UK: Liability Insurance For Directors Of AIM-Quoted Companies

MARKET BACKGROUND

Company directors are familiar with headlines suggesting that they should become subject to further restrictions and responsibilities. The global financial crisis and corporate scandals have led to an analysis of whether securities regulations worldwide should be tightened and weightier corporate governance measures introduced. Such measures have highlighted the role and heightened the responsibilities of a director. In particular, directors of publicly quoted companies are subject to greater regulation and public scrutiny than private company directors through securities laws, associated corporate governance and reporting requirements.

The Alternative Investment Market (AIM) is the London Stock Exchange's international market for smaller growing companies. There are currently around 1,300 companies traded on AIM, of which around 500 have the majority of their operations outside the UK.

Companies whose securities are traded on AIM must observe the AIM Rules for Companies, issued by the London Stock Exchange (AIM Rules). AIM company directors must accept full responsibility, collectively and individually, for compliance with the AIM Rules, both during the AIM application process and on an ongoing basis.

Given the nature and scope of the responsibilities assumed by AIM company directors, it is understandable that they will consider ways to insulate themselves financially against personal risk by seeking indemnities from the company and/or insurance cover.

Against this background, this article looks at:

• Company indemnities.
• Insurance policies.
• Day-to-day risks.
• Additional risks
• Directors' sanctions.
• The extent to which insurance is required.
• What areas of risk remain.

COMPANY INDEMNITY

If permitted by the Companies Act 2006 (CA 2006) and the company's articles of association, a UK company can give an indemnity to directors to cover costs and damages incurred in relation to civil claims. While a company indemnity provides a degree of protection, it is only effective if a company is able and willing to meet its obligations. For example, if the company becomes insolvent, the director has no choice but to self-finance claims.

In addition, the CA 2006 restricts a company's ability to indemnify a director in certain circumstances, such as successful claims by the company itself (including shareholder derivative actions) in relation to a director's negligence or breach of duty. No indemnity is available in relation to criminal penalties.

In cases where a director does not have an indemnity from the company, insurance can be obtained to cover any losses or expenses arising from claims.

INSURANCE POLICIES

A company can buy insurance for its directors, and those of an associated company, against any liability for negligence, default, breach of duty or breach of trust by them in relation to the company of which they are directors (section 233, CA 2006).

Without insurance, a director's personal assets are more likely to be at risk if the company's indemnity fails. Insurance is of growing importance as an added level of protection particularly with the introduction of additional legislation and codes of conduct (for example, Sarbanes-Oxley) as well as recent actions against directors, particularly in the US.

D&O insurance Directors and officers (D&O) insurance is designed to protect company directors from losses resulting from claims made against them in relation to the performance of their duties.

Prospectus liability insurance Directors can also take out prospectus liability insurance. This provides separate and additional cover for directors against liability for misrepresentations and errors or omissions in an admission document or prospectus.

Professional indemnity insurance Firms which are engaged in providing professional services have professional indemnity insurance cover to protect them and their partners, directors and employees against third party claims arising out of acts or omissions in providing professional services. It is unusual for a company's professional advisers not to hold professional indemnity policies.

DAY-TO-DAY RISKS

Corporate activities such as offerings of securities, acquisitions or disposals are areas where directors are faced with additional risks from allegations of wrongful acts or misrepresentations in relation to their activities. However, directors are also susceptible to claims arising from their day-to-day management of the company's business. D&O insurance policies typically cover the following matters (policies exclude cover where fraud or dishonesty is involved):

• Claims against directors for wrongful acts in their day to day activities such as:
• breach of duty;
• breach of trust;
• negligence;
• misstatements;
• misleading statements;
• defamation;
• breach of warranty of authority;
• wrongful trading;
• company (or shareholder derivative) claims.

• Investor losses arising out of profit warnings.
• Investor losses arising out of misstatements or misrepresentations in an admission document (or a prospectus).

The D&O policy will typically cover defence costs, settlements and judgments in relation to any civil claim.

ADDITIONAL RISKS

There are additional risks encountered by AIM company directors both on admission and on an ongoing basis.

On admission

The AIM Rules provide that an admission document (or a prospectus) (see box, When is a prospectus required?) must contain specific information prescribed by the AIM rules, and generally must contain all information necessary to enable investors to make an informed assessment or to have a full understanding of the following matters relating to the company:

• Assets and liabilities.
• Financial position.
• Profits and losses.
• Prospects of the company and the securities for which admission is sought.
• The rights attaching to the securities and any other matter contained in the admission document.

Directors are primarily responsible for the information in an admission document. The nominated adviser (Nomad), the company's lawyers and its other advisers will collectively advise on the specific content requirements of the admission document and will provide guidance on any general information which should be disclosed under the AIM Rules.

The admission document must include a declaration by the directors that, to the best of their knowledge, the information in the admission document is in accordance with the facts and the document makes no omission likely to affect the import of such information. In addition, the directors are also responsible for bringing any significant change, significant new matter or significant inaccuracy of which they become aware to the notice of the company and its advisers, as there may be a need to issue a supplementary admission document (or supplementary prospectus).

If the offer of securities is extended to overseas investors, there will be additional laws and regulations of overseas jurisdictions which must be observed. These can expose the directors to further liabilities.

It is also common for directors to give warranties in underwriting or placing agreements in support of the information in the admission documents in relation to which they will have personal liability. It is unlikely that this liability will be covered by a standard D&O policy. Although it is possible for directors to obtain such cover, either by extending the D&O policy or taking out a separate warranty and indemnity insurance policy, in practice, they rarely do so.

Issuing an admission document (or a prospectus) is a high profile and important event for a company and its directors, and requires directors to take due care to ensure the document complies with all statutory and regulatory requirements. As a result of this and as a means of safeguarding the directors, the company's lawyers undertake a verification exercise of the admission document. This involves a series of questions and answers in relation to each statement in the admission document requiring the directors to focus on the accuracy of its content and its implications, and to provide source material to substantiate the relevant information.

On an ongoing basis

An AIM company director's obligations under the AIM Rules do not cease on admission. AIM company directors are also subject to a number of disclosure obligations to keep the market properly informed of:

• Developments which could affect the company's share price.
• Acquisitions and disposals of assets.
• The issue of securities.
• Restrictions on dealing in securities, particularly by directors and their families.

Directors should take advice from their Nomad and legal advisers on these obligations.

The directors should therefore review the terms of the D&O policy to ensure that it offers appropriate cover for market announcements.

DIRECTORS' SANCTIONS

Sanctions can be imposed on directors for failure to comply with the provisions of the Financial Services and Markets Act 2000 (FSMA) and for certain criminal behaviour in relation to securities markets.

Importance of advisers

AIM companies must seek advice from their Nomad, on an ongoing and regular basis, to ensure compliance with the AIM Rules. Advice from professional advisers should be regarded as an important safeguard by companies seeking to demonstrate adherence with legal and regulatory requirements.

Compensation under FSMA

If there is an untrue or misleading statement in a prospectus (where there is an offer of securities to the public, see box, When is a prospectus required?) or if a matter which is required to be included in a prospectus is omitted, the directors, as persons responsible for the prospectus, are liable to pay compensation to any person who has acquired securities and suffered loss in reliance on such statement or as a result of such omission (section 90(1), FSMA). If there is no issue of securities to the public, the above provisions concerning compensation to investors do not apply. However, there are liabilities under common law, other statutes and the AIM Rules.

Common law

An investor may have claims against an AIM company and/or its directors for:

• Deceit.
• Negligent misstatement.
• Misrepresentation.
• Breach of contract.

Sanctions imposed by the AIM Rules

The AIM Rules do not include provision for the payment of compensation to investors. Instead, the London Stock Exchange can impose sanctions on the company for breach of the AIM Rules, including:

• Warning notices.
• Fines.
• Censure.
• Cancellation of the admission to trading of the company's securities.

The London Stock Exchange may also publish the fact that an AIM company has been fined or censured and the reasons for the fine or censure.

Sanctions against the company may lead to actions by the company against the directors.

Criminal sanctions

Section 397 of FSMA creates offences in relation to the provision of (or failure to provide) information in the context of investment activity including information in an admission document or market announcements. In addition, the publication of misleading statements or omission of information from an admission document could amount to an offence under the Theft Act 1968 or the Fraud Act 2006.

Other behaviour in relation to securities markets may constitute insider dealing, market abuse or an offence under FSMA.

THE EXTENT TO WHICH INSURANCE IS REQUIRED

The type and extent of insurance required depends on the nature and the likelihood of the relevant risk, and the cost involved.

D&O insurance

In the light of these liabilities, well-advised directors will ask the company to consider the scope of its D&O policy. While D&O insurance commonly covers the day-to-day business of directors, the extent of the cover may not necessarily be appropriate for securities transactions.

D&O cover offers reassurance for directors, and also has advantages for the company. Coverage can provide balance sheet protection for a company which has indemnified its directors, as the policy should reimburse the company to the extent of any indemnification.

In the context of an AIM company, D&O policy premiums are likely to be higher than premiums payable by private companies. In addition, an AIM company may require extended cover to that typically obtained under a standard D&O policy.

When is prospectus liability insurance appropriate?

A D&O policy does not always automatically cover issues of securities. Underwriters may consider the nature of securities transactions to be material to their risk and subject to their prior agreement. Therefore, the D&O policy terms should be checked carefully. In most cases, it is possible to extend D&O coverage with an additional premium. However, extending the D&O policy could dilute protection in other areas and in any event will not provide the same level of cover as prospectus liability insurance.

As a D&O policy is renewable every 12 months, misrepresentations in the admission document could affect renewal negotiations and future premiums. In contrast, prospectus liability insurance is a one-off policy over a specified period to cover the duration of the potential liabilities.

Further, there is a risk that the limit of coverage in the existing D&O policy may be exhausted by claims arising from past improprieties of the directors. As a result, the insurance cover available to meet later claims arising out of the admission document or market announcements could be inadequate.

A separate prospectus liability insurance policy ensures that insurance protection for all the information in the admission document can be ring-fenced separately from other risks.

Prospectus liability insurance is viewed as being relatively expensive as it covers what is perceived by underwriters as a high risk because a number of potential liabilities may arise out of the occurrence of a single event (that is, the issue of the admission document (or prospectus)).

In practice, prospectus liability insurance is much less common than D&O insurance. Most companies view the services and advice of its Nomad and other advisers as providing sufficient protection against their liabilities for misrepresentations, errors or omissions in the admission document. This is perceived as eliminating the need for a separate prospectus liability policy, perhaps on the basis that claims could be made against advisers and their professional indemnity policies. Such claims may, in reality, be difficult to establish and would not always be successful.

WHAT AREAS OF RISK REMAIN?

Criminal liability

Insurance cannot, for public policy reasons, be bought to defend against the risk of criminal fines, penalties or other matters which are deemed legally uninsurable.

Regulatory

A company or its directors cannot generally insure against FSMA fines as they are considered closer to criminal rather than civil penalties since they are punitive (rather than compensatory) in nature. Further, many insurers (who are themselves regulated by the FSA) are unwilling to offer insurance which might reduce the effectiveness of the FSA's disciplinary powers. However, insurance is widely available for defence and investigation costs where a director is defending himself against FSA regulatory proceedings. Most D&O policies cover these costs.

Reputational

Reputation is of key importance to companies and individuals operating in securities markets.

If the London Stock Exchange fines or censures an AIM company and its directors are implicated in the default, or if directors are found guilty of a criminal offence, their reputation will be significantly tarnished. No insurance can cover the risk to a director's reputation. Companies and their directors must ensure that appropriate systems and controls are in place to minimise such risks. In this context, the importance of a thorough verification process in relation to documents available publicly or released to the market and related professional advice should not be underestimated.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.