Duties and liabilities of European directors – too much risk for too little return?

May 2016 | SPECIAL REPORT: OPERATING AN EFFECTIVE BOARD

Financier Worldwide Magazine

Serving as a corporate director or supervisory board member can sometimes seem like a thankless task. Unlike chief executive officers or senior company executives, board members do not necessarily earn the substantial compensation packages which regularly hit the headlines or even much public recognition for their role except when things go wrong.

Furthermore, since the financial crisis, the risk oversight responsibilities and associated liabilities of European directors have been increasing. Many existing or potential directors are justifiably asking themselves whether it is still worthwhile serving as a board member and, if so, how they can mitigate their personal financial and reputational risks.

Many companies operate in a global marketplace and are exposed to a wide range of uncertainties. Along with complex cross-border supply chains and organisational structures, board members must understand the differing legal frameworks and business cultures to which they are exposed. In parallel, companies, and more especially board members, are subject to increased scrutiny by regulators and society at large. The role of social media is also more evident than in the past, and serves to magnify the exposure of directors to instantaneous adverse comment.

A growing source of litigation risk against corporate directors is regulatory action. In Europe, the impact of the financial crisis is still being felt with pressure on regulators to be vigilant after their earlier perceived failings. Investigations, settlements and convictions are on the rise as newly-empowered supervisors seek to flex their muscles.

For example, in March 2016 UK financial regulators implemented the ‘Senior Managers Regime’ in the UK banking sector. According to a new criminal offence, directors and senior managers of UK banks, building societies and regulated investment firms can receive custodial sentences of up to seven years for the most serious violations. In order to mitigate their liability, regulated individuals will have to demonstrate that they took all reasonable steps to prevent or minimise the failure of their bank. The new rules will apply to some non-executive directors as well as to managers with responsibility for the day-to-day running of the entity.

While much of this more robust enforcement is being felt in the financial sector, board members are also attracting the gaze of regulators in various other aspects of business activity – including anti-corruption and bribery, health and safety, pollution and the environment, data protection and antitrust activity.

For example, both the UK Bribery Act and the US Foreign Corrupt Practices Act (FCPA) are ostensibly national regulations which are nonetheless being enforced on a global basis against companies and their key leaders. FCPA enforcement activity by the Securities and Exchange Commission (SEC) and US Department of Justice (DoJ) has dramatically increased over the past 12 years. Most notably, in 2008, German engineering and electronics giant Siemens AG was the subject of a record $800m settlement. This payment related to at least 4200 allegedly corrupt payments, totalling approximately $1.4bn over six years, to foreign officials in numerous countries.

There are also signs that shareholders are demanding greater legal and operational accountability from European board members. In the UK, major lawsuits against the former boards of Lloyds Banking Group and Royal Bank of Scotland have been launched by shareholder action groups. The Netherlands has recently emerged as a possible centre for US style class action cases after the success of the Converium case in January 2012. Furthermore, over the last 12-18 months, activist shareholders have been challenging boards – at companies like Rolls Royce and Vivendi – in pursuit of more shareholder-driven business strategies.

Corporate insolvency continues to represent a significant source of personal risk for directors. With almost 600 companies entering liquidation in Europe each day, bankruptcy trustees in most countries have a duty to investigate the root cause of insolvency and consider whether the directors were to blame. They are becoming increasingly aggressive in their pursuit of claims on behalf of creditors alleging the personal culpability of directors. Given the typical lag between insolvencies occurring and legal cases being brought, the legal fallout from the post-crisis economic downturn could continue for some time.

How can European directors mitigate the risks of this increasingly difficult environment? As always, the best defence directors can give themselves is to carry out their duties to the best of their ability while keeping themselves informed about the risks they face.

But as well as actually doing the right thing, it is important for directors to be able to document that they have been fulfilling their role with adequate levels of skill, care and diligence. Directors’ liabilities are long-tail in nature and this means that a claim can be made against them many years after decisions have been made. Directors’ memories concerning the details of discussions and decision-making processes will inevitably fade over time – so it is important that they are properly recorded.

Directors should insist on receiving regular financial and risk reports as a means of keeping up-to-date with the company’s situation and projections. Where necessary, they should formally seek advice from external experts on the company’s legal or financial position. Board members should also require that their views on key decisions are noted in the minutes of each board meeting. This can be particularly important if the company’s financial situation is poor or the company is going through a highly scrutinised process, such as an M&A transaction or public listing.

In most jurisdictions, directors can rely on some variant of the so-called business judgement rule, which presumes that business decisions made by a board of directors are reasonable unless it can be proven that the directors failed to act in good faith or on an informed basis. Courts have little appetite to second-guess the commercial decisions made by directors in the past – even if they proved disastrous for the organisation – unless clear negligence in the decision-making process can be demonstrated, hence the importance of adequate record-keeping.

As well as simply doing a good job – and documenting the fact – it is increasingly common for European directors to request legal indemnification from their company and to purchase directors and officers (D&O) insurance. D&O insurance covers the potentially extensive costs of a legal defence against civil, criminal or regulatory proceedings – which could extend over many years – as well as any compensation costs that arise from an unsuccessful defence. However, it does not typically cover criminal or regulatory fines.

However, the assumption that a director cannot be held liable if they act in good faith based on information available at the time is beginning to change. Increasingly in some areas of the law (for example, including UK health and safety and anti-bribery laws) directors are being held liable even if they can demonstrate they had good intentions or had no personal knowledge of the wrongdoing.

This puts the emphasis on directors to put in place a corporate culture that will encourage good behaviour and a strong moral compass. And to carry out risk assessments and put in place frameworks that mitigate against unethical behaviour and excessive risk taking, among other things.

As a result, a European directors’ main form of mitigation in the future is not likely to be, “I didn’t intend for this to happen” or “I had no idea that this was happening”. Instead it moves the defence into the realms of, “I put in a good system and reasonable processes to guard against this happening”.

Dr Roger Barker is the senior advisor to the board of the European Confederation of Directors Associations. He can be contacted on +44 (0)7814 386 130 or by email: roger.barker@iod.com.