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How real are the risks of personal liability run by the directors of UK PLC and what steps should those directors take to protect themselves?

To answer those questions, we must first ask three other questions: what is the litigation environment in the UK at present? What are the main sources of liability for directors in the UK? And who are the most likely claimants?

Let’s look at the litigation environment first.

There are signs that litigation funding is becoming a growth industry in the UK. In July, a recently launched specialist broker secured approval from the Financial Services Authority to act as a specialised adviser and intermediary in litigation. The accountancy firm Smith & Williamson has confirmed that it is set to offer litigation funding in insolvency proceedings.

There has also been a significant growth in the UK of litigation funded by conditional fee arrangements — the so-called “no win, no fee” arrangements, whereby lawyers accept a share of the risk in exchange for larger fees in the event of a successful outcome.

At the same time, regulators as diverse as the Health and Safety Executive and the FSA have made it clear they intend to bring more cases against individuals, often senior management, whom the regulators regard as primarily accountable for ensuring that a firm complies with its statutory and regulatory obligations. We are likely to see more dramatic headlines about fines and penalties imposed on individuals.

Add to all that the turmoil in the financial markets and an increasingly uncertain economic outlook and it seems clear that the litigation environment in the UK is becoming more hostile.

Then there is the massive new Companies Act 2006, which contains the main framework governing directors’ duties, codified in English law for the first time. Under the Act, a director has a duty to promote the success of the company and to exercise reasonable care, skill and diligence. These duties are owed to the company and are only enforceable by the company. Other statutory duties are also imposed on directors under legislation as diverse as the Financial Services and Markets Act 2000, the Health and Safety at Work Act 1974, the Environmental Protection Act 1999 and the Insolvency Act 1986 — much depends on the particular sphere of operations of the company concerned.

In addition to these statutory duties, directors also owe common law duties. As a result of this, they may often find themselves liable to third parties. If, for example, you assumed personal responsibility for a misstatement to a customer, you could find yourself sued by that customer alongside the company.

Directors may also find themselves investigated and either prosecuted or fined by criminal or regulatory authorities over acts or omissions. Authorities such as the Companies Investigation Branch (CIB) of the Department for Business, Enterprise & Regulatory Reform, have wide powers of investigation that they are not afraid to use. Typically, investigations commence with an unannounced visit by the investigator to a company’s premises — the so called “dawn raid”.

A new Corporate Manslaughter and Corporate Homicide Act has finally made its way on to the statute books. Although it contains no provision for bringing a prosecution against individual directors, it is likely to focus a spotlight on the way in which directors manage the affairs of the company, since that will form a key aspect of any criminal investigation into whether a company was responsible for causing death. The way that directors manage their companies will come under greater scrutiny.

Who are the likely claimants? The answer depends on the nature of a company’s activities. In the case of a large multi-national company, the risk of investor-led proceedings is likely to be more significant. It should be said that English law offers fairly strong protection to directors of large companies from these type of claims, except in particular situations such as statements made by directors in public offering documents. But the position in relation to cross-border liabilities is much less certain.

In contrast, directors of a small or medium sized enterprises are likelier to face proceedings from a customer or client, or, if they have gone bankrupt, a liquidator, receiver or administrator.

As a result of changes in the law in 2005, companies are now permitted to indemnify their directors in respect of a broad range of liabilities and defaults. It is even possible for a company to fund the cost of the defence of any civil, regulatory or criminal proceedings provided that any such loan to a director is repaid immediately if the director is found liable.

It is important to understand, though, that while companies are now permitted to grant a broad indemnification to directors, they are not required to do so.

Directors may legitimately expect their companies to provide them with some protection from the risks of litigation, but there are no agreed standards. Moreover, in the event of a claim, an indemnity from the company may not turn out to be as valuable as the directors would hope. The company may either refuse to honour its obligations or not have the financial ability to do so.

An alternative method of protection is the purchase by the company on behalf of its directors of directors and officers liability (D&O) insurance. But as with indemnification agreements, there is no market standard as to the breadth or amount of insurance available. Much will depend on the directors’ individual requirements as well as on their ability to persuade the company to purchase adequate insurance.

Even then, given the variety of D&O insurance products available in the market, purchasing the right cover may not be that simple.

Francis Kean is a partner in the insurance group at Barlow, Lyde & Gilbert

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