UK: Crouch, Touch, Pause, Engage!

A raft of new legislation - much of it implemented in October 2007 - affecting directors of UK companies has been introduced. This comes when the daily news seems to be full of threats and warnings of the potential for ruinous claims against directors. Now is the time to pause for breath and ask whether it is as bad as they would have us believe (and if so what the implications for D&O insurance are) or whether it is instead all a tale "... full of sound and fury, signifying nothing".

With the exception of our recent sub-prime special, this is the first edition of the D&O review since many of the new provisions of the UK Companies Act 2006, including those relating to the codification of directors' duties and the new statutory derivative claim, have come into force.

For the first time under English law, directors must now have regard in their decision making (among a range of other factors) to the impact of their company's operations on the community and the environment. New reporting obligations for directors of PLCs require directors for the first time to produce an expanded "Business Review".

All of this comes at a time of dire warnings about liability exposures arising from the sub-prime lending crisis, the problems affecting structured finance products and the international credit crunch. These subjects compete for headlines with the increasingly muscular stance being adopted by the Office of Fair Trading ("OFT"). Examples of this include the recent conclusion of a civil investigation (and ongoing criminal investigation) by the OFT into alleged anti-competitive practices by British Airways and Virgin and the first ever representative action under section 47(B) of the Competition Act 1998 brought on behalf of consumers by Which? against sports goods retailer JJB Sports plc. Other regulatory agencies such as the FSA, the Environment Agency and the DTI have also shown themselves keen to bring directors to account where necessary. Nor is there any sign that the US law enforcement agencies such as the Department of Justice and the Securities and Exchange Commission are losing their collective appetites for long-arm jurisdiction claims and investigations; BAE being just one relevant example of their targets.

On top of all this, the new Corporate Manslaughter and Corporate Homicide Act 2007 has been introduced. Following a report of the Healthcare Commission into up to 180 deaths at Maidstone and Tunbridge Wells NHS Trust Hospital thought to have been caused by conditions at the hospital, police were called in to investigate whether any criminal offences of neglect had been committed.

The extradition threat is still a factor. An important judgment from the House of Lords on this is anticipated early next year. Moreover, extradition, subject only to low threshold tests, is possible to countries other than the US, including the Russian Federation, Azerbaijan, Albania, Macedonia and Montenegro.

Finally, in a highly significant report to the Lord Chancellor in the Summer of 2007 the Civil Justice Council recommended among other things that "properly regulated third party funding should be recognised as an acceptable option for mainstream litigation". Specific brokers keen to access this new opportunity are springing up (see, for example, Calunius). A growth of litigation funding in the UK seems inevitable.

Each of these subjects is deserving of more attention than it is possible to give them within the scope of this review ¹. Reams of paper have already been devoted to them elsewhere. Instead of attempting to cover familiar territory again, we think it worthwhile instead to pause, stand back for a minute and take a reality check. How much of this blizzard of bad news is really significant and what are the implications for directors and officers liability insurance? To help answer that question we have the results of the survey which accompanied the last edition of the review. We asked you to score in descending order of importance a range of 27 different liability and coverage issues. We had 125 responses to our survey from a broad cross-section of the market. The results were as follows:

Adjusting for the fact that sub-prime lending may have collected a higher rating overall had the poll been conducted in the very recent past, there remains a number of interesting features in these results:

• The number one issue, either in liability or in coverage terms (i.e. the issue which attracted the largest overall percentage score) was the need for policy terms and conditions to be "clear and easy to follow". At one level this seems to be a statement of the obvious. There is, perhaps though, a more profound truth buried here. D&O liability insurance policies are one of the most complicated forms of liability insurance. Wordings often run to many pages of closely typed text. There is also a tendency for them to grow organically. A good recent example is the forest of endorsements dealing with extradition (a coverage issue which, according to our survey, ranked joint bottom of the list of issues of concern!). As a rule of thumb, the more complicated a contract, the greater the scope for argument as to its true meaning and effect. This danger is compounded when (as a consequence perhaps of the soft market) the breadth of cover is continually expanded. The larger the tent, the greater the threat of collapse.

• It is perhaps no accident that the question as to whether side A (DIC drop-down) cover is viewed as worthwhile and available at a competitive price is virtually at the bottom of the list of coverage issues. We suspect this may be to do with the fact that these policies, because of their inherently complex nature, tend neither to be "clear" nor "easy to follow".

• Another very hot topic (third overall) is the growth in regulatory and other investigations and enquiries. The scope, size, reach and complexity of criminal and regulatory investigations and enquiries is set to grow. We suggest that it is one of the key reasons for purchasing D&O liability insurance. There are a range of issues specific to the nature and breadth of cover available for this important exposure. Our experience of handling claims involving investigations and enquiries (both for insurers and for insured) is that there is often an expectation gap as to the extent and availability of cover.

• It is interesting that the second most important coverage issue is as to the circumstances (if any) in which insurers can avoid the cover. There has been a trend in the recent soft market towards the inclusion of "non-rescission" clauses. Whilst this development is no doubt welcome from the "consumer's" perspective, the effect of such clauses is not always as apparent as it might appear (or arguably should be). Generally, English law relating to remedies for material non-disclosure and misrepresentation in composite policies is complicated and uncertain. These uncertainties are compounded when contractual variations to these laws are introduced. The position is made even murkier when D&O policies are made subject to choice of law clauses which select jurisdictions in which the concept of severability is neither recognised nor properly understood.

• The extent to which a company can indemnify its directors also scores highly in the results of our survey. In 2005, English law was changed. The scope for companies to indemnify their directors and to lend them the costs of funding their defence of any civil or regulatory or criminal actions was considerably enhanced. Practice seems to vary widely as to the extent to which companies avail themselves of this more flexible regime. Our impression, however, is that the relaxation of the law in this area has done nothing to improve the interface between company indemnification and D&O insurance. Indeed, unless this important issue is addressed carefully, the risk remains that the company which decides to grant the most generous indemnities to its directors will not reap the appropriate (or any) rewards when it comes to purchase its D&O insurance. Indeed, an argument can be run to the effect that the best way of maximising the benefit of a D&O policy is to do the opposite and restrict the scope for company indemnification as far as possible.

There is a temptation to look at the gathering storm clouds of potential liability and conclude that the best form of protection for directors (other than sound risk-management and corporate governance practices aimed at mitigating the effects of claims in the first place) must be to buy the highest limits of the broadest cover at the cheapest price. The danger with this approach is that it is akin to firing a blunderbuss. You might hit the target but, equally well, you might not. An alternative approach is to start with a blank sheet of paper and evaluate the likely (and indeed the unlikely) liability exposures faced by your company. You might then ask, having regard to that company's appetite for risk, its balance sheet strength and the size and reach of its operations, what sort of insurance protections you feel you most need. Given the range of different products available and the scope for negotiating enhancements in a continuing soft market, excellent opportunities should exist for you to emerge from the scrum with the ball!

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