Are You Protected as a Director?
Many responsibilities come with being a director, and there are harsh consequences if you don’t fulfil them. Know when protection and indemnification are possible and how to protect yourself.
While an exciting opportunity, becoming a director or officer of a company carries with it a number of duties, the extent of which many directors may not fully appreciate or understand. The majority of duties are set out in the Corporations Act 2001 (Cth), however, there are many other sources of obligations such as Federal and State legislation, tax legislation and work health and safety (WHS) regulations which directors need to comply with.
If a company has the financial capacity to offer a comprehensive deed of indemnity to the director, the contractual agreement between the company and the director is most important. This is still considered the best first line of defence to help cover or indemnify a director against personal liability. Side B cover (Company reimbursement) of the D&O policy can reimburse the company where it has provided indemnity to the Directors. Directors & Officers Insurance assists in situations where the company’s financial situation cannot accommodate a deed of indemnity; for example, the company is insolvent or near insolvency. It also serves to cover a class of liabilities where indemnification is prohibited.
Duties of Australian Company Directors
There are a number of legal obligations that come with being the director of an Australian company. These are in place to protect the stakeholders of the company and must be adhered to.
Some of the legal obligations a director must follow include the duty to:
- Act in good faith and for a proper purpose
- use care and diligence
- avoid improper use of information
- avoid abusing the use of position
- disclose certain conflicts of interest
For a comprehensive list of directors duties, see the Corporations Act 2001.
In the case of a company breaching relevant laws or legislation, the director may become personally liable in some circumstances. This is called vicarious liability and may be imposed upon the director if they were in force at the time the company breached the law. Vicarious liability can be brought about by breaches of various laws, including the following:
- Consumer and competition legislation aims to protect consumers by promoting competition and fair trading and relates to almost all areas of business activity. If a provision of this Act is contravened by a company, there’s a risk that the director will be held personally liable.
- WHS legislation. Each state has their own WHS laws that businesses must follow. WHS exists to protect the health and safety of workers and members of the public. If a company is found to have contravened the Act, the director may also be held accountable unless they can prove that they undertook all necessary due diligence.
Due Diligence of Company Directors
Directors must undertake due diligence to identify any risks in the company and manage them appropriately. Regarding directors’ duties and vicarious liability, due diligence can help to establish protocols and processes to ensure the smooth running of a company. Undertaking due diligence not only reduces errors and harm to stakeholders but can also help protect directors from liability. A keen understanding of duties, WHS and other legislation, is needed so the director can ensure the company is following all protocols to reduce risk and liability. D&O Insurance can help to minimise the risk of financial penalty in many circumstances, but not all.
Consequences of Breaching Directors Duties
Breaching Directors’ duties results in some serious consequences, including both Civil (monetary penalty imposed as a result of civil proceedings) and Criminal (criminal sentence, penalty or fine imposed) penalties:
Breaches resulting in Civil Penalties
- Breach of duty of care & diligence;
- Breach of duty to act in good faith in the best interests of the company and for a proper purpose;
- Breach of duty not to misuse position or information;
- Related party rules;
- Insolvent trading;
- Insider trading;
- Breaches of continuous disclosure.
Breaches resulting in Criminal Penalities
- Contravention of duties of good faith;
- Abuse of position;
- Improper use of information;
- Where there is conduct involving an element of recklessness or intentional dishonesty.
Most D&O insurance policies include a general exclusion for claims:
- arising out of director’s fraud & dishonesty;
- resulting from a contravention or prohibition of section 199B of the Corporations Act ;
- where the fines and monetary penalties arise from a reckless act or omission; and
- matters which are generally uninsurable under applicable laws.
When Indemnity is Prohibited
A company is able to financially protect directors against some liabilities, but not all. Indemnification and exemption of an officer or auditor by a company is limited by or prohibited in certain circumstances under s199A of the Corporations Act.
When Indemnities for liabilities are not allowed (other than legal costs)
A company or a related company must not indemnify a person (directly or through an interposed entity) against any of the following liabilities incurred as a director of the company:
- a liability owed to the company or a related company;
- a liability to pay a pecuniary penalty or compensation ordered under the Corporations Act; or
- a liability that did not arise out of conduct in good faith.
A key concern for directors when defending an action is whether the company can assist with indemnity for legal costs. S199A(3) prohibits this in the following circumstances:
When Indemnities for legal costs are not allowed
A company or a related company must not indemnify a person against legal costs incurred in defending an action for a liability incurred as a director of the company if:
- the director is found to have a liability for which the company may not indemnify them, as outlined above;
- the director is found guilty in criminal proceedings;
- ASIC or a liquidator brings the proceedings, and the grounds for making the order are established (for example actions by ASIC to disqualify a director); or
- the costs are incurred in connection with an action brought by a director for relief under the Corporations Act, and the relief is denied.
A typical D&O policy
In most instances, a director or officer will be covered by the Side A component of the D&O Insurance policy (KBI D&O policy structure) for general liabilities and legal costs where the company may not indemnify. There is a prohibition in Section 199B of the Corporations Act which prohibits a company from paying premiums for an insurance policy which indemnifies a director against liability for:
- wilful breaches of duty; or
- misuse of their position (s 182 of the Corporations Act) or misuse of information (s 183 of the Corporations Act).
The central theme of the prohibitions under s 199A and s 199B of the Corporations Act is that they focus on conduct towards the company itself or conduct accompanied by lack of good faith, intention, and wilful breach.
Work Health and Safety Breaches
The legislation regarding insurance and WHS differs slightly across Australia’s states and territories as they each have their own WHS Acts. Be sure to familiarise yourself with your state’s specific legislation.
In 2020 New South Wales amended their WHS Act to include the prohibition of entering into an insurance policy that intends to indemnify the person from their liability to pay a fine or an offence under the WHS Act. This law extends to insurers, making it illegal to issue a policy covering WHS breaches. Western Australia has followed suit by overhauling their Act, prohibiting insurance against WHS breaches.
WA’s Work Health and Safety Act 2020 brings with it the creation of the criminal offence, Industrial Manslaughter, which requires the following elements:
- A health and safety duty on the part of the PCBU; and
- the person engages in conduct which causes the death of an individual; and
- the conduct constitutes a failure to comply with the health and safety duty; and
- the person engages in the conduct knowing the conduct was likely to cause the death of an individual and in disregard of the likelihood.
Western Australia and South Australia are the most recent states to introduce a specific charge of Industrial Manslaughter, bringing them in line with Queensland, the ACT, Northern Territory and Victoria. New South Wales does not specifically have a charge for Industrial Manslaughter, but their WHS Act has been updated to include Manslaughter offences linked to workplace incidents. Tasmania is now the only state without an Industrial Manslaughter offence.
Directors have a duty to exercise due diligence to ensure a PCBU (Person Conducting a Business or Undertaking) complies with their obligations. Basically, the director is responsible for ensuring the company is keeping its workers safe. The duty imposed is a positive duty requiring a proactive approach by directors to ensure they comply with the obligations under the legislation. Failure to comply now brings harsher consequences with the prohibition of insurance and introduction of Industrial Manslaughter, with a maximum imprisonment term of 20 years for individuals and a fine of $5M, or a $10M find for a Body Corporate.
D&O Insurance is becoming increasingly difficult to obtain at competitive pricing. Cover is being scaled back due to reductions in capacity and changes in underwriting guidelines. As legislation develops, Directors & Officers will need to examine the structure of their D&O Insurance policy at every renewal. It is essential to revisit the gaps that may exist between their Deed of Indemnity and the D&O Insurance, keeping a careful eye on any areas of exposure.
At KBI, we can guide you when structuring your policy in a way that brings optimal risk minimisation. Talk to KBI about your D&O Insurance requirements.
Have any questions?
Talk to one of our D&O Experts today!
KBI is a boutique insurance brokerage with a focus on Directors’ & Officers’ insurance. Our team has placed Directors’ and Officers’ Liability Insurance for over 300 public companies in Australia, Asia, North America and Europe, including the ASX, TSX/TSX-V, SGX, LSE, Nasdaq, NYSE and LSE/AIM. Our team consists of senior brokers, lawyers and past ASX listing advisors. We add value to the process by helping our clients make an informed decision during the purchasing and claims process. We also continue to provide updates to our clients, so they are properly informed on the ever-changing landscape of Directors & Officers insurance.
By Dawn James
Dawn James is an Account Manager at KBI with a focus on Directors and Officers insurance.