Where do claims come from? (Part 2): Internal sources

In addition to external risk exposures, claims can also arise from within an organisation and its management ranks. These claims, while somewhat less common, are often of quite a personal nature.

In addition to sources of claims which exist externally to an organisation and its management, claims can arise from within. Internal sources of claims typically arise either as a result of one director or officer suing another, or the organisation itself bringing a claims against the same executives trusted with its management.

In Part 2 of ‘Where do claims come from?’, we take a look at what exactly these internal sources of claims are.

Administrators and liquidators

When an organisation becomes insolvent, an administrator is appointed to take over its operation in place of management. An administrator’s primary role is to evaluate the financial prospects of the organisation and determine whether it is in a position to trade out of insolvency, or if it’s assets are to be liquidated.

If it is decided that an organisation is to be wound up, a liquidator, during the process of selling off assets, may undertake an investigation into the circumstances surrounding the bankruptcy. If it appears that an organisation’s directors and officers have allowed it to continue trading and incurring debt while insolvent, they may be held accountable.

In these situations, a liquidator may assume the position of the organisation and sue the responsible executives for their breach of duty. By doing this, a liquidator can attempt to recover monies to assist in repaying outstanding debts owed to stakeholders.

More often than not, it is these stakeholders who encourage liquidators to pursue legal avenues of recovery against directors and officers. However, even if liquidators choose not to investigate their actions, they are by no means discharged of liability – as many jurisdictions permit individual creditors to then seek recovery instead.

Subsidiaries and joint venture partners

The directors and officers of a parent organisation can be exposed to claims by its subsidiaries. This can occur when a subsidiary becomes bankrupt and its creditors, or a liquidator on their behalf, commences subrogation against the parent organisation’s management in an attempt to recover outstanding debts.

In these situations, executives can be held accountable by a subsidiary and its stakeholders for their breach of duty, and subsequent contribution to the insolvency. In addition to claims from subsidiaries, management can also be exposed to litigation from joint venture partners.

When organisations enter into a joint venture, its executives must comply with their corporate duties by acting in the best interest of the joint venture, not director or officer acts in a way that is deemed inappropriate, they may be held personally liable.

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The organisation itself

In certain situations, directors and officers may face claims brought against them by the organisation in which they represent. These claims generally occur due to an alleged breach in duty, whereby their actions have resulted in financial losses or their behaviour is not considered to be in the organisation’s best interests.

In addition to derivative actions, these claims often arise following mergers or acquisitions, a change in ownership, or alteration in the composition of the board of directors. A change in an organisation’s management personnel may uncover decisions made by past executives, which are considered to be negligent or wrongful.

If a subsequent investigation finds that they have acted inappropriately, the organisation, led by the new board, may bring a claim against those responsible – even if they have since moved on from the organisation.

Other directors and officers

Directors and officers are occasionally exposed to claims made by other directors and officers. This can occur because although executives are generally reasonable and considered when performing their duties, boardroom tensions have been known to rise during moments of critical decision making.

While emotionally charged discussion and disagreements between managers rarely lead to threats of litigation, it certainly has been known to happen. And while being implicated in a claim from a colleague is obviously undesirable, it is entirely possible if someone feels as if they have been discriminated, abused or violated during the performance of their official duties.

Common allegations include:

• Failure to adhere to by-laws
• Improper removal from the board
• Defamation

Conclusion

Internal sources of claims against directors and officers can be just as threating as those that exist externally. At the very least, these claims can quickly become very personal, as executives are forced to defend themselves from allegations against the same trusted parties which appointed them to leadership in the first place.