Management Liability Exposure (Directors and Officers) A Whitepaper Prepared For The Canadian Home Builders Association

Transcription

1 Management Liability Exposure (Directors and Officers) A Whitepaper Prepared For The Canadian Home Builders Association

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3 Table of Contents Table of Contents... 1 Disclaimer... 1 Management Liability Exposure (Directors and Officers)... 2 Claim Types...6 Loss Prevention Practices... 8 General Principles Governing Directors And Officers Liability...9 A. The Duty of Care...9 B. The Duty of Loyalty...9 i. Conflicts of Interest...9 ii. Business Opportunities...10 iii. Confidentiality...10 C. The Duty of Obedience...10 Other Principles Governing Directors And Officers Liability...11 Business Judgement Rule...11 Indemnification...11 Employment Practices Liability...12 A Summary of Loss Prevention Measures...13 For the Association...13 For the Director or Officer...13 Disclaimer The following information is not intended to provide a legal opinion or substitute for expert legal advice. 1

4 Management Liability Exposure (Directors and Officers) Did you know that when you volunteer to sit on a board of directors you expose yourself to the possibility of being sued? Many people are unaware when they are appointed to any board of directors, even as a volunteer, they can be held legally and personally responsible for the decisions they make while acting as a director. In fact, volunteer boards and non-profit organizations are the most likely groups to be sued and the results of such litigation can be complex, time consuming, stressful, and costly. It should also be noted the legal fees and entire amount of any judgement may have to be paid out of the director s own pocket if there is no existing insurance coverage to pay for such matters. Business people are busy people. There are times when being busy and juggling too much as a volunteer board member can result in an oversight. Should such an oversight occur, don t think the courts will be lenient and consider you merely a volunteer and give you special consideration due to the competing demands of your family, your own business and life in general. There are as many lawsuits from failing to act, as there are from wrongful actions. This isn t the kind of surprise volunteers expect in their lives. Association volunteers are usually business leaders, who contribute their time to give something back to the industry they work in. As Directors and Officers, they become the leaders with the greatest influence for the direction and financial stability of the Association. They also become accountable for the effective management of the Association and as such, they can be held equally liable for the entire amount of any judgement that might come from a lawsuit. We do note that the Province of Saskatchewan instituted a change to their Non-Profit Corporations Act in Directors and Officers need to realize that the change limited their personal liability but did not eliminate the exposure. The limitation extends only to acts done in Good Faith. The action of Good Faith will be challenged and any defence costs, without insurance in place, will be the responsibility of the individual Director personally. Further, Gross Negligence may be used and viewed as a condition of not acting in Good Faith. As well, the limitation of liability brought by this Act will not extend to: Many Statutory Liabilities Fraud and/or Profit Taking Employment Practices Liability Exposure How common are lawsuits? In a recent survey by Watson Wyatt Company, 36% of the 726 Associations and other non-profit organizations surveyed had a Directors and Officers liability claim in the past ten years, more than double the percentage from the preceding ten years. The greatest increase of claims activity is among smaller 2

5 organizations. The same survey indicated that the average defence cost for a Directors and Officers liability claim was $114,000. The purpose of Management Liability (Directors and Officers) coverage is to protect the Directors and Officers for lawsuits against them by members of the Association, or third parties, that may not be pleased with the actions or directions taken by the board. Depending on the policy wording, the policy may also provide legal defence or at least reimburse the Association for these costs. Even if the board or board member is not determined to be negligent, this type of Directors and Officers policy can pay for the defence costs. If the plaintiff is successful and it is determined that any member of the board did not act prudently, the entire board may be responsible for paying any judgments against them from their personal income and savings. That s right you may be personally responsible for all costs and any judgments brought about by the actions of any other board member! This is a risk that all board members share, regardless of their personal actions. While only one board member may be negligent, the entire board may be sued jointly and severally, which means that the plaintiff will seek compensation from the board member that will likely have the most money to pay the settlement. From there, that board member may have to make the payment personally and then attempt to sue the other board members to recover a portion from each. Some board members may not have the ability to reimburse the first member, so there could be a lot of cost and definitely bitter results over such issues. Adequate Director and Officers insurance coverage addresses this risk. Many people do not understand what a board of directors can be sued for and why the courts can hold them liable to pay the award personally. The reality is that today, we live in a litigious society an individual will initiate a lawsuit because it is so easy to do, they hear of big rewards and they would rather blame someone else than take responsibility for their own actions. The courts have stated that board members, especially for non-profit boards have a higher standard of care to make sure that they are looking after Association and member assets to the best of their ability. Failure to do this, in any way, can suggest negligence or incompetence. As for what a board can be sued for, the list is endless, but here are a few examples: Missing, mishandled or misspent funds Issuing libellous or slanderous comments Engaging in sexual harassment Conditioning or carrying out a constructive dismissal Failure to purchase adequate insurance, (somewhat ironic a board can be sued by their members for failing to purchase Directors and Officers insurance or any other type of insurance that the Association should have had!) Engaging in inappropriate board activity (making decisions on matters outside the scope of their duties or engaging in activities with a conflict of interest) Failing to properly document or record their actions Irregularities in voting and the election processes Condoning inappropriate behaviour of other Directors Making decisions which violate another s human rights 3

6 Remaining on as a Director when the individual knew or ought to have known they had a medical condition compromising their ability or capacity to understand the decisions they were making Age discrimination (the largest growing source of employment related claims and the workforce is aging!) These examples illustrate the scope of a board s legal exposure. Realistically, any time someone is disgruntled about a board member or the actions of a board, there is the possibility that a lawsuit may be launched. In Management Liability claims, lawsuits evolve into court procedures, which can be complicated and expensive. Just as the Director and Officer are held to a higher standard of duty, so is their lawyer. In some situations, the Director s or Officer s lawyer will have to pursue all remedies in the representation of their client. This could involve commencing cross-suits against fellow board members or anyone else who can in any way be linked to the claim. Failure to do so will have the lawyer being sued for malpractice. It is probable that cross-suits against fellow board members will end those business relationships! Where proper insurance is not in place, we often see the lawyer being used is the Association s counsel. As they have represented the Association and the board members in the past for various issues, the lawyer will then be in a conflict of interest position. Management Liability insurance covers a WRONGFUL ACT defined as any actual or alleged act, error, omission, misstatement, misleading statement, neglect or breach of duty by the Directors and Officers, individually or collectively, in the discharge of their legal duties solely in their capacity as Directors and Officers. Simply put, this is insurance for the process of managing an Association versus the General Liability coverage for premises, products and workmanship of an entity. Management Liability insurance will provide coverage for any person who is, or was or becomes a director, trustee, officer, or committee member. It is important to note that Management Liability policy wording will differ from insurance company to insurance company. There is not a standard, universal template. Some policies will cover the Directors and Officers only. Others will extend coverage to the Association as well, should it be named in the statement of claim along with the Directors and Officers. Some policies have duty to defend wording, where the insurer will utilize their lawyer and pay them directly. Other insurers will provide coverage on a reimbursement basis, where the Director or Officer will need to retain their own legal counsel to work with the insurer directly. The insurer will then approve and pay reasonable legal expenses. The difference in policy wording makes it important to talk with your insurance provider to ensure the policy will meet the needs and expectations of the Association. Almost all Directors and Officers liability insurance is on a claims made basis. This means if the occurrence, giving rise to the claim, happened while the policy was in force, but then the claim is filed only after the policy expires, there would be no coverage. Reporting of the claim must be within the policy term. 4

7 With occurrence based policies, as long as the occurrence of the event that gives rise to the claim took place when the policy was in force, there is coverage, even if the policy subsequently expired. The disadvantage with claims made policies is that the insurance must continue to be in force for there to be coverage. The advantage of claims made policies is that they cost less than occurrence based policies since the insurers can better quantify their total risk exposure. Getting Management Liability coverage is only half the solution. The other half is getting enough. For the sake of saving a few extra dollars in premium, the Association and/or the Directors/Officers could still be left without a lawyer. The policy will provide them with defence counsel up to its stated limit of coverage. If a Director or Officer was hypothetically sued personally but covered for only $2MM, and some ill-informed or malintending lawyer with no basis whatsoever contrived a $5MM suit for damages in his statement of claim, the Director or Officer would have to hire their own defence lawyer for the excess $3MM claim. The defence for the extra $3MM claim would be a complete duplication of the defence for the first $2MM, but the Association and/or the Directors and Officers would be responsible for the bill regarding the duplicate defence. The complications and challenges of a Management Liability claim don t cease. Our legal system is founded on stare decisis, or precedent basis, which compels courts to look to previous decisions for direction and guidance. The third thing as predictable as death and taxes is that courts render differing decisions. Differing decisions give rise to ambiguity, so to err on the side of caution, lawyers sue for amounts found in the most generous cases they can find. Defence lawyers then take the position of the amounts cited in the least generous cases they can find. The result is vast differences of opinion. The resulting differences are routinely so extreme that only in court can the true entitlements be determined. Your lawyer will be sued for malpractice if he doesn t play the game and plead the lowest defence, or the highest claim arguable. Reason and logic disappear, and the system itself causes more and more cases to go to trial. Regrettably, the court costs awarded to a successful litigant will rarely be more than one third of their real legal bills. Lastly, the accompanying years of inconvenience and emotional turmoil go completely uncompensated. 5

8 Claim Types In a 2007 TOWERS PERRIN claims survey of Management Liability policyholders, the breakdown of who was making a claim was as follows: Upon further analysis of the allegations from employees, they found that the claims arose from: 6

9 A claim does not refer to just a lawsuit. A claim can arise in a number of different ways. It can be: A written demand for monetary damages A civil proceeding commenced by the issuance of a notice of action or statement of claim A criminal proceeding A formal administrative or regulatory proceeding commenced by a filing of notice of claim or formal investigative order An arbitration, mediation or similar alternative dispute resolution proceeding A written request to waive a statute of limitations relating to a potential civil or administrative proceeding Any insurance advisor would recommend that, should the Association become aware of a situation that may give rise to a claim, they advise their insurer immediately. Not surprisingly, with this type of specialized insurance product, insurers have specific claims personnel with expertise in managing this type of claim. The insurer will want to work in partnership with the insured Association to address the situation as efficiently and effectively as possible. 7

10 Loss Prevention Practices The goal of this document is to assist the Directors and Officers to become more aware of the issues that could give rise to claims of negligence or incompetence. They may then use this awareness to engage in pro-active and preventative decision-making practices to help prevent or avoid such risks. At the present time, the non-profit Association Directors and Officers are generally not subject to the same scrutiny, pressure and legal requirements as their for-profit counterparts. Yet, we are seeing the responsibilities of Non-Profit Organizations evolving. The Associations and their Directors and Officers do accept donations and contributions, but, as well, are creating new avenues for revenue income. The handlers of those funds are elevated to the station of Trustee. The duties, responsibilities and expectations placed upon a Trustee are at the level of a fiduciary. This is a much higher standard than is placed upon the proprietor of a business or an officer of a closely held corporation, answerable only to a select group of shareholders. With the elevated duties placed on a Trustee come elevated penalties when mistakes are made. As more Associations seek different avenues for financial support, exposure grows in regards to the management of those funds. Further to the growing financial responsibilities of Associations, we are watching the impact of a revolution in corporate accountability. Thank goodness for the death of the opportunity for high-ranking corporate officers and accountants to skirt liability for willful blindness by merely alleging I didn t know about it. But with that comes a price. The American Sarbanes Oxley legislation forcing Directors and Officers to execute legal declarations confirming that reports and statements are true, and deeming them personally liable for the state of their organizations, is now becoming entrenched in Canada as well (Bill 128). And while most of it applies only to highly capitalized market entities, this Bill is fast becoming the standard of review and expectation in all venues. This trend has also added more fuel to the fire in terms of Directors and Officers being personally sued. Any rebuttal by an Officer or Director that a misstatement or error is due to true lack of knowledge or an inadvertent IT glitch will now most likely be disregarded by the courts. That is why your accountants, bankers and contract advisors now seek indemnities and hold harmless agreements, which all shift liability back to Officers and Directors. But most importantly, this new standard is also working its way into courts and tribunals at all levels. 8

11 General Principles Governing Directors And Officers Liability Directors and Officers have three commonly recognized duties to the Association Care, Loyalty and Obedience. These duties become risk exposures when not managed in a responsible manner: A. The Duty of Care The Directors and Officers must act in a reasonable and informed manner when participating in the board s decisions and the oversight of the Association s operations. These individuals must be competent in performing their functions and use the care that an ordinarily prudent person would exercise in a like position and under similar circumstances. B. The Duty of Loyalty The Director or Officer must exercise their powers in good faith and in the best interests of the Association, setting aside their own interests and/or the interests of another entity or person. The Director or Officer cannot use their position for personal advantage. Directors and Officers should anticipate the possibility of being challenged from time to time for: Conflicts of interest Questionable business activities Confidentiality i. Conflicts of Interest The Director or Officer must be conscious of the potential for conflicts of interest and act with candour, as well as care, in dealing with such situations. Conflicts exist whenever a Director or Officer has the appearance of, or a material personal interest in a proposed transaction to which the Association may be a party. Where the appearance or possibility of a conflict arises the Director or Officer should disclose the conflict and the board would need to address how they will proceed. The conflict should not result in a breach of the Director s or Officer s duty of loyalty, or void the transactions under which the conflict arose, if the organization can show that certain requirements were met: The transaction was approved by a disinterested majority of the board or committee after full disclosure by the affected Director or Officer of the material facts regarding the transaction and the Director s or Officer s interest therein; The transaction was fair to the organization at the time it was entered into. Directors and Officers need to be aware that lack of disclosure of (or the appearance of) a conflict of interest exposes not only the affected Director or Officer, but also the rest of the board, to a greater risk. Where a board has discovered that action occurred 9

12 without a disclosure of a conflict of interest, it should re-examine the issues with an appropriate record of that examination. A best practice policy and a procedure for the Association to adopt is to have written conflict of interest policies and procedures in place for the Directors and Officers that include a regular communication of the policy. These should also include reference to its employees, customers, the public, and vendors as well. ii. Business Opportunities In the course of their regular business activities, Directors or Officers may become aware of a business opportunity for their firm that would plausibly fall within the Association s present or future activities. The Director or Officer should disclose the opportunity to the board in sufficient detail and in adequate time to enable the board to act or decline to act with regard to the opportunity. It is good business practice for a Director or Officer in such circumstance to make a clear record of the disclosure and request that the Director s or Officer s abstention from exercise of the opportunity be explicit and of record. Failure to make such disclosure could expose the Director or Officer and the entire Association to liability for criminal actions, negligence and/or incompetence. iii. Confidentiality A Director or Officer, at all times, is expected to manage any of their duties in strict confidence. Failure to do so could result in exposure to liability for negligence, incompetence and violation of appropriate privacy laws. C. The Duty of Obedience Each Director or Officer must, at all times, exercise their duties according to their Association s internal guidelines, i.e. constitution, by-laws or policy/procedure manuals. Failure to follow these provisions could expose a Director or Officer to liability for negligence or incompetence. 10

13 Other Principles Governing Directors And Officers Liability Business Judgement Rule Canadian Courts, like their counterparts in the United States, the United Kingdom, Australia and New Zealand, have tended to take an approach with respect to the enforcement of the duty of care that acknowledges the fact that Directors and Officers may have business expertise that courts do not. Many decisions made in the course of business, although ultimately unsuccessful, are reasonable and defensible at the time they are made. Business decisions must sometimes be made, with high stakes and under considerable time pressure, in circumstances where detailed information is not available. It might be tempting for some to see unsuccessful business decisions as unreasonable or imprudent in light of information that becomes available ex post facto. Because of this risk of hindsight bias, Canadian courts have developed a rule of deference to business decisions called the business judgment rule, adopting the American name for the rule. The law, as it has evolved in Ontario, has the common requirements that the court must be satisfied that the Directors or Officers have acted reasonably and fairly. The court looks to see that the Directors or Officers made a reasonable decision not a perfect decision. Provided the decision taken is within a range of reasonableness, the court ought not to substitute its opinion for that of the board even though subsequent events may have cast doubt on the board s determination. As long as the Directors or Officers have selected one of several reasonable alternatives, deference is accorded to the board s decision. This formulation of deference to the decision of the board is known as the business judgment rule. The fact that the Directors or Officers rejected alternative transactions is irrelevant unless it can be shown that a particular alternative was definitely available and clearly more beneficial to the Association than the chosen transaction. Indemnification Some provinces will allow the Association to indemnify (assume liability for) its Directors or Officers under certain conditions (note: that in British Columbia this requires court approval). In the case of civil actions, the Director or Officer must have undertaken such actions in an official capacity, they must have acted in good faith and for a purpose that he or she believed to be in the best interest of the Association. In respect to criminal actions, in addition to the previous standard in civil actions, the Director or Officer is required to have had no reasonable cause to believe that the action at issue was unlawful. In all cases of indemnification, the Association must determine whether the Director or Officer is entitled to indemnification by having met the applicable standard of conduct. The concept of indemnification is further challenged by whether the Association is in a financial position to provide it. As noted earlier, the cost of legal defence can seriously undermine the Association s financial position. 11

14 Employment Practices Liability Employment Practices claims are one of the fastest growing areas of Directors and Officers exposure. Associations (and the Directors and Officers) that are employers have further exposure to statutes that govern the relationship with employees. These laws address discrimination against individuals with respect to hiring, compensation, working conditions, promotion, discipline, termination and other employment practices. The organization needs to develop a formal equal employment opportunity policy regarding these concerns. The policy should: Be approved by the board of directors Receive an annual review by the board to assure it conforms to the current legal requirements Comply with all relevant laws The policy needs to state the Association s commitment to equal employment opportunity The policy must have a procedure for reporting any alleged discrimination The policy needs to prohibit retaliation against anyone who makes a report This will need to be posted publicly and distributed to all of the staff In addition to the Employment Practices policy, the organization needs to address antiharassment issues and the recent development of Whistle Blower protection. 12

15 A Summary of Loss Prevention Measures For the Association Develop an orientation package for new board members (the organization s Bylaws and Charter, their duties, responsibilities and obligations). Have a regular schedule for meetings and operate with a standard agenda. This agenda should be distributed prior to the meeting along with any supporting documents (note these in the minutes) and the previous meeting minutes at least two weeks prior to the next meeting. Act by written consent without a meeting for routine business or for approval of specific actions that have been fully discussed at prior board meetings. Create rules of procedure. Conduct the meetings in an unbiased manner and encourage open discussion. Have concise meeting minutes including names of attendees, along with votes taken and how the board members voted. The minutes need to include any material that was used to support the decisions. If a conflict of interest is reported, document the minutes accordingly. This will need to include any investigative reports and remedial actions, if taken. Create and maintain employment opportunity policies, anti-harassment policies, whistle-blower policy and conflict of interest policies along with the procedures. Conduct annual risk management reviews coordinated by a risk manager, which identify potential areas of risk and the measures undertaken to reduce them. As part of the risk management review, include reviewing all insurance coverage to assure it is up-to-date and sufficient in coverage. For the Director or Officer Needs to attend all meetings. Be aware of the duties and responsibilities of the board members. Must offer independent judgment in the organization s best interest. Be informed about the Associations policies, procedures, and issues. Be knowledgeable regarding all applicable Association contracts, documents, etc. Needs to conduct himself/herself with a strong commitment to the highest level of legal, moral and ethical standards. Be aware and vocal, should an issue give rise to a conflict of interest. Treat all matters as confidential unless there has been a public disclosure of the information. 13

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