Managing personal risks to board members
May 2014 | SPECIAL REPORT: OPERATING AN EFFECTIVE BOARD
Financier Worldwide Magazine
May 2014 Issue
Directors may not have noticed the increasing risks of potential personal liability which they may be facing. However, around the world, new avenues are being developed by which directors may be made personally liable for their conduct. Directors need to be aware of the developments which are taking place within their jurisdiction and ensure they are taking appropriate steps to manage those risks, including ensuring proper safeguards are in place to prevent the company from breaching any regulatory requirements and making sure they maintain proper insurance coverage.
Hong Kong is a useful example of the developments which are taking place generally, because Hong Kong tends to adopt those measures which have been introduced in other jurisdictions such as England and Australia and is therefore broadly representative of the common law world. In Hong Kong, it used to be relatively rare for directors to face personal claims. This was because, under the common law, directors were deemed to owe duties to the company, not to shareholders or third parties. Accordingly, as a general rule, shareholders and third parties had no cause of action against directors who breached their duties. Only the company, being a separate entity from its shareholders, had a right to take action. Although shareholders might in certain circumstances bring a derivative action against directors in respect of wrongs done to the company, any damages recovered would go to the company. In such a case, shareholders would be merely enforcing a right which is vested in the company to sue its directors for breach of duty. The ramifications of these rules made it difficult for directors to be held accountable.
However, the Hong Kong Government has recently introduced new obligations upon companies and, along with the imposition of those obligations, provided that directors and officers of the company may be personally liable to both regulatory fines and civil claims from third parties in the event the company fails to comply with those obligations.
For example, from 1 January 2013, listed companies have been made subject to a new statutory obligation to disclose ‘inside information’ (being non-public price-sensitive information about the company as defined in the Securities and Futures Ordinance) to the public as soon as reasonably practicable after any inside information has come to the knowledge of the company.
A company is considered to have knowledge of inside information if: (i) information has, or ought reasonably to have, come to the knowledge of an officer of the corporation in the course of performing functions as an officer; and (ii) a reasonable person, acting as an officer of the corporation, would consider that the information is inside information. An ‘officer’ is defined as “a director, manager or secretary of, or any other person involved in the management of, the corporation”. Every officer is also under an express obligation to take all reasonable measures to ensure that proper safeguards exist to prevent the corporation from breaching the disclosure requirements, including creating and maintaining appropriate internal control and reporting systems, and ensuring that the corporation complies.
Corporations, directors and officers who appear to have breached their disclosure obligations may be the subject of proceedings brought by the Securities and Futures Commission before the Market Misconduct Tribunal. The Tribunal is empowered to make various orders in the event of a breach, including imposing a regulatory fine of up to HK$8m. Moreover, any person who is in breach of their disclosure obligations may be liable to pay compensation by way of damages to “any other person” for any pecuniary loss sustained as a result of the breach, thereby creating a direct right of action on the part of third parties against directors and officers.
A further example is the newly established Competition Tribunal under the new Competition Ordinance (provisions of which are being implemented in phases), which has the statutory power to impose pecuniary penalties on “any person” who has contravened, or been involved in the contravention of, a competition rule, including paying the government: (i) a pecuniary penalty of up to 10 percent of the infringing undertaking’s Hong Kong turnover for a maximum of three years; and (ii) an amount equal to the costs incurred by the Competition Commission in investigating and bringing proceedings for the contravention. A person will be deemed to have been “involved in” a contravention if he or she: (i) attempts to contravene the rule; (ii) aids, abets, counsels or procures any other person to contravene the rule; (iii) induces or attempts to induce any other person, whether by threats or promises or otherwise, to contravene the rule; (iv) is in any way, directly or indirectly, knowingly concerned in or a party to the contravention of the rule; or (v) conspires with any other person to contravene the rule. In this regard, directors may be subject to substantial pecuniary penalties for breaches of the Competition Ordinance and may face subsequent third party civil actions.
Another development potentially expanding directors’ liability is the fact that the Courts have recently confirmed that the Securities and Futures Commission, as regulator, may bring civil proceedings to enforce the rights of the company against directors. In particular, section 214 of the Securities and Futures Ordinance provides that, where the Commission considers the business or affairs of a listed company, or a company which was listed, have been conducted in an improper manner, namely, in a manner: (i) oppressive to shareholders; (ii) involving defalcation, fraud, misfeasance or other misconduct towards it or its shareholders; (iii) resulting in its shareholders not having been given all the information with respect to its business or affairs that they might reasonably expect; or (iv) unfairly prejudicial to its shareholders, the Commission may apply to the Court for various remedies against the directors concerned and the Court may under section 214(2)(e) “make any other order it considers appropriate”. In Re Styland Holdings Ltd (No. 2), the Court recently determined that section 214(2)(e) allows the Commission to seek and the Court to grant orders that the directors pay damages to the company for breaches of their private law duties owed by them to the company, meaning the regulator may enforce the company’s rights on behalf of the company.
In light of the recent developments, there is now a direct nexus between directors and shareholders/third parties in various circumstances, and there is an increased risk of exposure to personal liability for directors with respect to their duties. Accordingly, not only should directors be attentive to risks associated with increasing personal exposure, they should also be proactive in taking steps to avoid being caught in a situation where they will find themselves faced with substantial civil liability.
It would be prudent for directors to understand the obligations applicable to them in their relevant jurisdictions. In order to protect themselves from personal liability, directors should ensure that a directors and officers liability insurance policy with sufficient coverage is taken out on their behalf. Further, directors should take all reasonable measures to ensure proper safeguards are in place to prevent the company from breaching any statutory requirement and/or themselves from breaching their duties as a director.
Nathan Dentice is a partner and Cordelia Yu is an associate at Reed Smith Richards Butler. Mr Dentice can be contacted on +852 2507 9865 or by email: nathan.dentice@reedsmith.com. Ms Yu can be contacted on +852 2507 9806 or by email: cordelia.yu@reedsmith.com.
© Financier Worldwide
BY
Nathan Dentice and Cordelia Yu
Reed Smith Richards Butler