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D&O: diligence optional?

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Directors’ and officers’ (D&O) cover gives company executives and board members crucial protection – but might it also encourage reckless behaviour and hinder efforts to improve workplace safety?

The dilemmas of D&O, and whether it can subvert public policy, have prompted NSW Chief Justice Tom Bathurst to tell the Australian Insurance Law Association that more dialogue on the issues is needed.

He says liability insurance plays an essential role encouraging productive economic activity. Without it people may not join boards and directors may become excessively risk-averse.

But he says there is a legitimate concern that D&O cover may undermine public policy objectives.

Making directors, executives and other “gatekeepers” such as auditors personally liable provides a deterrent to reckless behaviour and an incentive to exercise due diligence, he says.

It can be argued that D&O cover might encourage unscrupulous directors to pursue questionable activities, while dulling incentives for honest directors to act in their company’s best interests.

Justice Bathurst says most D&O policies address this concern by excluding dishonest or fraudulent activity, and the Corporations Act and consumer legislation also impose limitations on insurance cover.

“Notwithstanding these provisions and principles, there remains a significant lack of clarity about the circumstances in which it will be deemed to be against public policy for directors or other company officers to access liability insurance,” he said.

“That uncertainty applies to both liability in relation to third-party claims and statutory liability imposed on directors directly.”

Justice Bathurst says the insurance contract will usually exclude liability considered to act against public policy. But there may be cases when a contract that purports to indemnify directors and officers may be unenforceable for public policy reasons.

It seems accepted that directors can insure against third-party claims when they have breached a civil obligation through negligence, but that they cannot be covered for a wilful criminal act.

“Between the two extremes of intentional criminal conduct and civil negligence, things are much less clear,” Justice Bathurst said.

There is also the question of whether D&O cover is available when a claim is brought for a civil wrong but the insured’s conduct was criminal. A company or liquidator may want to avoid establishing directors’ criminal liability because of how it affects the D&O policy.

Justice Bathurst says there is uncertainty about cover for fines and penalties and for third-party claims, noting the courts have expressed reluctance about insurance against fines for workplace injuries.

In May the SA Magistrates’ Court sentenced a company director for failures to comply with occupational health and safety obligations.

The magistrate noted the director had insurance for criminal fines and said this had undermined the court’s sentencing powers, sending a message that there is little need to fear the consequences of serious offending, even if an offence had fatal consequences.

Justice Bathurst says allowing cover for civil penalties may undermine the goals of deterring and punishing offences.

But such penalties often result from honest but careless behaviour, and not allowing people to insure against them could cause “great consternation in boardrooms across the country, and justifiably so”.

“What I do think is undesirable is the lack of clarity around these issues,” he told the law association conference.

“At the moment, the market’s best guess seems to be that insurance for criminal penalties is likely to be deemed illegal or unenforceable by the courts, and that it is not clear if a similar situation applies in relation to civil penalties.”

The Chief Justice’s comments add fuel to the ongoing debate about D&O. The question as to whether the product allows directors and company managers to behave more boldly over company issues is only one side of the equation. The other is whether the same people would be prepared to make crucial decisions without adequate insurance cover to protect them when they are shown to have been wrong.