30 Mar 2020

In brief:

  1. Capital raisings: ensure any emergency capital raisings are covered, consider ring-fencing cover with a standalone prospectus policy. Ensure speed doesn’t outstrip due diligence and thorough disclosure.
  2. Privacy/Cyber liability: D&O’s need to ensure appropriate IT posture is rolled out and data handling procedures are adequate for the new remote working environment.
  3. Trading whilst insolvent: not all companies will make it. When considering taking on debt, raising capital, or taking on other liabilities take expert advice if in doubt. Your personal liability is not worth the risk.
  4. Continuous disclosure requirements: the fast-paced changes and uncertainties make continuous disclosure a challenge, however D&O’s need to step up to the plate and investigate these new areas and impacts requiring disclosure. We will discuss some of the key areas of focus.
  5. Disclosures to Insurers of Material Change in Risk: some policies, in particular Management Liability policies, have material change in risk conditions. Thoroughly disclose the material changes to insurers through your broker.
  6. Employment practice liability: speed of restructuring and cost cutting may lead to increased EPL claims against D&O’s. Early employee consultation, flexibility, and following formal procedures will help.
  7. Notification of Claims/Circumstances: notify early and notify often. It may already be appropriate for some D&O’s/companies to notify under their D&O policies. We haven’t experienced it to date however blanket Covid-19 exclusions are possible, and in that situation, notification is essential to ensure any future claim has a home.

In detail:

Every board of directors and executive team has unique challenges right now. The current situation with COVID-19 is a reminder that good company structure, risk management framework, and thorough consistent management never go out of style. The goal should not be to predict every future event or outcome, but rather to have structures and plans in place that are resilient and allow sensible decision-making through a major disruption or crisis event. Whenever there is a major global event, recession, or specific company issue this is what companies fall back on.

Here are our takeaways for D&O’s:

Capital Raisings

  • If you’re raising capital make sure you have D&O cover for the prospectus and disclose any capital raisings to your broker. Many companies have Prospectus Exclusions of some type so it’s important that you get cover for the new capital raising;
  • Bake in any additional premium for cover into the capital raising;
  • Consider taking out a standalone Prospectus Liability policy. For large or higher risk capital raisings this ring-fences the D&O (and entity) exposure for this and locks the cover in (typically for 7 years) to give you certainty that cover is in place for the statute of limitations of the capital raising; and
  • Don’t let urgency outstrip due diligence and thorough disclosure.

Some companies need urgent capital to survive and certain regulators have relaxed rules on capital raising. The relaxation of equity capital raising rules focuses on things such as increasing the cap on how much a company can raise in a given period, the offering window to existing shareholders, and how quickly a raising can proceed.

It’s important to note that access to quicker capital raisings shouldn’t mean a wholesale reduction in due diligence. There’s little point surviving severe short-term financial issues to then walk straight into a D&O shareholder action - as many companies did following the Global Financial Crisis (GFC).

The issues will be varied and include:
  • Setting the implied value of the company (noting the balancing act given it may be hard to attract capital at present);
  • Calculating how much you need to weather the storm; D&O claims can arise when a company raises insufficient capital and later collapses after running out of capital and not being able to raise further capital at a critical point;
  • Forecasting prospects and disclosing all material changes and uncertainties (difficult as some of them would never have been contemplated); and
  • The financial viability of the company.

It remains important to engage as early as possible with shareholders and to ensure that good quality advisors are used.

Privacy and Cyber Liability

  • IT posture and the handling of confidential information is critical as companies race towards fully remote operations;
  • Employees using their own devises and standard protocols being softened presents a real threat;
  • D&O’s should manage the need to remain online with maintaining appropriate controls; and
  • Cyber criminals are already targeting these vulnerabilities

The last five years have seen a sea change for expectations of D&O’s expected knowledge and management capability of data privacy and cyber issues. This has required upskilling of their knowledge, amending management structures, and changes to board compositions and senior executive team to include such positions as Chief Information Officer and Chief Technology Officer. This will be a big universal test of how much D&O’s have upskilled in terms of knowledge and awareness.

One of the big challenges of the crisis has been the speed of change with shutdowns happening quickly. Whilst a lot of companies have some secure remote working capabilities, many companies were not prepared to have their whole workforce work from home. Some of the exposures are easy to identify such as security issues with employee-supplied devices, however there will no doubt be more complex exposures unfolding so being fully engaged with the IT security and data privacy teams is important.

With regard to Cyber policies, companies should consider notifying their broker of material changes to the disclosed security arrangements and processes. Whilst most insurers are taking a constructive approach it remains to be seen if they will pay a multi-million-dollar loss in the event that the breach was due a non-disclosed change in procedure or IT posture.

Trading whilst Insolvent

Unfortunately, not all companies will survive the current crisis. As D&O’s try to navigate the situation it’s important that they understand all regulatory obligations and avoid trading whilst insolvent. The bid for company survival is not more important than your personal liability.

Insolvent trading is considered where a D&O allows the company to incur a debt at a time when the company is insolvent where, at the time that the debt was incurred, there existed reasonable grounds for suspecting that the company was, or may become as a result of incurring the debt, insolvent.

When it comes to deciding whether to incur a debt or continue to trade, understandably D&O’s may struggle with the complexities of the current situation and to remain impartial, so use expert accountancy and law firms as required.

Continuous Disclosure Requirements

For listed companies this is a particularly challenging time. What to disclose, how frequently to update the disclosures, and ‘how-to’ disclosure are all important considerations.

Some areas boards may consider for disclosure are:
  • Immediate financial impacts: these include levels of cash at bank, cash flow issues due to lack of payment from customers, and upcoming renewal of debt facilities;
  • Revenue drivers: whilst this is a routine consideration, companies will need to stay ahead of disclosing known changes and provide context to such changes. Changes may be driven by supply issues as well as demand and some companies will experience issues with major contracts. Some companies will have to focus on financial outperformance certain companies such as pharmaceuticals, supermarkets, and medical industry manufacturers will see spikes in revenue. They will need to update the market for what might be only a short-term uplift or where it’s affected by consumer patterns such as hoarding, which may lead to diminished future demand;
  • Supply chain disruption: companies may already know that supply delays may extend past the current lockdown period;
  • Counterparty exposure: critical counterparties might be financially failing, unable to deliver good/services, or be known to be dishonouring contracts;
  • Government or regulatory intervention: companies unable to operate or that have had resources redirected into other services for a period;
  • Direct Covid-19 exposure: some companies will have employees exposed to Covid-19, leading to a direct impact on the business.

Unfortunately, it’s bad news in terms of frequency of required updates. As D&O’s of listed companies are aware, the question of how often to update the market comes down to materiality of the changes and new information to hand. At present some clients have shareholders demanding daily forecasts updates.

How disclosures are made is an important consideration given the pace of change. An example of a common issue is where a company makes public disclosures followed by an analyst briefing several days later. During this period things may have developed further. Care regarding what information is disclosed at the analyst briefing is important

Consideration needs to be given to equal access of information for shareholder and the market given the restrictions for the general public to attend in person and receive physical information. Companies need to post transcripts of calls, provide timely dial in detail for conference calls, and provide voice and video recordings of calls.

Companies should be wary of private briefings. There have been D&O claims in recent times with respect to providing market sensitive information to select shareholders in closed door sessions. It’s more important than ever to be vigilant in this area with the pace of change.

Disclosures to Insurers of Material Change in Risk

Some Management Liability policies (that have D&O cover) contain material change in risk conditions. We are not an advocate of such conditions because of their broad and ambiguous nature.

If you have D&O cover with such a condition, then you should strongly consider providing an update to your insurer via your broker to ensure that you don’t fall afoul of such a condition.

Employment Practice Liability

The current environment for employee management and engagement must be one of the most challenging in living memory. The sheer pace of the government mandated changes and restructuring required for some companies to survive is mind boggling.

We expect to see an uptick in employment practice claims - both against companies and D&O’s.

The key to companies navigating this will be early and honest engagement, empathy and flexibility where possible, following formal procedures, and engaging human resource and employment consultants where necessary.

Notification of Claims/ Circumstances

COVID-19 has the potential to produce many different types of D&O claims. Some will be made today, and some will develop in the future as the situation plays out. What is important is that these claims and circumstances have an appropriate home under a policy. We will borrow the words of Clayton Utz’s Fred Hawke for our advice: D&O’s should notify early and notify often.

When it comes to actual claims made against D&O’s, this is often straight forward. Engage your broker and notify your insurer and they will respond accordingly.

D&O policies also allow for the notification of circumstances that D&O’s believe will reasonably give rise to a claim. If there is an act, error or omission, or event that D&O’s believe could give rise to a claim they have the right to notify that as a circumstance under the policy.

Most often if D&O’s are considering making a notification of circumstance, they should do so. There is also little downside to making a notification. If it’s declined by the Insurer (generally for not being specific enough) then under most good D&O policies D&O’s should be able to notify that claim in the future.

Finally, it’s possible that insurers apply policy restrictions to D&O renewals as they seek to ring-fence the exposure in their portfolio and to restrict future losses. This could be a COVID-19 specific exclusion or a more common exclusion, such as an insolvency exclusion, if they’re concerned about the viability of a company going forward. If a COVID-19 exclusion is applied, it is essential that a notification is made under the current policy to ensure the best chance of having cover if a claim does develop from COVID-19.