Management is exposed to claims from a variety of sources on a daily basis. Each source provides its own level of threat, and therefore, a different set of challenges for executives who seek to mitigate them.
The type, size and frequency of claims faced by directors and officers largely depend on how their decisions affect an organisation’s stakeholders. Stakeholders generally have a broad range of interests and are often prepared to hold management responsible for any mistakes or reckless behaviour. As a result, directors and officers can have claims brought against them from a range of internal and external sources.
In Part 1 of ‘Where do claims come from?’, we explore the sources of claims which exist externally to the organisational entity and its management. These consist of an organisation’s shareholders, employees, customers, suppliers, competition, the beneficiaries of its employee retirement funds, government and regulatory authorities, as well as its creditors.
Shareholders are an integral part of an organisation’s corporate structure. As part owners, they provide it with capital to maintain and expand operations. Due to their significant financial investment, shareholders have an incentive to monitor ongoing performance and ensure that directors and officers are acting with the organisation’s best interests in mind.
Shareholders vary in size and sophistication, ranging from large organisations, banks and fund managers, through to high-net-worth individuals and ‘mum and dad investors’. In return for their investment, they expect to receive a benefit, such as a regular dividend payments and/or capital growth. With potentially large sums of money at stake, if shareholders are not pleased with an organisation’s direction, they may take drastic measures to protect the value of their investment.
If it appears that management has breached their duties to the detriment of an organisation, shareholders may bring a claim against those responsible. This can leave directors and officers exposed to claims for any number of offences, such as:
- Inaccurate disclosure of information
- Misleading statements
- Undisclosed conflicts of interest
- Failure to keep proper accounting records
- Excessive executive compensation
- Poor financial performance
- Inadequate sales price, following a merger or acquisition
If shareholders wish to bring a claim against executives for any of these infringements, legal proceedings are usually commenced in one of two ways:
1. Direct action
In a direct action lawsuit, a shareholder or group of shareholders, called a class action, bring a claim against management for damages in their interests as shareholders, with shareholders being the benefactor of any financial settlement.
2. Derivative action
In derivative proceedings shareholders effectively ‘step into the shoes’ of the organisation, and sue the directors and officers on behalf of the organisation. In this form of litigation shareholders generally claim for damage caused to the organisation, with the beneficiary of any settlement being the organisation itself. As a result, shareholders only benefit indirectly, through the improved strength of their investment.
For example, News Corp. was sued by investors in the aftermath of the News of the World phone-hacking scandal. The newspaper was found guilty of engaging in phone-hacking and police bribery, which resulted in its advertisers withdrawing support and eventually closure of the publication.
In response, shareholders of the parent company launched derivative action against the board of directors for failing to investigate the allegations of inappropriate behaviour, rumoured years before. To settle the claim, the board agreed to pay the company $139 million without any admission of wrongdoing.
Employees present a challenging risk exposure for an organisation and its management. Directors, officers, and the employees they manage interact on a daily basis, working together to achieve a common goal. For the most part, they forge successful working relationships. However, from time to time the dynamic can change, with a breakdown in communication leading to frustration and strained relationships.
An organisation engaging labour in any capacity faces the prospect of an employment-related claim. Directors and officers are responsible for ensuring that all employees have access to a safe and culturally sensitive workplace, free of harassment and bullying. Therefore, it is not only full and part-time staff that present an exposure, as third-party contractors and volunteers have rights to the same working conditions.
If an employee feels mistreated during any phase of their employment, from initial recruitment through to termination, they may address their concerns to the organisation and executives involved. If they feel that their concerns have been not been acknowledged as expected, they may become disgruntled and see a claim as a means of rectifying their grievance.
Claims can be instigated by an individual, a class action, or by an employee representative group, such as a trade union. Common claims can include allegations of:
- Wrongful dismissal
- Discrimination, including workplace and sexual harassment
- Wrongful failure to employ or promote
- Wrongful evaluation or demotion
- Breach of employment contract, oral or written
- Invasion of privacy
Employment liability exposures exist in organisations of all sizes. However, it is often smaller organisations, lacking the skill and experience of a dedicated human resources department, which are caught out infringing on their workplace obligations. While many organisations find that workplace issues can be mitigated through the use of sensible policies and procedures, this isn’t always the case.
Finally, it is important to note that employment claims often attract opportunistic claimants. Unfortunately, this means that directors and officers may be drawn into claims, which have little or no legal merit. In these situations, even frivolous allegations may be difficult to disprove, often leading to an out of court settlement.
With ambitious goals of bringing new products and services to market, the trading practices of an organisation can sometimes appear to step beyond what is considered fair and reasonable. Creative marketing strategies and aggressive distribution methods can place management at risk of claims from an organisation’s customers if they feel unfairly sold or lied to.
Disgruntled customers can range from individuals consumers and other businesses, through to consumer advocacy groups and class actions. Allegations of misconduct may arise from the way a product or service is displayed, demonstrated, advertised, or in relation to its quality and the terms and conditions surrounding its use. Additionally, claims may come in the form of contract disputes, allegations of misleading and deceptive conduct, as well as a host of other wrongful behaviour, including:
- Predatory lending
- Collusive behaviour, such as price fixing
- Distribution of faulty and unsafe products
An organisation relies on its suppliers to deliver it with goods and services so it can conduct its own day-to-day business. Organisations require their suppliers to provide anything from raw materials and production inputs through to manufacturing, wholesale or transport services. While white-collar services, such as accounting, banking, insurance and information technology, are required by almost all organisations.
The relationship between an organisation and its suppliers can be sensitive. On one hand, an organisation relies on the prompt supply of goods and services to operate its business, while on the other, to ensure profitability they actively seek competitive deals. Negotiations with suppliers can be fierce, as management attempt to strike a balance between reducing expenses and agreeing to contract terms that suit all parties.
If a supply agreement does not turn out as expected, a supplier may attempt to hold directors and officers personally accountable for behaviour deemed to be unreasonable, unfair or illegal. Common claims include:
- Breach of contract
- Breach of fair trading legislation
- Intellectual property infringement
- Wrongful refusal of credit
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An organisation is required to conduct its business activities within the boundaries of competition law, which specifies what is expected of it within the marketplace. These rules outline what is considered fair and reasonable behaviour, allowing all organisations to compete on a level playing field.
As an organisation attempts to grow its market share, management must ensure that this is done using honest and competitive practices. If an organisation’s competitors believe that they have been disadvantaged by dishonest or wrongful behaviour, management may be held personally responsible.
Claims against directors and officers can range from breaches of intellectual property and misappropriation of trade secrets, through to allegations of collusion and anti-competitive behaviour. Managers may also be held liable for actions that are perceived as misleading or defamatory, with claimants seeking damages for their perceived losses.
For example, consider the claim brought against the CEO of family-owned sporting goods business, who allegedly disguised himself as a manager of a competitor’s store in order to steal trade secrets. The CEO, who had previously starred in an episode of Undercover Boss, may have got a little bit carried away this time, when he persuaded employees to show him around the store’s private back areas and answer questions about store operations.
Retirement fund beneficiaries
In many jurisdictions, the directors and officers of an organisation are responsible for administering the retirement schemes of its employees. Retirement schemes, known as superannuation in Australia or 401k in the United States, allow employees to make regular contributions into an investment fund for the purposes of financing their retirement. If management fails to adequately manage this process, they can be exposed to claims alleging breach of duty or breach of trust.
Depending on the specific requirements of a jurisdiction, executives may be responsible for registering employees into approved schemes, managing accurate records, and ensuring that timely contributions are made. Administration of these schemes is generally subject to heavy regulation, with stringent monitoring potentially exposing executives to liability in the event of a discrepancy.
Common claims by retirement fund beneficiaries include:
- Wrongful administration
- Providing advice with negligent errors or omissions
- Failing to monitor an outside fund manager’s performance
- Inadequate management of conflicts of interest, between an organisation and its employee’s retirement fund
Government and regulatory authorities establish and monitor the legal environment in which all organisations operate. They are present in each jurisdiction and ensure that directors, officers and the organisations they control, conduct their activities in a lawful and socially acceptable manner.
Government and regulatory authorities oversee an organisation’s compliance with the rules and regulations governing corporate behaviour. From management’s perspective, the enforcement powers held by these supervisory agencies present a real and significant personal liability exposure.
Regulators often take a proactive approach to their administrative duties, by aggressively investigating alleged breaches. If they discover that wrongful conduct is likely to have occurred, they have the ability to pursue the executives involved. Government and regulatory authorities typically monitor a broad range of laws, such as:
- Corporations law: governing the ownership and management of organisations
- Securities law: governing the administration of publicly listed companies
- Consumer protection law: governing the way in which organisations distribute products and services to consumers
- Occupational health and safety law: ensuring that organisations maintain a safe workplace
- Taxation law: governing the taxation of organisations and individuals
- Environmental law: ensuring that industry participants adhere to environmental restrictions
Directors and officers are required to stay informed of the particulars of each of these laws, or risk facing the consequences of a breach. Additionally, in many jurisdictions executives can be held personally accountable for breaches made by the organisational entity itself. A failure to meet these standards can result in severe civil, criminal or administrative penalties for individuals, including monetary fines, suspension, or even imprisonment.
As legislation is complex and forever changing, understanding and complying with it can consume significant resources. This can be particularly onerous for organisations operating internationally, as they are required to comply with laws in every jurisdiction of their presence. Without sufficient diligence an organisation, and in turn its management, can be exposed to accidental infringements.
A great example of a claim involving regulators can be found in the aftermath of the 2008 financial crisis, when the SEC brought a civil lawsuit against a former Procter & Gamble director for passing inside information to a hedge fund manager. Once the regulators were on his trail, criminal charges were eventually laid, ultimately resulting in a guilty verdict for insider trading and a two-year prison sentence.
When an organisation becomes insolvent it often leaves many stakeholders, particularly creditors, owed outstanding money. A creditor is a party that has provided goods, services or finances to an organisation without receiving immediate payment. An organisation’s employees, who are owed unpaid wages and other entitlements, may also be considered creditors.
The management of an organisation has a responsibility to stay informed of its true financial position, and its ability to meet debts as they become due. If an organisation becomes insolvent, creditors will often scrutinise the actions of managers to see if they can be held personally responsible.
actions on creditors, particularly when entering the zone of insolvency. If this duty has been ignored, or errors have been made, and debts are left unpaid when an organisation goes into liquidation, creditors can pursue executives personally in an attempt to recover outstanding funds. Common allegations by creditors include:
- Breach of fiduciary duty
- Breach of duty of due care
- Deliberate misconduct
As you can see, directors and officers face a broad range of claims from sources external to the organisational entity and its management. In Part 2 of ‘Where do claims come from?’, we take a look at the personal liability exposures which arise from internal claim sources.