To what extent might the directors be personally liable for losses suffered by the company itself and by creditors of the company?
Although these questions have attracted particular attention in recent high profile company cases, in reality they arise whenever a company encounters financial difficulties. The liquidator of an insolvent company will almost invariably consider whether a claim should be made against its directors because of their conduct of the company's business in the period leading up to liquidation. The proceeds of a successful claim can be paid into the general pool for the benefit of all creditors, or a Court might direct that they be paid to a particular creditor. Money from such claims can make a huge difference to the amount available to creditors - witness in particular Air New Zealand's payment of $150m to the receiver of Ansett.
Apart from exposure to claims arising from insolvency the directors and senior management of a company also face the possibility of personal liability because of the actions of the company while it is trading solvently. Breaches by a company of (among other Acts) the Resource Management Act 1991, the Commerce Act 1986, and the Fair Trading Act 1986 can result in a personal liability of the directors and officers responsible.
Even if a director is ultimately successful in defending a claim or charge, the costs of doing so can be crippling. To help meet these costs, and where possible to help meet any liability if a proceeding is successful, many directors and most professional directors take out directors and officers' insurance and/or statutory liability insurance.
This can be at their own cost, but usually the company will pay, since it is of benefit to a company that its directors feel free to act robustly when the need arises without being unduly constrained by the fear of claims or charges against them.
It is not possible to insure against liabilities of a criminal nature (eg fines) and a company cannot indemnify a director against liabilities of that nature, but it is possible to insure and to indemnify directors against the costs of defending a criminal action if the person is acquitted. The Companies Act 1993 requires that the constitution of the company authorises the placement of the insurance, and that there must be prior board approval. Because the company cannot do so the directors will have to pay the portion of the premium that entitled them to cover for the costs of defending a criminal action that results in conviction.
This type of cover is offered by most insurance companies providing professional indemnity insurance. For maximum benefit to those insured, the cover should include the costs of defending claims as well as any damages, judgments, or monetary awards (including awards of costs), made against the director.
As is the case with any insurance contract the wording of the policy is critical to the protection provided. Company officers taking up this insurance should seek legal advice on what is covered by the wording of the policy and, more importantly, what is excluded, or simply not covered. A contract of insurance is invariably carefully drafted with the insurer having a full understanding of what it intends to include and exclude from cover. Regrettably, insurers do not always draft their policies so that what is covered by the policy is clear and free from ambiguity. Companies and their directors need to be careful to ensure that the wording of the policy matches the risks that are likely to be faced.
Directors must also know when the cover ceases. A director who resigns or is removed from office does not immediately become safe from any claim. Civil claims can be lodged up to six years after the event that gives rise to the claim and in some instances the period can be longer. A charge under the Resource Management Act 1991 must be laid within six months after the contravention on which it is based first became known or should have become known. In some cases, for example of illegal dumping, this might be many years after the offending conduct occurred. Cover for the period after a person has ceased to be a director is known as run out cover, and is an essential element of any comprehensive indemnity scheme.
Most directors and officers' insurance is on a claims made basis. This means that the insurer agrees to cover those claims that are made during the period of cover, regardless of when the circumstances giving rise to the claim may have occurred. Once a claim is made the insurer remains liable under the policy to meet the claim even if, in subsequent years, the company or officers change their insurer or do not renew their cover (they might be foolish to do either while a claim is outstanding - an unhappy insurer can be an uncooperative insurer).
The alternative to claims made insurance is occurrence based cover. This covers events that occur during the currency of the cover, regardless of when a claim is made. For example, if a director had cover for the 1967 year, and a claim arises from events that occurred in that year, the director will be covered, even if there is no current cover. The disadvantages of this type of policy are the added cost (30% higher would not be unusual), and the need to keep track of what has become of past insurers (mergers might make it difficult to trace the insurer, or insolvency might make the insurance valueless).
Therefore, directors are well advised to ensure that they have appropriate indemnity cover for their actions as directors. The cover does tend to be quite expensive, but is usually not a huge amount in relative terms when compared with the turnover of the company and the nature of the risks involved.
Copyright The Lawlink Group Ltd 2001
Every effort has been made to ensure that this information is accurate. However, it is general introductory information only. It does not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters. Any reference to law and legislation is to New Zealand law and legislation.
Alan Stuart is a Partner in the Auckland Lawlink firm of Webster Malcolm and Kilpatrick. His principal areas of practice are conveyancing and commercial law.
Email: a.stuart@wmklaw.co.nz
Web site: Webster Malcolm Kilpatrick
March 2002
Although these questions have attracted particular attention in recent high profile company cases, in reality they arise whenever a company encounters financial difficulties. The liquidator of an insolvent company will almost invariably consider whether a claim should be made against its directors because of their conduct of the company's business in the period leading up to liquidation. The proceeds of a successful claim can be paid into the general pool for the benefit of all creditors, or a Court might direct that they be paid to a particular creditor. Money from such claims can make a huge difference to the amount available to creditors - witness in particular Air New Zealand's payment of $150m to the receiver of Ansett.
Apart from exposure to claims arising from insolvency the directors and senior management of a company also face the possibility of personal liability because of the actions of the company while it is trading solvently. Breaches by a company of (among other Acts) the Resource Management Act 1991, the Commerce Act 1986, and the Fair Trading Act 1986 can result in a personal liability of the directors and officers responsible.
Even if a director is ultimately successful in defending a claim or charge, the costs of doing so can be crippling. To help meet these costs, and where possible to help meet any liability if a proceeding is successful, many directors and most professional directors take out directors and officers' insurance and/or statutory liability insurance.
This can be at their own cost, but usually the company will pay, since it is of benefit to a company that its directors feel free to act robustly when the need arises without being unduly constrained by the fear of claims or charges against them.
It is not possible to insure against liabilities of a criminal nature (eg fines) and a company cannot indemnify a director against liabilities of that nature, but it is possible to insure and to indemnify directors against the costs of defending a criminal action if the person is acquitted. The Companies Act 1993 requires that the constitution of the company authorises the placement of the insurance, and that there must be prior board approval. Because the company cannot do so the directors will have to pay the portion of the premium that entitled them to cover for the costs of defending a criminal action that results in conviction.
This type of cover is offered by most insurance companies providing professional indemnity insurance. For maximum benefit to those insured, the cover should include the costs of defending claims as well as any damages, judgments, or monetary awards (including awards of costs), made against the director.
As is the case with any insurance contract the wording of the policy is critical to the protection provided. Company officers taking up this insurance should seek legal advice on what is covered by the wording of the policy and, more importantly, what is excluded, or simply not covered. A contract of insurance is invariably carefully drafted with the insurer having a full understanding of what it intends to include and exclude from cover. Regrettably, insurers do not always draft their policies so that what is covered by the policy is clear and free from ambiguity. Companies and their directors need to be careful to ensure that the wording of the policy matches the risks that are likely to be faced.
Directors must also know when the cover ceases. A director who resigns or is removed from office does not immediately become safe from any claim. Civil claims can be lodged up to six years after the event that gives rise to the claim and in some instances the period can be longer. A charge under the Resource Management Act 1991 must be laid within six months after the contravention on which it is based first became known or should have become known. In some cases, for example of illegal dumping, this might be many years after the offending conduct occurred. Cover for the period after a person has ceased to be a director is known as run out cover, and is an essential element of any comprehensive indemnity scheme.
Most directors and officers' insurance is on a claims made basis. This means that the insurer agrees to cover those claims that are made during the period of cover, regardless of when the circumstances giving rise to the claim may have occurred. Once a claim is made the insurer remains liable under the policy to meet the claim even if, in subsequent years, the company or officers change their insurer or do not renew their cover (they might be foolish to do either while a claim is outstanding - an unhappy insurer can be an uncooperative insurer).
The alternative to claims made insurance is occurrence based cover. This covers events that occur during the currency of the cover, regardless of when a claim is made. For example, if a director had cover for the 1967 year, and a claim arises from events that occurred in that year, the director will be covered, even if there is no current cover. The disadvantages of this type of policy are the added cost (30% higher would not be unusual), and the need to keep track of what has become of past insurers (mergers might make it difficult to trace the insurer, or insolvency might make the insurance valueless).
Therefore, directors are well advised to ensure that they have appropriate indemnity cover for their actions as directors. The cover does tend to be quite expensive, but is usually not a huge amount in relative terms when compared with the turnover of the company and the nature of the risks involved.
Copyright The Lawlink Group Ltd 2001
Every effort has been made to ensure that this information is accurate. However, it is general introductory information only. It does not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters. Any reference to law and legislation is to New Zealand law and legislation.
Alan Stuart is a Partner in the Auckland Lawlink firm of Webster Malcolm and Kilpatrick. His principal areas of practice are conveyancing and commercial law.
Email: a.stuart@wmklaw.co.nz
Web site: Webster Malcolm Kilpatrick
March 2002
March, 2002
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