2020 Litigation Forecast - Continued squeeze on directors – increased litigation risk and reduced protections
Company directors are called ‘directors’ because they direct how companies are run. No matter the size of the company, the power to make the big decisions, including setting corporate strategy, ultimately rests with its board. But with great power comes great responsibility.
Historically, directors were largely insulated from liability for the conduct of the company, with few duties owed in their personal capacity and an ability to insure or be indemnified against most risks.
However, this is changing. Recent and proposed amendments to legislation that affect various aspects of company operations, coupled with restrictions on the ability of companies to indemnify directors, show that directors are increasingly likely to be more accountable for a company’s liabilities and misdeeds.
Directors owe statutory, common law and equitable duties to a company, and in some circumstances to its creditors – including duties to act in good faith and in what they believe is the best interests of the company; to exercise their powers for a proper purpose; and to exercise the care, diligence and skill of a reasonable director.
The recent High Court decision ordering the former directors of Mainzeal Property and Construction Limited to pay $36 million to Mainzeal’s liquidators is a timely reminder of the significant liability directors can attract for failing to meet the standards of governance imposed by the Companies Act 1993.
Directors will be aware that the Health and Safety at Work Act 2015 (HSWA) expanded the scope of directors’ duties, imposing a new duty upon them to exercise due diligence to ensure that the company complies with the HSWA. Directors who fail to do so are subject to enforcement action by WorkSafe for failure to comply with those duties – and they cannot be indemnified or insured for penalties.
The start of a trend in New Zealand?
This same approach appears to be happening across a range of environments. For instance, the Credit Contracts Legislation Amendment Act (passed in December 2019) further expands the scope of directors’ duties by imposing a duty on directors and senior managers of lenders to exercise due diligence to ensure compliance with the Credit Contracts and Consumer Finance Act 2003 (CCCFA).
Directors are required to take reasonable steps to ensure that the company has appropriate procedures to comply with the CCCFA, detect deficiencies in those procedures and promptly remedy any deficiencies discovered. Failure to discharge this duty exposes directors to prosecution by the Commerce Commission and penalties of up to $200,000 per act or omission.
In a similar vein, the Tax Working Group has recommended making directors who have an economic ownership in a company personally liable for arrears on GST and PAYE obligations where there has been deliberate or persistent non-compliance. The Government considered this a ‘high priority’, though ultimately did not include this recommendation in its Tax Policy Work Programme for 2019-20.
A recent options paper regarding regulation of the conduct of financial institutions published by the Ministry of Business Innovation and Employment also contemplates the introduction of personal liability for directors and senior managers of financial institutions who fail to discharge the ‘overarching duties’ of ensuring good outcomes for customers. These include:
- a general duty of care.
- a duty to consider and prioritise the customer’s interests to the extent reasonably practicable.
- a duty to pay due regard to the information needs of customers.
- to communicate in a way which is clear and timely.
These proposed directors' duties have not formed part of the recent Financial Markets (Conduct of Institutions) Amendment Bill but may still be on the regulators' radar.
New interpretations to go along with new duties
Beyond adding wholly new duties, existing duties owed by directors may also be interpreted more expansively. Climate change is a notable example. A recent article published by the Institute of Directors suggests that considering, disclosing and taking steps to mitigate foreseeable climate-related risks might be recognised as a component of the director’s duty of care under the Companies Act.1
Limited scope to protect against liability
Following the lead of the HSWA, the Credit Contracts Legislation Amendment Act prevents directors and senior managers of lenders from taking out insurance policies against potential liability and from being indemnified by the company.
This goes a step beyond the restrictions under the Companies Act, which permits such insurance and allows the company to pay for it where it is authorised in the company’s constitution; restricts insurance to civil liability; and directors resolve that the cost of the insurance is fair.
The clear intention of these changes is for directors to take greater personal responsibility for the activities of the company and to remove any ‘moral hazard’ the assumed protection of an insurance policy or indemnity might create.
Board minutes: shield or a smoking gun?
As boards increasingly grapple with how much detail to include in board minutes, we are seeing evidence of the challenges associated with managing the expanding potential for director liability.
On one hand, insufficient detail can expose boards to censure from regulators for failing to adequately consider (or at least document consideration of) compliance risks. For instance, while investigating Wynyard Group Limited for potential continuous disclosure breaches in 2018, the Financial Markets Authority criticised the company’s board for inadequately documenting discussions regarding continuous disclosure compliance.
This issue has gained increased salience following the publication of the Australian Royal Commission’s report, which singled out the Commonwealth Bank of Australia for its failure to appropriately record board discussions regarding the Bank’s AML/CFT obligations between 2013 and 20162. On the other hand, excessively detailed board minutes can bolster regulatory investigations and prosecutions and record unhelpful evidence. A careful balance needs to be struck in managing litigation risk.
Looking forward – what does this mean for directors?
We view the trend of increasing director responsibility as one that will continue. We expect regulators to test the waters by bringing more prosecutions, enforcing duties owed by directors and senior managers in their personal capacity. We will also be watching with interest to see whether personal duties affecting directors might be added to other regulatory regimes (e.g. tax).
Liability deterring enthusiasm for directorships?
If this trend continues, we anticipate this may have a cooling effect on willingness to accept director appointments. In its recent Director Sentiment Survey 2019, the Institute of Directors observed an increase in the number of directors reportedly being deterred from assuming governance roles by the increasing scope of potential liability. That is of real concern.
The Institute of Directors has also reported that directors are becoming more cautious in making business decisions, in response to the expanding scope of personal liability. This is also potentially harmful if companies become unduly conservative.
Companies need competent and experienced individuals to sit on boards. If such individuals opt to sit on the side-lines, fearing exposure to personal liability, the quality of corporate leadership in New Zealand will suffer.
Another possibility is that directors will expect greater compensation to accept directorships to reflect the increased threat, which will increase the cost of doing business.
Greater exposure to personal liability strengthens the imperative for boards to carefully manage litigation risk. Now, more than ever, it is essential that directors are aware of the personal duties they owe and are proactive in ensuring compliance.
Lloyd Kavanagh “The gathering storm – and how to prepare” (30 Oct 2019) Institute of Directors New Zealand
Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry