At the time of writing, social media sources have already reported two US securities claims relating to public statements made by companies in relation to COVID-19i. Are these cases outliers or the beginning of a trend? As they arose from the cruise and pharmaceutical industries, which are closely connected to the fallout from COVID-19, it is not altogether surprising they were filed. Claims are anticipated in other industries that are closely affected too, and possibly others.
Investors (and plaintiff law firms) will be watching closely as companies and their directors make announcements about the effect of COVID-19 on their business models. Clearly, companies and their directors cannot be liable just because the virus has a business impact: it came out of the clear blue sky and will impact every business in some way. It is what they say about the likely impact of the virus and the measures being taken to mitigate it that may give rise to a brush with securities laws. Companies will need to take great care in drafting communications about the virus and its possible consequences, particularly given this is a quickly developing situation with constantly changing horizons.
There is also the potential for mismanagement related claims against directors, namely, that the board was in breach of its fiduciary duties in failing to adequately address the risks and steer its company through the crisis with the least possible damage. In Australia, these could be framed as a breach of the duty to act with care and diligence (Section 180(1), Corporations Act 2001 (Cth) (the Corporations Act)), and there are similar or equivalent duties in virtually every other jurisdiction. Such claims could be brought by companies themselves, or via the derivative action process (in which a single shareholder can bring a claim on behalf of the company), or by liquidators following an insolvency. Directors may, however, seek to rely on the Business Judgment Rule under section 180(2) of the Corporations Act to demonstrate that they have met their obligations under Section 180(1).
Of course, directors of all companies are coping with extremely challenging conditions and complex problems on a scale that has not been seen before. Honest mistakes will be made by people doing their best.
The Federal Government and regulatory bodies are cognisant of the additional pressures being placed on business and have introduced a range of measures to support organisations as they navigate the changing landscape. These measures include; ASIC taking a “no action” position in relation to delays of up to two months in the holding of AGMs which were required to be held by 31 May 2020 and supporting the holding of those AGMs via “hybrid” and “virtual” meetingsii,iii and the ASX introducing temporary measures to facilitate the raising of capital.iv
The ASX also released a compliance update on 31 March 2020 in relation to COVID-19 and Continuous Disclosure Obligations. Whilst the ASX notes that “a listed entity’s continuous disclosure obligations do not extend to predicting the unpredictable”, practical guidance is afforded to enable ongoing compliance with the obligation including strongly encouraging entities who have not reviewed their published guidance in light of COVID-19 to do so.v
The D&O policy
It is by no means inevitable that directors will be liable if sued; there may be strong defences, and it will be important to access defence costs coverage and/or any available indemnification from the company to ensure they are fully deployed. A securities class action arising from false or misleading disclosures or an alleged breach of the company’s continuous disclosure obligations or corporate mismanagement of a COVID-19 driven event would be the type of claim expected to be covered under a D&O policy.
As with any insurance policy, the specific facts and allegations of any claim will dictate coverage.
To be prepared, directors, officers and companies should proactively review their D&O insurance policies, in conjunction with their advisers, paying particular attention to any relevant exclusions and limitations.
For example, at the time of writing a minority of insurers are considering whether to apply specific exclusions. Generally, however insurers are seeking to underwrite the additional perceived risks, a position that Aon is advocating strongly.
In addition, D&O policies normally contain varying forms of a “bodily injury” exclusion limiting the extent of coverage for claims involving “bodily injury [other than emotional distress or mental anguish], sickness, disease, or death of any person, or damage to or destruction of any tangible property, including the loss of use thereof…”. The bodily injury exclusion is often narrowly framed so that it can only relate to direct injury claims of the type a general or public liability policy would be expected to cover. This would be unlikely to adversely affect coverage for securities or mismanagement claims. Alternatively, it can contain specific “carve-backs” to the exclusionary language providing further clarity regarding the intent of the exclusion to not apply to securities claims, defence costs, or non-indemnifiable / Side A claims (among other things). Therefore, simply because a claim arises from, is based upon, or relates to bodily injury from the COVID-19 virus, coverage is unlikely to be automatically excluded. However, the actual language used will dictate the outcome.
The COVID-19 crisis will give rise to events that are covered under other corporate policies of insurance. Companies should be carefully examining these to check if and when they can make claims. Although not commonplace today, some D&O policies may contain a “failure to maintain insurance” exclusion. A failure of the company to maintain policies that could have mitigated losses for the company could be an obvious source of mismanagement claims against directors.
There is some speculation that certain insurers may look to add an “insolvency exclusion” to D&O policies in certain specific sectors perceived to be more likely to have an increase in corporate insolvencies. We will be looking to minimise the impact of such a clause should it be introduced.
Side A cover
Some final remarks should be made concerning the D&O programme structure and the purchase of Side A (non-indemnified coverage):
- There is the potential for mismanagement claims to be brought, with the leave of the court, via a statutory derivative action by a shareholder on behalf of the company under Part 2F.1A of the Corporations Act. In addition, directors of non-US companies that have US shareholders cannot assume they are immune to a US derivative lawsuit and can expect an expensive jurisdiction contest before the claim even proceeds. In Australia, it has not often been the weapon of choice for shareholders, but this could change in extreme circumstances such as those we find ourselves in now. Failing that, in Australia, there could simply be an increase in “New Board v Old Board” claims, i.e., by companies against their former directors.
- Insolvencies will inevitably rise due to cashflow and supply chain issues, particularly among companies that were already in a weakened financial state before the pandemic. In Australia, insolvency is already a potent source of D&O claims. In the case of an insolvent company, there can be no company indemnification, and so D&O coverage is the primary source of protection.
In anticipation of either of the above events, insurance buyers would be well-advised, in particular, to review their Side A coverage (which is typically broader than a Side A/B/C policy).
Temporary relief from insolvency actions against directors
With effect from 24 March 2020, the Government enacted temporary changes to insolvency provisions contained within the Corporations Act. For a period of six months directors are provided with increased protections for debts incurred as a result of the coronavirus health crisis.
Notwithstanding, directors must continue to assess the solvency of their company. They must continue to act with care, diligence and in good faith. Directors must not act fraudulently or dishonestly and, of course, any debt incurred remains payable.
Further details can be found here – https://www.business.gov.au/risk-management/emergency-management/coronavirus-information-and-support-for-business/temporary-relief-for-financiallydistressed-businesses
How can you secure the best D&O renewal terms
D&O insurers are still working through their own individual approach to assess the potential risks associated with COVID-19. Notwithstanding this, there is already a clear set of underwriting concerns which have materialised. In assessing their preparedness to provide go-forward coverage, insurers will require satisfactory responses to the following three key areas of concern:
- how strong is the balance sheet
- how strong is the liquidity position of the organisation
- how geared is the organisation and what covenants apply to debt/credit arrangements
- how is the organisation protecting its revenue stream
- (for publicly listed organisations) how is the organisation managing its continuous disclosure obligations
Supply chain disruption
- what impact do third party suppliers have on an organisations ability deliver its products and services
- what contingencies has the organisation deployed to address any supply chain disruption
- has the organisation acted appropriately in standing down or making employees redundant
- how has the organisation addressed work from home arrangements, including related cyber security and privacy concerns
- has the organisation adopted an appropriate safety standard where personal interactions are undertaken between employees and clients/customers
These are extraordinary times. The early signs are that companies and their directors will face D&O claims arising from the impact of COVID-19, from a variety of sources. There will often be strong defences given the speed that the pandemic has developed and its unprecedented effects. The D&O policy is there to help protect boards by ensuring they can robustly defend litigation and allow
them to keep doing what is important – running their businesses.
D&O Insuring Clauses
D&O insurance policies traditionally provide two insuring clauses – Side A and Side B. Both insuring clauses are designed to provide personal protection for the benefit of insured persons (i.e, directors and officers). A third insuring clause – Side C can be purchased by publicly listed entities. This insuring clause is designed to protect the organisation (rather than an individual). All three insuring clauses are further explained below:
Side A / Insuring Clause A
Covers claims brought against an insured person where such individual is not indemnified by the insured organisation.
Side B / Insuring Clause B
Reimburses the insured organisation for its indemnification obligations in respect of claims brought against its insured persons.
Side C / Insuring Clause C
Covers claims brought against the insured organisation arising from the issuance, sale and purchase of securities.
i Eric Douglas, individually and on behalf of others similarly vs Norwegian Cruise Lines, Patick McDermid, individually and on behalf of others similarly vs Inovio Pharmaceuticals, Inc.
ii Corrs Chambers Westgarth; COVID-19: Head Office Guide https://corrs.com.au/insights/covid-19-head-office-guide-unprecedented-times-call-for-unprecedented-measures