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Litigation against SME directors: a growing issue

Personal claims against company decision-makers are on the rise. Who is vulnerable, under what circumstances and how can you reduce the risks?

Did you know that a claim can be brought not just against a business, but its individual directors, owners or managers? What’s more, these kinds of cases, known as D&O (Directors and Officers), which took off in the US in the late 1980s, are becoming increasingly common across Western Europe.

Who is vulnerable to a D&O claim?

Anyone who makes major decisions in your company is vulnerable to a D&O prosecution case. Typically within an SME, this will be an owner, partner or director. In any case, it will be a person with the power to make major business decisions. As Allianz says of such personnel:

‘No matter how prudently they act and how strong their business acumen is, any manager’s decision can result in losses for the company or a third party, and the directors and officers who made those decisions can be held personally liable for those losses and can be involved in costly litigation.’

D&O claims can be made by a variety of third-parties, including:

  • Employees, past and present
  • Investors
  • Clients
  • Shareholders
  • Suppliers
  • Tax authorities
  • Social security
  • Competitors

D&O cases can even be made (and lost) by directors themselves.

Trethowans Solicitors recently obtained a costs order against the principal director of a company who had brought a speculative claim. The director brought the case to court through defending the safety of his product (the litigation concerned the fitness for purpose of a product that had been adapted for use in the oilfield industry but which had been rejected on the grounds of safety).

He alleged that those who had come up with an alternative product to alleviate those safety concerns had been motivated by spurious reasons and acted in bad faith. If the claim had been successful, the director would have stood to benefit financially. Therefore, when the case was unsuccessful, the courts ruled him personally liable for the loss.

Why are D&O claims made against individuals?

D&O claims against individual decision-makers can arise from many different contexts. For example:

  • An employee might sue a director for discrimination on the grounds of age or sex
  • A director might be prosecuted by an authority for his or her personal failure to comply with laws or regulations
  • Misrepresentation or inadequate disclosure might cause a client to claim damages
  • A shareholder might prosecute if they felt that a manager or director had made a decision that caused avoidable financial loss

AS Green & Co. Insurance Brokers cite the following real-life D&O claims:

An engineering firm’s directors were sued when they dismissed an employee without following a fair dismissal process. The claim was settled out of court at £50,000.

A director of a management consultancy made derogatory remarks about a client, based on confidential information he had seen about them. The client sued for defamation and the firm’s data protection practices were investigated by the authorities.

A former director of a company prosecuted the other directors, claiming that they had wrongly calculated his pension benefits, leading to a large financial shortfall.

These examples show that D&O claims can be extremely varied in their nature, which makes it hard to know where they might come from.

How can you minimise the risk of a D&O claim?

Companies can minimise their exposure to D&O suits by following good corporate practice and regularly reminding directors and senior managers of their duties. But the reality is that smaller businesses often need to take risks in order to thrive. As Allianz say, company decision-makers “constantly walk a fine line, making tough and complex decisions with huge impacts on the basis of the sometimes limited information available.”

If the worst happens despite your best intentions, D&O insurance can help to protect your assets by covering the legal costs of defending a claim, as well as any damages awarded against you.

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