Most directors think that they are adequately protected if they have D&O insurance cover in place and rights under a deed of access and indemnity. They might or might not be right.
With the introduction of the Australian Consumer Law, it is a good time to review what protections directors and officers have in place – in respect of both existing laws and the new reforms which came into effect on 1 January 2011. Directors and officers might want to check the extent of cover under their Deeds of Access and Indemnity arrangements and D&O insurance, and what other arrangements they may need.
What's the current position?
A director or manager can already be disqualified for breach of a civil penalty provision in the Corporations Act 2001 or of certain provisions in the Trade Practices Act 1974, such as misuse of market power, exclusive dealing or resale price maintenance, and for failure to ensure that certain product safety provisions are met. In deciding whether such an order is appropriate, the court looks at whether the breach was intentional or dishonest, what damage was caused by the breach and the likelihood of the offending conduct being repeated.
What's changed under the Australian Consumer Law
Under the new Australian Consumer Law, either ASIC or the ACCC will be able to seek orders disqualifying directors and managers if they breach any of a number of consumer protection provisions. The disqualification can be either for a limited period of time, or permanent. Directors and officers also face significant fines if, for example, they are "knowingly concerned" in breaches of the legislation.
These contraventions include
- unconscionable conduct;
- false representations in relation to the supply of goods;
- breach of certain consumer safety provisions, including a failure to notify certain product-related injuries; and
- a failure to comply with a substantiation notice.
Directors and officers can be held liable if they are involved in:
- a contravention or attempted contravention of such a provision;
- aiding, abetting, counselling or procuring a person to contravene such a provision;
- inducing or attempting to induce a person, whether by threats or promises or otherwise, to contravene such a provision; or
- in any way being, directly or indirectly, knowingly concerned in, or party to, the contravention; or
- conspiring with others to contravene such a provision.
The new prohibition on indemnifying directors and officers
Defending proceedings brought by the regulators under the new Australian Consumer Law will necessarily involve significant legal costs. A company is not allowed to indemnify against liability for these breaches, or against legal defence costs if such liability is established.
The new Australian Consumer Law makes it an offence (section 229 ACL) for a company to indemnify:
- a liability to pay a pecuniary penalty under section 224 ACL;
- legal costs incurred in defending or resisting proceedings in which the person is found to have such a liability.
Any attempt to do so is void (section 230 ACL).
This means that a company cannot indemnify its directors and officers for pecuniary penalties and legal costs, if they are found personally liable for contraventions of consumer protection provisions in the Australian Consumer Law.
Does D&O insurance cover these breaches?
At the moment companies are not prohibited by the Australian Consumer Law or the Corporations Act from arranging D&O insurance for directors and officers, covering them against liabilities for breaches of the consumer protection provisions and associated legal defence costs.
Nevertheless, because the wording of D&O policies varies and the Australian Consumer Law is creating new statutory liabilities for directors, it is important that any policy be carefully reviewed to ensure it actually does cover the liabilities as far as possible. Whether a policy will provide cover, even when a director or officer can establish that he or she is not personally implicated in any wrongdoing, will depend upon the specific definitions and wording of the policy. Some D&O policies, for example, have unqualified fines and penalties exclusions, which might apply to the new ACL civil penalty offences. Other policies provide limited cover for "civil penalty" liabilities, provided that the conduct involved does not fall within the fraudulent, criminal or wilful misconduct exclusion. Most policies will cover Compensation Orders, which are to be distinguished from civil penalties, but it is important to check that sub-limits do not apply.
Provisions in indemnity deeds and insurance policies which insure or indemnify in respect of fines and other penalties for criminal offences are potentially illegal, void or unenforceable, on public policy grounds. It is not yet clear, however, just how far this principle applies to civil penalty provisions, and many D&O liability insurance policies purport to provide some cover in respect of them "to the extent permitted by law". Compensation Orders, by contrast, are fully insurable in the same way as a liability to pay damages.
Can the company make a loan to cover the cost of legal proceedings?
A further issue which directors and officers may want to consider is whether a company can make a loan to cover the cost of legal proceedings. Some D&O policies still do not pay legal costs in advance. Nearly all policies will only pay "reasonable" legal costs – and opinions may differ between insurers and insureds as to what is reasonable.
The Corporations Act (section 212(2)) does not prohibit a company from making a loan to a director or officer to fund legal costs, provided that the terms are reasonable in the circumstances and the loan is fully repayable in the event it is established that the costs in question cannot be the subject of an indemnity. There is no reason why such a mechanism could not apply in relation to consumer protection breaches of the Australian Consumer Law, although any loan would need to be set up very carefully.
Will any amount be recoverable under D&O insurance?
The objective in comparing deeds of indemnity with directors and officers liability Insurance policies is to ensure, as far as possible, that where the company cannot or will not indemnify the director or officer, he or she is then covered under the D&O insurance to the maximum extent that is legally and commercially feasible. Where the company can and does indemnify, it wants to be able to claim under the company reimbursement side of the insurance coverage, on the same basis. The critical issue will always be how the language of the policy applies to the basis of the insured person's alleged liability and the nature of the claim that is being made against him or her. This issue was highlighted by the New South Wales Court of Appeal in Silbermann, Greaves, Rich v CGU Insurance  NSWCA 203.
The former directors of One.Tel made a claim on the company’s D&O policy. The insurer denied indemnity and defence costs under an exclusion of any claim "brought about by, contributed to by or which involve[d]" dishonest, fraudulent or other related wrongful conduct by the insured director. The Court held that under the actual terms of the policy, the insurer was entitled to deny cover (and refuse to advance defence costs). even though the disentitling conduct had not been established or admitted at that point.
Most D&O liability insurers responded to the Silbermann decision by qualifying their disentitling conduct exclusions so that they only apply once the conduct is admitted or proven, and by including an express provision for advancement of defence costs up until then. It is important to ensure that the policy contains such terms.
Where a company advances defence costs by way of a loan to a director, repayable if the director turns out not to be entitled to indemnity under the Deed of Access and Indemnity, the director may nevertheless be entitled to claim the defence costs under a D&O policy – assuming that the conduct is not also disentitling conduct under the policy.
What should directors and officers do now that the new laws are into effect?
First and foremost, of course, you should ensure your company is ready for the new laws. The better your compliance, the lower the risks you face in the first place.
Secondly, directors and officers should review their policies to confirm that the definitions of "Claim", Civil Liability", "Loss", "Investigation" and "Defence Costs", as well as the Insuring Clause, are wide enough to encompass the new personal liability exposures under the Australian Consumer Law. They should also confirm, which will probably be the case, that their policy contains an affirmative obligation on the insurer to advance defence costs in respect of claims falling within the insuring clause (unless and until it denies indemnity), and a "final adjudication" proviso in the conduct exclusion. The insurer probably will reserve the right to recover any defence costs from the directors, officers or the company if it is subsequently established that they were not entitled to the defence costs so advanced.
It is probably also prudent for directors to have the indemnity provisions in their Deeds of Access and Indemnity reviewed. As part of this review, directors and officers might also seek to have a provision in the Deed of Access and Indemnity requiring the company to fund the director, in a viable claim against the D&O insurer, if the company cannot indemnify the director directly and the insurer refuses to do so.