commitment is (in the form of a service contract, for example). A copy of the indemnity provision must be kept for inspection at the registered office for at least one year after expiry (s237 CA 2006). Thus indemnity may be considered to provide an additional layer of comfort for directors to any insurance policy.
Derivative shareholder action
One area of the law that directors are possibly unaware exists is the ability of shareholders to sue individual directors via a ‘derivative’ claim.
Directors have always been liable for losses (wrongs) incurred but in any claim in which a wrong is alleged to have been done to a company, the proper claimant has always been the company itself (as per the Foss v Harbottle 1843 rule). However, this common law action proved to be complex as well as expensive and therefore Part 11 of the Companies Act 2006 (headed ‘Derivative claims and proceedings of members’) was introduced supposedly as a simplified procedure whereby individual minority shareholders or members of a company can take ‘derivative actions’ to sue individual board members on behalf of the company for any loss suffered by the company due to the same ‘negligence, default, breach of duty…etc’ even if the director has not benefited personally.
Since the passing of the Act the number of successful claims has been disappointingly low; the reason being that it has proved difficult to bring a claim. The process is two-staged and to date only two reported cases have successfully overcome the second stage of the claim.
- The claimant firstly needs to provide evidence to the court that there is a prima facie case (the ‘Good Faith’ Test) and
- if that is found they then have to persuade the court to grant permission to continue.
The claim will not proceed if the act or omission complained of has subsequently been ratified by the company or if the court deems the claim unreasonable. In both Franbar Holdings Ltd v Patel & Ors (2008) and Stimpson & Ors v Southern Landlords Association (2009), permission to continue with the claim was refused mainly because the judges did not think that a ‘hypothetical director’, with his duty to promote the success of the company (s172 CA 2006), would seek to continue with the claim (the ‘Hypothetical Director’ test).
Once the tests have been proven the second stage is to request that the respondent provides evidence to defend the action and only then will the court decide whether to proceed.
We might see an increase in the number of these claims once one high profile company director is brought to court via this method as more company shareholders may think that they could succeed. Indeed, a minority shareholder is understood to be bringing an action against the directors of Caffyns for alleged ‘breach of duty etc‘ for the underperformance of that company.
D & O insurance and the use of the indemnity clause in the model articles are both items that directors need to understand – should either be something that accountants suggest to company directors as a matter of course.
http://www.accountingweb.co.uk/article/protecting-directors-get-details-right/528092
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