Directors and officers inherit a great deal of responsibility in their role of leaders. For all benefits and prestige that this brings, it also means they can be held personally accountable for their actions when things don’t fall their way.
Directors and officers are responsible for making decisions which are often complex and difficult. They use the information available at the time, to make calculated calls on important matters. For the most part they understand the duties imposed on them, have the best intentions and do a pretty good job in taking everything into consideration.
When things go wrong
But what happens when things don’t quite go to plan? Because the reality is, that despite years of education and experience, sometimes directors and officers get things wrong, open their mouth when they shouldn’t, and don’t necessarily have all the answers. After all, they’re human and like the rest of us, they make mistakes.
There is, however, a difference between the management of an organisation and the rest of us. That is, that they are bound to their corporate duties by law and often have some very interested onlookers, in the form of stakeholders, keeping tabs on their performance.
The risk of personal liability
With these challenges and the often-serious implications of their decisions, it’s easy to understand how even the most honest of mistakes can land directors and officers in trouble. In this context, ‘trouble’ represents the possibility of a director or officer being held personally liable for their actions.
Personal liability arises out of an executive’s failure or alleged failure, to adequately perform their duties as required by law. It imposes accountability on an executive for their behaviour, which if deemed to be wrongful, can expose them personally to the implications of litigation.
So in what circumstances can a director or officer be held personally liable?
If a stakeholder believes that they have been adversely affected by the actions of an organisation or its management, many jurisdictions may allow them to make a claim against those responsible. At the very least, this may result in a formal investigation into the alleged behaviour, with the possibility of it evolving into a fully-fledged lawsuit.
The list of possible offences alleged to have been committed by directors and officers are extensive, ranging from a breach of duty or trust, through to any error, omission, misstatement or misleading statement made in their managerial capacity.
While these issues can be enough to worry even the most prudent manager, there is also a slew of civil, criminal and statutory laws that can apply to the actions of executives and the organisations they control.
Remedies for wrongful behaviour
From a claimant’s perspective, the purpose of bringing a claim against management is to seek a remedy for losses, financial or otherwise, incurred as a result of management’s wrongful behaviour. Demands for compensation or the enforcement of penalties, aim to right the wrongs of offending executives by holding them personally accountable for their actions.
The types of remedies sought by claimants vary depending on the extent of an alleged infraction, but are likely to include one or more of the following:
Damages consists of the payment of money by an offending party to the claimant, and generally falls into one of two categories:
- Compensatory damages are paid from the defendant (an organisation or its executives) to a claimant to compensate them for their loss.
- Punitive damages are awarded in the form of a monetary penalty to deter executives from similar wrongful conduct in the future. While the purpose of punitive damages is not to necessarily compensate the claimant, they often will receive part, if not all, of the award.
An injunction is a remedy issued by a court that requires directors and officers to perform, or refrain from performing, specific acts. If they subsequently fail to comply with the injunction granted they may face civil or criminal penalties, such as monetary fines or even imprisonment.
If management enters into a contract, which is unjust or where there is an undisclosed interest, a claimant can demand that the transaction be unwound. By doing this, the agreement is effectively reversed, bringing the parties of the contact back into the position they were before the agreement.
Account of profits
If a director or officer receives an unwarranted financial payment, and profits as a result – e.g. receiving personal payments from leasing out an organisation’s assets – a claimant can attempt to recover these funds. By similar means, if an executive unjustly holds any of an organisation’s property this can be claimed back also.
If a director or officer fails to meet their legal responsibilities, and their conduct is deemed unfit, they can be disqualified from occupying a position of directorship. Examples of unfit behaviour include a failure to keep proper accounting records, a failure to pay tax, or allowing an organisation to trade whilst insolvent.
If directors or officers breach criminal laws they are likely to face a range of sanctions, including the possibility of being sent to prison. In the United Kingdom, for example, a company director has recently been sentenced to two years in prison, after being found guilty of price fixing and cartel offences under the Enterprise Act 2002.
Defending claims against executives
If a claim is made against management, the executives involved are required to defend themselves. In the eyes of the law, actual and alleged behaviour is treated with the same integrity, and as a result, all claims must be addressed with sincerity – even if it is believed that the allegations are frivolous and do not carry any merit.
Any claim that is made against directors and officers requires a thorough investigation into the circumstances surrounding the incident. This usually consists of the collection and analysis of key documentation relating to the allegation, such as emails, letters, memos, internal correspondence, financial statements, prospectus documents, and the like.
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Obtaining legal advice
Before contesting a claim, directors and officers generally seek the assistance of legal counsel for professional advice. The role of lawyers in this respect is to gain an understanding of a claim by interpreting the allegations, reviewing documentation and collecting an executive’s account of events. Through this, they help guide the executive through the claim process and use the information available to construct a robust defence.
Lawyers are usually responsible for responding formally to a claimant on the executive’s behalf, using legal principals to support their position. The strategies applied to constructing a defence can be varied, however, their objective is generally to reduce the extent of an executive’s liability, and if possible, rebut the claim altogether.
Defending actions with the business judgement rule
Directors and officers don’t need to be flawless in their decision making, however, they must do their best to comply with their corporate duties. If a decision is later proved to be a mistake, an executive is presumed to have satisfied their basic duties if the business judgement rule applies.
Business judgement is available in many jurisdictions, and its application means that courts will not second-guess the quality or wisdom of a decision, provided that reasonable procedures were followed. It will not apply, however, if no actual business judgement has been exercised, such as where an executive has failed to act.
Settling claims before they escalate
With lawyers acting as intermediaries, claims can be and often are, settled before a matter ever reaches court. In many cases, a negotiated settlement is preferred to litigation, as battling a claim through courts and tribunals is an expensive, drawn out, and uncertain process, for all involved.
If initial negotiations are not successful, you’ll find that the majority of claims are resolved by means of alternative dispute resolution, such as mediation and non-binding arbitration.
No quick solutions
If a claimant’s demands cannot be satisfied using alternative dispute resolution, or an executive faces criminal prosecution, it may be necessary for a claim to be heard in a court of law. In these situations, lawyers on both sides have a chance to put forward their arguments, before having a judgement handed down to them.
Whether a claim is settled with or without court intervention, the legal process is likely to be long and tedious. It is not unusual for claims against directors and officers to last for many years, even if an allegation is eventually withdrawn or dismissed.
No one has ever said that being a director or officer is easy. As you can see, they have a great deal of responsibility and can be held personally accountable by stakeholders when things don’t turn out as planned. Facing claims is certainly not a nice experience, but is a realistic risk faced by leaders in organisations of all shapes and sizes.