Directors’ Liability

Greg Shields was happy to respond to the request for a second article by the Canadian Society of Physician Executives (CSPE) Newsletter (www.cspexecs.com). With their permission we have re-published it here.

Directors’ Liability
By Greg Shields

All good things come with risk and reward. Company director is a vital role. Our organizations, whether they are large or small, public, private or non-profit, require strong, educated and dedicated people in a governance capacity to be successful. However, it is easy to find somebody who will tell you that you would be crazy to take on a director position, especially of a public company, and sometimes that is the only excuse we need to say no. But you would be missing out on a great opportunity. These roles allow you to make a real difference in the community. Your experience, education and leadership will allow for better decisions by management and help create a growing and successful operation. A strong and active board will help identify and attract quality management, will help raise funds (donations or capital), and protect investors, employees and clients from negligence and fraud. A broadened network, introductions to people you would never otherwise have the opportunity to meet and the challenge of developing new skills and abilities are some of the material benefits from taking on a directorship function.

There are also real risks that should not be ignored. Over 150 pieces of legislation have to do with some aspect of risk of personal liability for an individual director. The most obvious is unremitted source deductions if the corporation goes bankrupt. The Canada Revenue Agency is not afraid to pursue these claims, which include income taxes, Canada Pension Plan contributions and employment insurance premiums. There is also potential recourse against directors for sales tax, severance pay, vacation pay, workplace liabilities, and environmental liabilities. In addition, there is a civil liability a shareholders, employees, clients, creditors, competitors and other stakeholders in the organization.

 While considering these sources of risk, it is important to remember that meaningful protection is built into our laws. The due diligence defence is the strongest of these. Arguments demonstrating that specific actions were taken to attempt to prevent loss will almost always prove successful. The courts will consider the knowledge and education of the individual directors and look at their actions to determine if they acted in good faith and in the best interest of the organization, thereby fulfilling their duties of care, loyalty and obedience.

This may be obvious from some of the very public directors’ liability cases, but, the courts have not set a very high bar for directors. Acting in a manner that is free of conflict of interest and self dealing; gaining an understanding of withholding and remittance requirements to a level of a reasonably “like” person (if you are not a chartered accountant, you will not be required to have the knowledge and experience of one); establishing some policies for reducing unremitted source deductions and other liabilities; and relying on management and independent experts for advice will go a very long way toward mitigating director risk.

I also recommend the use of personal contractual indemnity agreements for all directors of organizations that have the financial ability to indemnify its directors. Indemnification provisions are built into the Canadian Business Corporations Act, Ontario’s Business Corporations Act, many corporate by-laws and most of industry specific acts, but, these are not all created equal and none of them is as good as a well vetted individual contractual indemnity.

Another risk mitigation tool is Directors’ and Officers’(D&O) Liability insurance. This insurance coverage is demanded by directors of most non-profit and publicly traded entities and is gaining popularity with private companies.  This insurance is not a panacea of coverage. It should not be a priority over good general liability, property or operation-specific products, such as professional liability (includes medical malpractice), errors and omissions liability (E&O), environmental, fidelity/crime, and cyber/media/privacy insurance policies.  And D&O is not a priority over good governance, risk management and compliance (GRC) activities.

But, when these other issue have been considered, and some investigation and action taken, the D&O purchase should not be taken lightly. Far too often this insurance is sold, not purchased. Somebody says they want it, and then it is left up the insurance broker to decide what is best. The outcome of this method is “insurance risk” that has not been identified or managed. Insurance risk is the failure of the policy to act as anticipated.

A decision to purchase D&O insurance should be based on the limit liability, not on the insurance premium. The limit of liability has, or should have, a value that is material to the corporation, whereas the premium often does not. Even for a small non-profit, this is a $1-2 million dollar decision. For a small publicly traded company it is a $5-15 million dollar decision. For a large public company the range is $25-100 million. The purchase decision deserves this level of attention.

Second, the purchaser should contemplate and prioritize the separate interest of all potentially insured parties under the policy. Special attention must be paid to the personal liability of the individual directors and officers. Most directors and officers make the critical assumption that their D&O policy is designed to cover their personal liability. For many, and perhaps even most, directors in Canada, that assumption is incorrect. Through aggressive competition among insurance companies and under-educated, over zealous insurance brokers, policies have been “broadened” to such an extent that they may now be a detriment to individual directors. Claims made against the corporate entity and coverage for non-traditional parties and matters are now fair game under many D&O policies. This level of coverage can be very attractive to aggressive plaintiffs and their even more aggressive lawyers, because a broader policy means a better chance for at least a modest settlement, which reduces the risk of pursuing  a long-shot chance of discovering the smoking gun that will produce the a settlement made up of the entire policy limits, plus corporate contribution, plus third party contribution, plus individual director or officer contribution.  However, there is only one limit of liability that is shared by all parties for all claims; thus, a loss by the corporate entity or other party can erode or even fully exhaust the limits otherwise available  to the individual directors.

Third, it should be fully understood that there is no regulation of (specialty lines) policy wordings in Canada. Dozens of insurance companies, managing general agents, captives and reciprocals provide D&O insurance coverage and there are hundreds of versions of policy wording, endorsements and applications, any part of which can determine the difference between coverage and denial. There are also many brokers who are willing to pass themselves off as independent experienced brokers, when in fact they limited or no direct experience with D&O policies and claims, and when they owned by, or have a material debt or non-standard remuneration agreement with, an insurance company. Therefore, the decision purchase D&O insurance should include, 1) a direct request of all brokers to disclose all potential conflicts of interest, including any “exclusive insurer” programs, 2) direct questions of all brokers to explain to your satisfaction the key issues regarding all coverage options as they relate to your operations, and, 3) a direct request of all brokers to not approach any insurance markets on your behalf until you have made your choice of broker.

With the inherent protection built into statute and legal precedent, an ounce or two of loss prevention, a solid individual contractual indemnity and a well-negotiated D&O policy, the benefits of a board position will far outweigh the risks. And your industry and the Canadian business community will be much better served by the involvement of independent, dedicated and experienced corporate directors.

Greg Shields is a Partner with Mitchell Sandham Insurance brokers, an independent company providing commercial, private client and financial services insurance. He specializes in casualty products that address directors’ and officers’ risk, crime, fiduciary liability, professional errors and omissions and cyber / media risk. He provides insurance negotiation and risk consulting services, coverage and claims advice to small and medium-sized enterprises, multi-nationals and nongovernmental organizations. Greg can be reached at 416 862-5626 or gshields@mitchellsandham.com .

Posted: 3/10/2011 12:00:00 AM by Global Administrator
Filed under: and, Broker, D&O, Director, Directors, Duties, Indemnification, Independent, Liability, Officers, Personal


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