While Directors Reminisce About the Good Old Days the Perfect Storm Rolls In
In today’s economic climate, directors who don’t admit to yearning for the “good old days” when legislative requirements where less stringent and the economy was booming, are either in denial or lying. The imminent changes to the new Companies Act are a fine example of a new complication that is adding to the stresses faced by this group. The act which has increased the board of directors’ exposure could now see members being held personally liable when the new act is passed. With the current decline in economic conditions, coupled with the new act, one can but wonder if this will expose the board of directors to more actions than is the current status quo.
Going Back in Time / History the Great Teacher
To get a view of the foreseen exposure facing a board of directors and to consider how bad things could potentially become, one needs to go back in history to the time of the great depression. The Roaring Twenties preceded the great depression; a time of prosperity and high living when it was believed that the higher market prices could be sustained. But the real estate values peaked in 1925 and declined before the stock market collapsed in 1929. It was these conditions that led to the first D&O policy being written in the 1930s by Lloyds as a direct result of directors and officers being liable for stakeholder and shareholder losses.
A Modern Day View
The period 1997 to 2007 can be considered boom years, the modern-day equivalent of the Roaring Twenties. In 2009 the real estate markets are feeling the economic pinch, and stock markets have crashed, but unlike 80-years ago, the world banking market has been crippled. All these factors have ushered in the perfect storm which has now hit the world economy and everywhere, companies are sinking or battling to stay afloat in these turbulent waters. The bad news is that some expert opinions say the storm will only blow over in a couple of years.
Locally, even though South African Banks were shielded from credit default swaps, they are still repossessing an alarming amount of homes and cars. Consumers continue to struggle to meet these payments and with more job losses on the cards, it will compound this default situation. Higher risk factors and lower returns will stop local banks giving loans to entities like they did in the boom years. Shareholders will also be reluctant to invest in risky and uncertain ventures. This will drastically affect the cash flows of many entities who are currently struggling to secure capital to keep them in operation from month to month.
In the good times, as long as the returns are being accrued, investors, shareholders, creditors and suppliers remain upbeat. But the question that begs answering is how will they react when their returns become negative as a direct result of non-payments? One just needs to look at the contingent liabilities in an organisation’s financial statements to realise the exposure risks. Nearly every one of these liabilities is against the entity; very rarely do these issues involve actions against the board of directors and their personal assets. But as the economic conditions worsen and cash flows diminish, lawyers will soon turn their focus to the next in line with viable assets - the board of directors who were entrusted with the entity in the first place.
Act Ushers in New Era
The new Companies Act will give shareholders and stakeholders more rights than they had previously and this will in turn increase the directors and officers personal liability. In the past if a company suffered a loss, the board would take appropriate action. Now the stakeholders and shareholders can start derivative actions by applying to the court on behalf of the entity to force directors to take what they would consider, the corrective course of action. A further amendment to the act is the codification of director’s duties and by not complying, directors will be more exposed to future litigation. The definition of “knowledge” has also been widened and now includes negligence. If it is believed that the relevant information could have been obtained by asking, directors may well be found liable. Another addition to the act is the introduction of class actions which can even be brought about by a consumer organisation on behalf of customers and trade unions on behalf of their members.
The USA, United Kingdom and many other parts of the world have reported an alarming increase in the amount of actions against boards of directors. If actions are being taken in a traditionally litigation-conservative environment like the United Kingdom and with the new Companies Act about to be promulgated, one needs to recognise that South African directors could face similar cases in the not too distant future. While most of the actions being brought to book are against financial institutions, once the economic downturn spreads into further industries, more actions will undoubtedly occur. Most of these actions will be groundless but the directors would still need to pay excessive defence costs to preserve themselves, as stakeholders and shareholders try any means to recoup some of their losses.
John D. Rockefeller was reported as saying: "These are days when many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has always returned and will again." If Rockefeller is to be believed then good always follows bad and the calm will follow the storm. In today’s operating environment, organisations require a dynamic board of directors and management team to face the storms and safely bring the ship to shore so that they can enjoy the prosperous times bound to follow a down turn. Of course, to retain the right board of directors, an entity will be required to offer attractive packages, as well as adequate cover provided by a D&O policy.
Camargue Underwriting Managers is a specialist underwriting insurance firm with approved coverholder status at Lloyd’s of London and writes its business on behalf of Lloyds of London and Centriq Insurance Company Ltd, on a 70/30 coinsurance basis.
