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Directors’ and Officers’ Liability, Risks and Insurance Update
- In our update last year, we noted that there were a number of notable (and ongoing) developments concerning D&O liabilities, risks and potential exposures, including: sustained shareholder activism (such as the steady growth of securities class actions) and continued regulatory activism. Aon Risk Solutions also anticipated that these and other developments would cause the D&O market to harden this year: with D&O insurers taking substantive action in light of portfolio profitability suffering as a result of material claims activity (driven predominantly by shareholder class action claims).
The D&O market this year continues to undergo substantial premium increases (particularly for Side C Coverage). The concern is that this trend will continue as existing developments persist, coupled with new legal risks and/or exposures, including:
Continued shareholder activism (in particular the filing of securities class actions) fuelled by legal and social developments, such as:
- recent and substantial class action settlements (including the $132.5 million settlement of the QBE shareholder class action);
- this is reinforcing the impression (if not, reality) that there is a real prospect of substantial returns to be achieved in class action funding. This is encouraging new litigation funders to enter the market which, in turn, fuels more class actions to be filed;
- in light of this demand, we have also witnessed a rush by plaintiff law firms to file class actions. Accordingly, corporate defendants and their D&Os face the real prospect of having to defend multiple class actions which arise from the same (or substantially similar) set of facts; and
- a positive – the Commonwealth and State Governments are conscious of this effect of litigation funding on class actions. A report has been published by the Victorian Law Reform Commission on the use of litigation funding (while a separate Commonwealth inquiry, which commenced in December 2017, recently issued a discussion report for public consideration). Both inquiries have proposed a number of steps to deal with issues raised about litigation funding – either through regulatory powers and/or court case management powers – and we recommend that these matters be monitored.
Increased regulatory activism, with regulators remaining very active (both locally and globally) and with a continued focus on corporate culture and misconduct:
- We expect there will be increased regulatory oversight and enforcement as a result of the ongoing Financial Services Royal Commission, with the Commonwealth Government also releasing a proposal in April 2018 to substantially increase penalties for corporate misconduct; and
- Anti-bribery and corrupt conduct also remain on the regulatory agenda, with the Commonwealth Government in December 2017 introducing a proposal for, relevantly, a new strict liability offence of failing to prevent foreign bribery;
- As to insurance law developments and consistent with these trends, a recent decision allowed shareholders to proceed against an insolvent company’s D&O insurers (but not the company itself). This is another development which will concern and impact the D&O market.
Continued Growth in Securities Class Actions
The hardening of the D&O Market has largely been driven by insurers’ perceptions of claims and litigation, especially the effect of class actions claims (particularly securities class actions) and their settlements. A recent report has found that: 1
- since the first securities class action in Australia settled in 2003, settlements have now surpassed $1.5 billion; and
- nine out of ten filed securities class actions were settled in Australia, with insurers facing an average bill of $40 million for each class action settled. The total value of D&O insurer contributions to securities class action settlements in Australia since 1999 is estimated to slightly exceed $1 billion (excluding defence costs) and around $1.28 billion (when including defence costs).
The following developments are also worth briefly noting:
- there were approximately 30 class actions filed in 2016/2017. 2 There also remains continued growth in the filing of securities class action claims, with recent examples including those filed against AMP, Commonwealth Bank of Australia, Crown Resorts and GetSwift Limited.
as we had demonstrated in last year’s update, the empirical data tends to demonstrate that the growth in the number of class actions filed each year has fluctuated and in recent years, has been relatively constant. Our updated graph below, which is drawn from data (including from the work of Professor Vince Morabito), continues to dispute earlier concerns that there would be a significant “avalanche” of class action litigation being commenced after the GFC. While there has been an increase in the number of actions filed last year (compared to previous years), we note the phenomenon of multiple competing class actions commenced against the same entity (which we address further below) has the necessary effect of skewing the data on the number of actions filed per year.
Australian class actions filed (by year)3
A recent paper published by Professor Morabito also supports this notion,4 which relevantly concludes that:
- a total of 563 class actions have been filed on or before May 31, 2018. This constitutes an average of 21.4 class actions every year;
- compared to other countries, in a nation with a population of over 24 million people, an annual average of 24 class actions filed over the last four years in the country’s national court (being the Federal Court), cannot rationally be viewed as excessive; and
- in analysing the data, to focus on any increase in the volume of class action litigation over the last four years (particularly in the Federal Court, where the majority of shareholder class actions are commenced) provides an “incomplete and therefore misleading perspective”. A balanced perspective, according to Professor Morabito, would find that “in the June 2002 - May 2006 period there was a substantial drop in the number of federal class actions and that it has taken 12 years for the level of federal class action activity to go back to (and indeed surpass) the volume of litigation seen in the June 1998 - May 2002 period”.
- Settlements: there have also been a number of recent settlements, including in the Slater & Gordon and QBE shareholder class actions. In the QBE class action, the Federal Court made orders on 4 May 2018 approving a $132.5 million settlement of the proceedings (with public records indicating that the settlement would be covered by QBE’s own insurance and provisions);
- Common Fund: since the Money Max decision5 on common funds was made in October 2016, it appears only three common fund orders have been made (although in the period since, a significant number of applications have been mooted by plaintiff law firms at the commencement of class action proceedings). The first was the Allco settlement decision (which we discussed in our previous update). The second was the decision of Murphy J in Pearson v State of Queensland  FCA 1096, where a common fund order was made with a funding commission approved at a rate of 20% (though the Court reserved its right to set a lower percentage at a later date). The third was the decision again of Murphy J in Caason Investments Pty Ltd v Cao (No 2)  FCA 527 which ordered a commission, based on a 30% funding rate (reduced from the rate to be paid by class members of 35-40% under their funding agreements). Professor Morabito has also noted that since the Money Max decision, the empirical data reveals an increase in the use of open classes in federal class actions.6 It remains to be seen, however, whether the Money Max decision will lead to more competing class actions being filed (an issue which we address in more detail below);7
- Competing Class Actions: Australian courts are starting to develop jurisprudence on the treatment of competing class actions which are filed against a single defendant, and which arise from the same (or substantially same) set of facts. The spectre of competing class actions is a real issue for corporate defendants, who face increased cost and delay. It is a phenomenon partly driven by the prospect of increased returns for plaintiff law firms and litigation funders. Entities that are currently facing competing class actions include AMP, CBA and Quintus. Courts are continuing to grapple with the issue, including in the GetSwift class actions (where we are acting for the company and its directors). In the recent judgment of Perera v GetSwift Limited  FCA 732 (where we acted for the respondents), the Federal Court ordered that two out of three competing class actions be permanently stayed, and thereby permitted only one action to proceed. (This decision has be appealed to the Full Court of the Federal Court and is listed for hearing on 6-7 August 2018.)
Litigation Funding: There have also been further entrants into the Australian litigation funding market, with UK and US funders including Therium and Burford Capital – proclaimed to be the world’s largest publicly traded funder – being notable examples. Two inquiries were commenced into the use of litigation funding in class actions: first, the Victorian Law Reform Commission (VLRC) started an inquiry in December 2016; and secondly, a separate inquiry was commenced by the Australian Law Reform Commission (ALRC) in December 2017, after being provided with terms of reference by the Commonwealth Government:
On any view, there is a strong desire at the right levels of government to address key issues arising out of class actions and litigation funding.
- the VLRC tabled its final report to Parliament on 19 June 2018. The VLRC, in recognising the constraints of state regulation, focussed on granting the Supreme Court of Victoria with greater powers over case management and costs to protect the interests of class members. The VLRC also supported the introduction of guidelines on duties and responsibilities of lawyers to class members in class actions, and the lifting of the prohibition of lawyers to charge contingency fees (as it could increase competition with litigation funders which may reduce costs in some instances); and
the ALRC released a discussion paper on 31 May 2018, in order to facilitate public submissions on this subject matter. The paper set out a number of proposals for consideration, including:
- a review of the impact of continuous disclosure obligations;
- requiring litigation funders to obtain and maintain a licence to operate in Australia;
- requiring solicitors to obtain specialist accreditation in class action practice;
- permitting solicitors to charge contingency fees (subject to certain limitations);
- providing the Federal Court with statutory power to reject, vary or set the funding commission rate in funding agreements; and
- establishing a statutory regime to deal with competing class actions;
Risk management: in the current D&O insurance market and with the growing trend of securities class actions, the pervading perception appears to be that in order for publicly listed companies and their insureds to mitigate any potential exposure from a securities class action, they must pay increased premiums and/or request increased limits under their insurance policy. However, increased limits may not necessarily provide better protection and insurance coverage for insureds (particularly in this present environment).
What tends to be forgotten in this debate is that an insurance policy is intended to be a last level of protection in a company’s risk management strategy against these risks and exposures. The primary level of protection for a company is, of course, their corporate governance processes (including risk prevention and internal control systems). After all, prevention is always better than a cure. Companies should continue to monitor and review their processes, to ensure that they have adequate procedures to comply with their obligations (including continuous disclosure). This includes having in place robust systems which can identify and respond to events which may trigger a company’s continuous disclosure obligations (as well as to manage any associated process risks).
- Deeds of Indemnity: In the course of our review of corporate clients’ D&O insurance documents, we have also come across D&O deeds of indemnity which have not been updated to reflect recent legal developments, including the continued growth in class actions and regulatory investigations (which often focus on alleged corporate misconduct, as we discuss below). These developments inform and affect (more so than ever) the balancing exercise to be undertaken as to which terms in a deed of indemnity should be included, where the commercial and legal interests of a company and their directors and officers must be managed. This balancing and the potential for a conflict/tension between the company and its directors/officers becomes particularly acute in the scenario where a company seeks to take sole control of proceedings and/or a defence to a claim. Based on our experience through these reviews and as a matter of general principle, we do consider that a balance can be struck: with the interests of a company, its directors and officers being treated similarly.
- Community expectations: We think it is well accepted that the legal developments experienced in Australia to date bear some similarity to that encountered in the United States. In that regard, and as with the United States, it is often overlooked that legislation and court decisions not only reflect core community standards and expectations, but are also intended to compel compliance with these standards. A number of recent developments, including the Financial Services Royal Commission and the adverse financial media coverage in response to controversies arising from that inquiry, are a reflection of a hostile attitude held by the broader community towards certain sections of corporate Australia. It will therefore come as no surprise that as a result of these developments, there will likely be increased regulatory oversight and enforcement initiatives from the Federal Government (which we discuss further below). Historically, regulators such as ASIC have also endorsed class actions as a private enforcement tool.8 In the current environment, we see no reason why that position will not be maintained.
Increased Regulatory Activism
We note a number of recent regulatory developments may also impact the potential liabilities, risks and exposures of directors and officers:
on 24 April 2018, the Commonwealth Government released a proposal to broaden the powers of ASIC and for increased penalties for corporate misconduct. These proposals include:
- harmonising penalties for the most serious criminal offences under the Corporations Act to a maximum of: for individuals, 10 years imprisonment and/or the larger of $945,000 or three times the benefits; and for corporations, the larger of: $9.45 million, three times the benefits or 10% of annual turnover;
- expanding the range of contraventions which are subject to civil penalties, and also increasing the maximum civil penalty amounts to the maximum of: the greater of $1.05 million (for individuals, from $200,000) and $10.5 million (for corporations, from $1 million); or three times the benefit gained or loss avoided; or 10% of the annual turnover (for corporations);
- permitting ASIC to seek additional remedies to strip wrongdoers of profits illegally obtained;
- in December 2017, the Government also introduced the Crimes Legislation Amendment (Combatting Corporate Crime) Bill 2017 which seeks to create a new strict liability offence of failing to prevent foreign bribery and a new deferred prosecution agreement scheme. The Bill is presently before the Senate; and
- overseas, the US Department of Justice continues to remain active, disclosing that in 2017 about $4.6 billion were handed down in corporate US criminal fines, penalties, forfeiture and restitution, with total enforcement action amounts payable to US and foreign authorities totalling $6.8 billion.9 A notable example of an anti-bribery case prosecuted involved SBM Offshore, N.V. (SBM), a Netherlands-based company specialising in the manufacture and design of offshore oil drilling equipment, which entered into a three-year deferred prosecution agreement and agreed to pay criminal penalties totalling $238 million for violations of the Foreign Corrupt Practices Act.
Insurance Law Developments
- Shareholders of an insolvent company were recently granted leave to proceed against the company’s D&O insurers under the recently enacted Civil Liability (Third Party Claims Against Insurers) Act 2017 (NSW).10 While the decision does not create new law, it unfortunately reflects the trends of growing D&O liabilities and potential exposures (as set out above).
- D&O insurers will also no doubt be aware of the impact of increasingly hostile community attitudes towards elements of corporate Australia, including increased regulatory oversight and enforcement initiatives (as we have discussed in paragraph 4(h) above). Insurers are likely to continue taking further corrective steps so as to offset the prospect of increased claims activity (and portfolio unprofitability), whether by significant premium increases or otherwise.
Michael Mills & Michelle Fox
31 July 2018
- 1 XL Caitlin and Wotton+Kearney, Show Me the Money! The Impact of Securities Class Actions on the Australian D&O Liability Insurance Market (September 2017) at pp 5, 9 and 11.
- 2 Vince Morabito, An Empirical Study of Australia’s Class Action Regimes: Fifth Report ,The First Twenty Five Years of Class Actions in Australia (July 2017) (Morabito Fifth Report) p22. Morabito analysed the available data, based on the period from 4 March 2016 to 4 March 2017.
- 3 Our graph is based on a number of sources, including the Morabito Fifth Report.
- 4 Vince Morabito, Competing Class Actions and Comparative Perspectives on the Volume of Class Action Litigation in Australia (11 July 2018).
- 5  FCAFC 148.
- 6 Morabito Fifth Report p40.
- 7 Morabito Fifth Report, pp 40-41.
- 8 See ASIC INFO 180 “ASIC’s approach to involvement in private court proceedings”; see also “Regulators are ready for action”, Australian Financial Review (31 March 2012)
- 9 Department of Justice, Fraud Section Year in Review 2017, p 2.
- 10 Rushleigh Services Pty Ltd v Forge Group Limited (In Liquidation) (Receivers and Managers Appointed)  FCA 26