A significant number of Directors and Officers (D&O) claims result from liquidations, companies being in financial distress, or companies being placed in business rescue. The economic fallout following the COVID-19 pandemic, combined with the impact on business operations due to lockdown, could foster financial hardship and expose directors to consequent claims.
Conflict of interest risk
Any decisions made during times of financial crisis will be subjected to increased scrutiny, as they often involve a trade-off between competing interests. It is possible that such decisions negatively impact one or more of the involved parties, who may feel strongly enough to litigate. A director may be held liable by the company if they breach their duties. Some guidance on a directors’ duties can be found in the Companies Act 71 of 2008, and may be summarised broadly as:
- A director should act in good faith and in the best interest of the company and not take personal advantage of the information gained by virtue of the position occupied;
- A director should communicate relevant information that may affect the company to the board;
- A director should act with care, skill, and diligence, in regard to their skills, experience, and to the position occupied; and
- Directors also have a duty to ensure that the company they serve does not trade recklessly.
- Directors can discharge the above duties, by:
a) Taking reasonably diligent steps to become informed about the matter;
b) Having no material personal financial interest in the subject matter of the decision, or disclose the interest and abstain from partaking in the decision making in terms of the Act; and
c) Making decisions with a rational basis for believing, and actually believing, that the decision is in the best interest of the company.
Section 77(9) of the Act requires directors to act in the best interest of the company and affords leniency to directors if they act honestly, reasonably, and on the reasonable belief that they are acting in the company’s best interest. Per section 76(5), directors may depend on reliable and competent employees of the company, legal counsel, accountants, and other professional persons and committees of the board on matters that are within the respective persons’ competencies.
Claims during financial distress
Claims that arise from a breach of a director’s duties are usually specific to an industry or the circumstances of the company concerned. One example is that directors may be asked to appear before inquiries held by liquidators under insolvency laws, in which case they may require legal representation.
It is also possible for liquidators, creditors acting through the company, or other stakeholders to allege that the conduct of a director is in breach of his or her duties. They may claim damages that result from such breaches from the director. Employees of financially distressed companies may also seek recourse for actions taken by directors. And finally, in times of financial distress, there may be a need for loans to related parties. Directors must stay within the parameters of regulatory requirements, such as the ‘solvency and liquidity’ test or risk a personal liability claim.
Responding to D&O claims
There are steps to follow should a director be subject to one of the above actions. You should first inform your insurance broker and D&O insurer. Best practice is not to admit or acknowledge any wrongdoing and avoid discussing the matter with external parties wherever possible. It is also advisable to thoroughly document all decisions made, as this will be useful in presenting a defence to any claim.
It is important for directors and company boards of directors to work jointly with their insurers to deal with the personal legal challenges arising from their directorship positions to ensure the best possible outcome, particularly during uncertain times.
Source: SHA Specialist Risks