Insurance for corporate accountability

By Kinita Shenoy

Chartis’ Liability Insurance is urging company directors to obtain insurance to safeguard themselves against legal action and personal liability.

Chartis outlined its assistance mechanisms recently during a symposium for directors and officers, on the duty of directors and personal liability.

Under the new Companies Act presented in 2007, indemnity and insurance for director’s actions on given circumstances may be allowed by companies if the articles permit it, so “directors can rely on the mechanisms of protection” such as insurance and relief granted by the court.

This is in cases of negligence, losses of revenue of shareholders and criminal liability. Chartis’ Liability Insurance as a mitigatory solution covers personal liability, corporate reimbursement and legal defence costs.

The Regional Vice President at Chartis, John Hopper provided the symposium with a global perspective. He pointed out that director’s and officer’s liability is distinct from other types of commercial insurance, and that the liabilities of publicly traded company’s officers were at stake should the company be found guilty directorial negligence.

He said that due to a “continued unwind of the global financial crisis”, the risk is more tangible, and markets are more interconnected, which means that economic problems cannot be contained or isolated.

There is also a much higher demand for disclosure and transparency as well as counterparty exposure. Hopper elaborated that the global impact is mixed and that there is enormous volatility in asset pricing, and divergence in asset markets.

The gradual shift in ‘claims culture’ has made litigation more prevalent and people more aware of legal rights. There has also been an emergence of litigation funding, and regulatory activism globally. This has created a much larger focus on corporate governance, which is now a key issue for investors.

Hopper went on to discuss the far reaching changes created by the sections added in the Companies Act of 2007. These created a codification of director’s duties, strengthened stakeholder rights, recognises derivative actions, and the possibility of private prosecutions.

Then, the new listing rules created in 2008 led to onerous legal corporate and regulatory framework in Sri Lanka, which appear to be very stringent in comparison to others in the South East Asian region. Thus, there is a clear “roadmap to liability” for directors in the country, as they are subject to scrutiny to regulators and shareholders, at the risk of significantly large fines and legal proceedings.

Dr. Harsha Cabraal, member of the President’s Council, was the first speaker at the symposium. Discussing the segregation between official and personal liability under company’s law, he also discussed Section 218 — insurance and indemnity. He stressed that the new act very clearly sets out the duties and purpose of a director, and that a company should be run by a board of directors, not shareholders.

In reference to Section 187, he mentioned that those who exercise control in the company shall be treated as directors and the subsection details the conduct of a director of a subsidiary company, should a conflict of interest between parent company and subsidiary company come into play.

Cabraal also mentioned that it was imperative that all directors should act in the best interests of the company. The following articles establish further ideas: Section 188, the Director’s Act and Articles of Association, and Section 189, the standard of care expected while on the board.

Section 190 was explored in detail in the presentation on ‘Engaging professional advice to avoid personal liability’ by Neomal Gunewardane, attorney-at-law and partner at Nithya Partners. This section involves the action of directors in reliance on financial reports, accounts, or on professional/expert third parties. In certain cases, this reliance may render the directors and officers exempt from personal liability.  However, it is necessary that the director has acted in good faith, makes proper inquiry of the source under circumstances, and has no knowledge that such reliance is unwarranted. The individual may also receive this information from internal sources or any other directors in relation to their designated authority.

Gunewardene also spoke about instances such as the Nippon Express Ltd. vs Woodward case (1998), in which a ‘nominee director’ from a parent company is managing the goings on of a subsidiary company. The parent company may see a ‘total picture’, which could be beneficial to them, but detrimental to local companies or banks. In the case of directors “acting as puppets” and not exercising their directorial powers, they will be held accountable and responsible for losses by creditors.