Directors & Officers cover: is your company’s top brass adequately protected?
Johannesburg - Muted economic growth, the ongoing energy crisis, numerous infrastructural failings and the impact of geopolitical tensions abroad have caused significant shifts in the local risk landscape. Within this high-risk environment, company directors are called upon to make critical decisions and to perform under pressure. Unfortunately, these conditions leave greater room for misjudgment and miscommunication. Without adequate Directors and Officers (D&O) insurance cover, the cost of these human errors could be irrecoverable.
According to the World Economic Forum, the three top global risks facing businesses are the energy supply and cost-of-living crises as well as rising inflation. All three of these factors are highly prevalent in South Africa and can have a direct impact by increasing the cost of doing business and reducing growth potential.
"It is within these recessionary environments, that when shareholders' expectations are not met and companies underperform, directors are placed in the firing line," says Makolo Kalambaie, Business Head of Financials Lines and Structured Portfolio at SHA Risk Specialists.
Recessionary conditions lead to higher risk exposures:
As he explains, the number of liquidations, as well as the sheer volume of companies undergoing business rescue are clear indicators that the current economic environment is one characterised by high risk.
According to Stats SA, the number of company liquidations recorded at the end of 2022 showed an increase of over 30% compared to the previous year. A total of 1,907 businesses closed their doors during 2022, only down slightly from 1,932 in 2021. While this minor decrease is a relatively encouraging finding, the large number of liquidations which took place over one year, remains indicative of the fact that many South African companies are up against higher risks and overwhelming operational difficulties.
Under these conditions, directors and officers have a larger burden of responsibility to assess the solvency of a company and determine whether it can service its debts on a timeous and consistent basis. In the event of a liquidation, directors are expected to assist any court-appointed liquidator in accurately and truthfully declaring the company's assets, liabilities and financial transactions.
In the case of a liquidation, directors actions leading up to the liquidation typically face higher levels of scrutiny. If found to be engaging in wrongful or reckless trading, or as being negligent in the fulfilling of their fiduciary duties, third parties may enact legal claims against the company and/or the director in his/her personal capacity.
In South Africa, active cases of business rescue saw a 100% increase over the 2021/ 2022 period, when compared to the pre-pandemic years. As in the case of liquidations, directors play a pivotal role in facilitating the process of business rescue by providing relevant practitioners with the correct supporting documentation. It is also incumbent on directors to act in accordance with the suggested business rescue plan and to offer their full cooperation in making the necessary changes to the company's operations, financial structure and governance policies.
Directors and their fiduciary duties:
As set out in Section 77 of the Companies Act, directors and officers are expected to exercise reasonable care, skill and diligence in the fulfilment of their role. They are also mandated to act in the best interest of the organisation, to act within their powers and for a proper purpose and to exercise unbiased judgment.
In addition, they are called upon to avoid conflicts of interest and to not accept benefits from third parties or enrich themselves in a fraudulent manner. Failure to fulfill these duties could result in the director or officer being held personally liable for damages suffered by the organisation or a third party, as a result of such failings.
As Kalambaie explains: "This is where D&O insurance cover can make the difference needed to keep the business afloat. Put simply, companies purchase D&O cover because managers make mistakes, and as history has illustrated, often the biggest risk facing any business relates to human error.
D&O cover explained:
This kind of cover serves several purposes. Primarily, it protects directors and officers from claims which may arise from the decisions and actions taken within the scope of their regular duties. Secondly, it covers the reimbursement of the insured company in case it has paid the claim of a third party on behalf of its managers in order to protect their employee. Cover also includes financial protection for managers against the consequences of actual or alleged 'wrongful acts" by advancing defence costs.
Companies' D&O cover will be called into action when any such claim is made in a formal manner. This can be enacted in the form of a court summons, notification regarding investigation by a regulatory body, a written demand, or a notice of criminal prosecution. Once such a notice has been issued, directors have a duty to notify their insurer and seek their advice on how to proceed and build a defense against the claim.
The role of brokers in the D&O claims process:
For Kalambaie, this is where the guidance of an insurance broker can prove to be invaluable. Dealing with D&O insurance claims involves a complex – and often daunting – process, which will take shape depending on the nature of the client's business and its organisational structure. Brokers are in the best position to provide advice on how the various risks may affect a company and the kind of action to take in preparing a defense against a claim and being proactive about recovering from the related damage.
As he concludes: "Brokers should advise their clients to always maintain uninterrupted cover, especially during a recession, so that they can benefit from the best available coverage in the market. A break in cover can expose directors and officers' personal assets and their ability to take the reasonable steps required to ensure business continuity. To this point, SHA offers regular product training and brokers are encouraged to attend sessions through the year to equip themselves with the knowledge needed to advise their clients adequately."