In a post published last month, I wrote about an interesting U.K. case in which a claim had been asserted post-bankruptcy against a director of a private company. In the following guest post, Francis Kean, a partner in the financial lines team at McGill and Partners, takes another look at the case and considers its implications. A version of Francis’s article previously was published on LinkedIn. I would like to thank Francis for allowing me to publish his article as a guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly of you would like to submit a guest post. Here is Francis’s article.
I am indebted to Kevin LaCroix for his excellent blog on a High Court judgment handed down in January 2020 in Re Systems Building Services Group Limited (Systems) the transcript of which can be found here. As Kevin writes, the case is interesting in that it confirms that a director’s fiduciary duties (codified under sections 171 – 175 Companies Act 2006) survive and continue post liquidation even if his or her powers do not. This disparity creates the potential for claims against directors based on wrongful acts committed after a company goes into liquidation and, in extreme cases such as this one, even after the company ceases to exist following termination of the liquidation process. As Kevin also comments, this case prompts us to re-evaluate whether D&O policies are apt to capture this exposure. It is true that the scope for directors to commit wrongful acts after their powers have been removed or suspended is significantly reduced. The most obvious surviving arena for incurring fresh liabilities is in dealings between the directors and the insolvency practitioners themselves. This was indeed the case here where (among other things) the director was accused of buying company property from the administrator at an undervalue.
The Facts of the Case
The facts of this case were unusual in that the original administrator of Systems was herself found liable for misfeasance in her capacity as office holder for an unrelated company. This prompted the insolvency practitioner who took over from her to apply for an unusual order to restore Systems to the Companies Registry expressly to allow him to bring this case. Since some of the allegations concerned dealings over company property between the original insolvency practitioner and the director post administration, the question arose as to the nature of the director’s duties which survived insolvency. Having conducted a review of the few English law authorities on the subject the judge had no difficulty in concluding that:
“The fact that, on a company’s entry into administration or creditors voluntary liquidation, the Insolvency Act 1986 is engaged, imposing a series of additional specific duties on the part of a director and limiting his managerial powers to those authorised under or in accordance with the Act, does not, in my judgment, operate so as to extinguish the fundamental duties owed by a director of a company to the company as reflected in ss.171 to 177 CA 2006.”
So there will be instances such as occurred in Systems where the legal duties of directors which survive post insolvency give rise to fresh liabilities. This potential risk is unlikely to be confined to English law since the basic principles of fair dealing which underpin the fiduciary duties codified in the Companies Act are common to insolvency proceedings in many jurisdictions perhaps even including the US itself as Kevin suggests in his blog.
The D&O Implications
The first point to make is that even in the absence of facts such as in the Systems case, there is a fundamental tension between the annually renewable “claims made” principle under which D&O policies operate and the fact that it may take months or years before claims against directors are formulated and brought by insolvency office holders. While a company is solvent and continues to buy D&O insurance the “claims made” principle works well enough. If a director commits a wrongful act in year one but this does not give rise to a claim against him or her until year three, generally it will be the policy in year three which responds to the claim and not that in year one. A problem arises if the company has become insolvent in year two since the overwhelming likelihood is that there won’t in this situation be a policy in year three to respond to the claim because the company can neither afford nor are insurers keen to offer such cover once insolvency has occurred or is imminent.
A Dangerous Gap in Cover?
There are only two ways of avoiding this potentially dangerous gap in cover.
- The first is to notify “circumstances which may give rise to a future claim” before the expiry of the policy which is in force at the time of the insolvent event. A valid notification will “attach” any future claim to the expiring policy. Making a valid notification may be challenging especially if the insolvency occurs towards the end of the policy period for the simple reason that there may be insufficient time in which (and evidence on which) to identify and articulate the particular circumstances which may give rise to a claim. (The mere fact of insolvency alone is almost certainly not an adequate basis on which to make a valid notification).
- The second alternative is to use a so called “run off” option if the expiring D&O policy provides for this or (more unusually) if insurers can be persuaded to offer (and the company can afford to buy) a separate policy when the insolvency is imminent. The concept is simple enough. Under a run off policy, insurers agree to cover directors for a specific period of time often six or ten years in respect of claims arising from wrongful acts which occur before a specified date. The option can be tailored to individual directors personally who leave the company during the policy period and/or to the company as Policyholder on the expiry of the policy period or on the occurrence of an insolvency event or some other event. The terms on which this extension of cover is offered (if at all) and the premiums charged (if any) vary tremendously and are coming under close scrutiny by insurers in challenging D&O market conditions.
The Systems case summarised above throws a further variable into this mix with the potential to create an even wider coverage gap. Run off cover (or extended reporting periods as they are sometimes referred to) only apply to claims in respect of wrongful acts which occur before the expiry of the policy period or other trigger event. Such extensions would not cover directors in respect of fresh wrongful acts committed after the trigger date for the run off cover. To this extent, even if the Systems director benefitted from cover in respect of wrongful acts committed pre insolvency, the policy would not respond to claims based on unrelated wrongful acts occurring during the insolvency.
For good reason, the risk of company insolvency is one of the main drivers behind any decision to purchase D&O insurance. Not only is it the time at which the threat of claims or investigations against directors is at its height but it is also the point at which the directors lose the benefit of any company indemnity. For this reason close scrutiny (perhaps with the benefit of scenario testing with expert advisers) of what happens to the D&O cover on insolvency is a worthwhile exercise. Cases such as the Systems show that this is an area which should be kept under constant review and may indeed result in the need for additional enhancements of cover.