Liability of senior management and directors has assumed the centre stage of discussion in India against the backdrop of new laws expanding the scope of director’s liability, headline grabbing boardroom battles and unpleasant run-ins of global giants with regulators.
The legislative changes have brought into focus the corporate governance practices in India, with an added emphasis on the responsibilities and liabilities of the senior management of a company in their individual capacity.
The (new) Companies Act, 2013 (“Act”) imposes stricter civil and criminal penalties on the directors and officers. It has further broadened the statutory duties of a director to act in the best interests not only of the company, the shareholders and employees, but also of the community and for the protection of the environment. The duties of an independent director as provided for the in the Act have assumed greater significance as seen in the high profile boardroom fracas publicised in the media lately.
The recently enacted Insolvency and Bankruptcy Code 2016 (“Code”) further imposes strict penalties for wrongdoings by the directors and officers such as fraudulent initiation of insolvency proceedings, false representation to creditors or falsification of books, amongst others, as specifically identified in the new code.
Globally, there is a trend towards the directors/officers being held personally liable for the wrongdoings.
Those affected by corporate failures consistently find that legislation and the courts that apply the law are unable to hold the corporation liable as it is difficult to identify who exactly within the organisation was responsible. That is changing and as evidenced by the recent imprisonments of individual traders in the LIBOR scandal and Societe General, there is a growing emphasis on holding directors/officers and senior managers accountable for wrongdoing and no longer can they hide behind the corporation as a whole. A number of factors are currently helping bring about this change:
- Regulatory authorities working together to allow overseas authorities to extend their long arm jurisdiction to charge foreign nationals with wrongdoing;
- Courts ordering discovery of documents and information located overseas which would normally cannot be disclosed in the home country;
- Public policy considerations of being seen to address investor losses;
- Senior Managers’ Regime in the UK and the Yates Memo in the US focused on the duties and obligations owed by individual directors and officers.
Given the above it would be surprising if we do not see more charges being made against the individual as opposed to the corporation going forward, and as evidenced by the recent decision of the Hong Kong Market Misconduct Tribunal which has held the Chairman and the CEO of a company liable for failure to disclose highly sensitive insider information.
Furthermore, the macro-economic environment has a significant impact on the exposures faced by directors/officers globally and whilst the Indian economy appears healthy at present, unexpected events such as the recent demonetisation initiative create environments laced with uncertainty.
If we look at the Australian example, a once in a lifetime mining boom has recently come to an end due to a combination of shifts in supply and demand conditions as well as significant falls in various commodity prices including iron ore, coal and oil. While these commodity prices have recovered recently, for many companies the damage is already done. The effects of the slowdown has seen a significant uptick in insolvencies particularly in the junior mining/exploration and mining services industries. Too often these companies run very short term strategies without much consideration for the long term. When the shocks come, they can be very damaging with many companies facing failure.
In such an economic downturn where investors and creditors are losing money, it is common for litigation to be more prevalent as parties are more motivated to seek compensation to recoup their losses. Most common litigation stems from insolvent trading allegations or various breaches of directors’ duties. The danger that arises for Directors & Officers of small to mid-size companies is that the D&O cover purchased can often be grossly inadequate in terms of either limit and/or coverage. For Non-Executive Directors (NEDs) of these companies this is of particular concern for a number of reasons. When the Company goes bust it can no longer provide indemnification to the NEDs (because it is insolvent), leading to the potential exposure the NED has regarding possible personal liability.
Risks for Directors/Officers of an Indian Company
From the Indian perspective, the directors/officers of an Indian company can no longer afford to turn a blind eye to the rapidly changing and stricter regulatory environment in India and globally. Most mid to large size companies likely have business interests in various parts of the world and are exposed to the risks in different jurisdictions. It is, therefore, imperative for the directors/officers of a company to be aware of such risks and exposures and to protect the interests of the company in the best way possible.
In addition to putting in place strong corporate governance practices, maintaining a well-structured directors and officers insurance policy is a long recognised risk mitigation practice globally. It protects the directors/officers against personal liability for acts committed on behalf of the company. Whilst this is now also being recognised in India, it is still at a nascent stage. It is important to ensure that the directors and officers insurance policy is structured such that it can respond to the domestic and international risks anticipated by a company, with adequate limits. For instance, in the recent boardroom battle involving a well-known India headquartered global conglomerate, one of the observations has been whether the company has adequate insurance capacity in place should there be a more litigious fallout of the dispute.
The newly introduced concept of class action suits in the Act further raises the question as to whether the shareholders’ concerns are likely to take an expensive litigious turn going forward. For instance, the D&O class action environment in Australia has developed rapidly over the last ten years and should be viewed as a case study for India to take seriously. Australia is now commonly accepted to be the second most litigious jurisdiction for D&O class actions outside of the US. With an estimated annual D&O premium pool of between AUD210m and AUD250m and a rumoured D&O class action pipeline of anywhere between AUD1B to AUD1.5B (some say more), it is clear that a sustainability issue exists.
Of interest to India, is that just ten years ago it was common for brokers in Australia to struggle to explain to their clients the need for the cover to be taken seriously (limits, expertise of carrier etc.).The reason for this was the lack of large scale losses, similar to the situation in India at present. Fast forward to 2016 and it is rare that the financial news in Australia is not awash with either news of proposed or settled shareholder actions or even full page advertisements by litigation funders encouraging shareholders to join proposed actions. Key to this rapid and frightening development, amongst other things, has been the rise of litigation funding as a business. Testament to this is as at today, the ASX now boasts four litigation funders on its boards. While supportive legislation in the Corporations Act 2001 and a very empathetic court system (towards consumer/investor related claims) certainly supports the development of D&O class action experience, it is undeniable that litigation funding has been the major driving force contributing to D&O class actions in Australia.
Originally developed to facilitate the concept of ‘social equity’, in providing access to compensation for those who could not afford to fund it themselves; litigation funding nowadays is big business and ultra specialised. While India is very much in its infancy in terms of D&O litigation, class actions are allowed and the Indian Act provides Directors with a very clear set of duties required to be discharged. If litigation funding were to take hold in India, then it is likely the D&O class action landscape has the potential to follow the Australian experience.
While India is very much in its infancy in terms of directors and officers litigation, the newly introduced provisions pertaining class action in the Act provides directors with a very clear set of duties required to be discharged. If litigation funding were to take hold in India, then it is likely the D&O class action landscape has the potential to follow the Australian experience.
The rapidly changing regulatory environment, stricter duties and liabilities of the directors and officers and global exposures being faced by Indian companies is the new corporate norm which cannot be ignored, but instead needs to be managed in a prudent manner to limit exposures for a company and its senior management. D&O insurance together with strong corporate governance practices provides a powerful tool to manage the risks arising in the present business environment. In light of this, it becomes important for company directors to pay attention to their D&O insurance buying behaviour and establish relationships with strong and experienced underwriters of the class to ensure they are ahead of the potential risk exposures.
Contribution by: Nilam Sharma, CEO, Nilam Sharma Ltd; Joel Pridmore, Specialty Manager, Australia & New
Zealand, Corporate Insurance Partner, Munich Re Group and Richa Shukla, Partner, Khaitan Legal Associates