The new reality of boardroom risks in India

August 2014 | EXPERT BRIEFING | BOARDROOM INTELLIGENCE

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The American President Harry S. Truman was famous for keeping a sign reading “The buck stops here” on his desk in the Oval Office. This quote has become a mantra for business leaders across the world, and remains the everyday reality for Indian CEOs, both of local firms and foreign firms operating in the country. Recent enforcement actions in India have made this quote even more pertinent, with regulators around the world, and at home, increasingly taking aggressive actions and holding senior executives personally accountable for any alleged or actual wrongdoing.

While India is a popular investment destination, attracting more than US$20bn foreign direct investment per year on average, it recently ranked 134th in the 2014 ‘Ease of Doing Business’ annual survey. This was lower than all of its BRIC counterparts, and was primarily due to a plethora of regulations and rules that often overlap.

Company directors and officers in India have much to keep them occupied, with an economic slowdown, delayed projects, licence issues in many key sectors, an aggressive tax authority, and an increase in minority shareholders action against multinational corporations (MNCs). Growing a business and managing stakeholders in such a dynamic business environment is challenging, and many directors and officers find themselves directly in the line of fire at a personal level. Directors’ and officers’ duties and personal liabilities are covered by both Indian common law and statute. Under common law, directors and officers can be held vicariously liable for the acts of the company.

Take, for example, the Bhopal gas leak in 1984 involving Union Carbide India Limited (UCIL), which resulted in the deaths of thousands of people and permanent and partial disabilities to many more. In response to this tragedy, seven of the company’s directors and officers were convicted by Indian courts for causing death by negligence.

Liability can also arise under statute, including the Securities Exchange Board of India 1992, the Foreign Exchange Management Act 1999, the Factories Act 1948, and a host of environmental and consumer protection laws. Each of these laws carries its own definition of who is the “deemed person in default” and this frequently includes company directors. The new Companies Act of 2013 assumes directors and key management personnel to be the sentinels of governance and attributes criminality to the “officer who is in default”.

Individuals are now liable to penalty or imprisonment. A mere awareness of any wrongdoing makes an officer liable to penal action and/or individual liability; the offending officer need not even participate in any meetings of the board, since both passive (where the officer doesn’t raise any objection) and active (which includes consent or connivance) actions can give rise to liability. There is no special treatment for independent directors either; they face the same liabilities as those faced by executives or owners/promoters.

As an increasing number of Indian firms expand overseas, companies and directors are also increasingly exposed to statutes with extra-territorial jurisdiction, such as the US Foreign Corruption Practices Act and the UK Bribery Act. Recently, the chief financial officer (CFO) of an Indian joint venture operating in the retail sector was suspended after the parent company started investigating its practices in India. In other instances, a foreign food manufacturer and a foreign beverage company were recently fined millions after they were discovered to have been making improper payments to government officials in India.

A quick round-up of some of the latest news items in the public domain confirms this trend.

The Satyam case was India’s ‘Enron’. In 2009, the then chairman resigned after announcing he had falsified earnings and overstated Satyam’s assets by US$1.5bn. The announcement led to a stock collapse, an investigation by India’s Central Bureau of Investigation (CBI), the prosecution of three company directors (including the guilty chairman) and securities class actions by US shareholders. As recognised by the business media, the Satyam scam triggered one of the biggest directors’ and officers’ claims in India – worth US$75m in insured policy limits. However, the final settlements with shareholders alone amounted to around US$125m, according to Bloomberg.

Elsewhere, the chairman and managing director of a leading telecommunications service provider were summoned recently by a special CBI court on behalf of their respective companies. The CBI didn’t name them individually, but the court summoned them, stating that: “They were/are the ‘alter ego’ of their respective companies. In this situation, the acts of the companies are to be attributed and imputed to them.”

In another case, SEBI fined the owner of a growing Indian conglomerate and its other directors a record Rs 50 crore for dropping its proceedings through the consent procedure, an out-of-court-like settlement, without any admission of guilt by the accused. Two group firms of the conglomerate collectively paid, through their directors, to settle the charges. The two companies, its directors, and the chairman of the group were also debarred from accessing secondary markets for a period of time.

Four investors have filed what could be the first class action lawsuit in India, against the promoter of one of the reputed commodity stock exchanges in the Bombay High Court, to prevent it from selling its assets as it battles a US$1bn payment crisis.

A government-appointed committee has held a foreign automotive firm in India responsible of ‘corporate fraud’ and stated the involvement of its top management including CEOs and managing directors, following an investigation into the recall of more than 126,000 vehicles between 2005 and 2012.

Finally, one of the largest automakers in India faced stiff resistance from its minority institutional investors, following its decision to hand over its proposed plant in Gujarat to its Japanese parent. The investors also sought SEBI intervention to safeguard their interest and ensure good corporate governance.

As these cases suggest, actions against directors and officers are being brought for a wide range of wrongful acts, with a majority involving allegations of insider trading, self-dealing, the misstatement of accounts, misleading customers, bribery, failure to honour employment contracts, discrimination and harassment, and false statements to government authorities. There have also been claims for tax violations and breaches of duty to minority shareholders, and other claims arising from mergers and acquisitions.

Most companies provide their directors and officers with some form of indemnity through their constitution and/or by a letter of indemnity. There are, however, certain claims for which companies may be unwilling or legally prohibited to indemnify their directors. Arguably, the most serious financial risk faced by directors and officers is that of a claim where their company does not pay for their defence costs or costs incurred in a settlement or judgment.

Directors’ and officers’ (D&O) insurance enables a company’s leaders to act with confidence. Even after they retire, the policy can still provide protection. Until recently, MNCs operating in India usually had D&O insurance under a single policy which was issued to the parent company and offers worldwide coverage (called a global non-admitted program). Today, this has changed, especially with a host of actions making individuals (even owners and promoters, who carry no executive responsibilities) directly accountable for their firm’s corporate behaviour. The Indian insurance and tax authorities also demand local insurance to be purchased that protects the individual policyholders’ interests.

It is important to seek expert advice when arranging a company’s D&O insurance program, and especially at the time of an event or a claim. The localisation of internationally-accepted policy forms to ensure proper treatment of India-specific issues, such as tax-related demands, corporate indemnification, consent orders, compoundable offences, the allocation of defence costs, non-invalidation of cover, and severability of innocent insureds, is crucial. The insurer’s intent, experience, capabilities and track record of processing claims and their settlement remain paramount.

To end where we began, Harry S. Truman was also famous for saying “If you can’t stand the heat, you’d better get out of the kitchen”. For most executive leaders, this is an option of last resort. However, a well-conceived and implemented D&O insurance program can help mitigate these exposures and enable executives to focus on growing their business.

Anup Dhingra is Practice Leader, Financial & Professional Risks (FINPRO) at Marsh India. He can be contacted on +91 993 099 1978 or by email: anup.dhingra@marsh.com.

Anup Dhingra

Marsh India