AIG SA: Directors likely to face wave of litigation

• AIG saw 26% increase in Directors & Officers (D&O) liability policy applications in 2008
• Corporate liquidations rose 69% in January compared with January 2008, placing additional pressure on directors and officers

Directors and officers, often charged with making difficult management decisions, may face heightened litigation once the New Companies Bill comes into effect. The Bill, expected to be promulgated in 2010, codifies the common law and makes director’s duties more onerous.

Provisions in the Bill will raise directors' accountability to shareholders and allow the participation of shareholders beyond meetings, which is one area the current law has always been inflexible.

In 2008, AIG saw a 26% increase in D&O liability policy applications demonstrating that companies are mindful of liability concerns and are stepping in to ensure that cover is in place to see them through the interim period and beyond the Bill’s promulgation.

Currently, the duties and liabilities of directors are governed by both common law and statute. If a director fails in terms of his common law duties, he may be personally liable to pay monetary damages. If he fails in terms of his statutory duties, currently regulated by the Companies Act of 1973 and the Corporate Laws Amendment Act of 2006, he may face criminal liability in addition to personal liability.

However, according to Philip Hobson, Financial Lines Manager at AIG South Africa, the New Companies Bill will heighten directors’ personal liability.

“Tighter regulation in South Africa will fuel corporate litigation,” says Hobson. “South Africa is following the trend in countries like the US, UK and Australia in becoming more litigious and directors and officers need to be prepared for this. The change in regulation combined with a dire economic environment is not a nice concoction for directors to swallow.”

”For example, Australia, which has gone through a similar corporate law evolution, has seen D&O Claims double in the last 4 years.”

Hobson also warns that management should not wait until the promulgation of the Bill to make sure they are covered.

“The fact remains that directors are currently liable for committing wrongful acts. They are expected to act in the best interests of the company and exercise powers for the proper purpose. In the future these standards of conduct are only going to increase.”

The current macroeconomic environment is increasing the likelihood of claims. As company values fall & share prices decline, shareholders and other stakeholders will look for scapegoats.

“We have seen overseas that there is a clear inverse relationship between share prices and shareholder claim. As you would expect, as stock indices decline, D&O claims rise.

“The legal costs alone, which are covered by the policy, of defending an allegation can be extremely expensive.”

In terms of the Bill, directors will be personally liable for breaches of their fiduciary duties and may be sued for loss and damages caused to creditors, employees, customers, competitors (e.g. unfair competition), shareholders or other stakeholders of a company.

Typically D&O insurance policies will indemnify management against any loss resulting from a wrongful act which they have committed or are alleged to have committed. These losses include: civil damages; investigation costs; legal costs, which include costs of defending an action and costs awarded against a director; and reimbursement to the company for losses suffered where the company provided indemnification to the directors.

Hobson also notes that D&O liability often arises through merger and acquisition activity, which is increasing in South Africa. There are duties owed to existing shareholders, new shareholders, employees, suppliers, customers and the regulatory authorities. Directors can be held personally liable when failing in their duties.

“Companies involved in mergers and acquisitions are much more likely to face at least one D&O liability insurance claim,” he says. “In terms of the Bill, there is a clear codification for appraisal rights to dissenting shareholders.”

“The thing is, companies, directors and their insurance advisors often don’t adequately account for these risks. They will always take out traditional insurance, like asset policies for example, but the exposures from intangible events are the ones that are growing exponentially.”