Directors Source News - July 2008

Directors face a range of legal exposures in respect of their association with and fiduciary duty to a corporation. They increasingly look to the state of their indemnities and insurance and to their professional advisors for assurances that they have an appropriate level of protection in place. Boards are well advised to take an active interest in their corporation’s provisions for indemnification and insurance for directors' and officers' liability. 20 Questions Directors Should Ask about Directors’ and Officers’ Liability Indemnification and Insurance will help directors understand the protection available to them under corporate indemnification and directors’ and officers’ insurance. The document discusses indemnification and insurance in three sections: indemnification, insurance coverage, and insurance claims, and provides questions that directors may ask the CEO and their professional advisors to ensure that they fully understand the protection available to them.

Summarized answers to two questions are included below.

Can the sitting directors be held liable for approving the payment of an inappropriate indemnity?

Yes, the sitting directors (those deciding whether to pay an indemnity to another present or former director) can be held liable to the corporation for causing the corporation to pay an indemnity that is prohibited by statute — for example, to a director who is found to have acted against the best interests of the corporation concerned. An indemnification contract will not relieve against this liability.

Where indemnification is discretionary, different considerations apply. The statutes contemplate that the directors sitting on the board at the time a request for indemnification is received will consider it and apply their judgment as to whether indemnification is permitted, perhaps obtaining the assistance of the court. They must then exercise their discretion to cause the company to pay or withhold indemnification by applying their business judgment in the best interests of the corporation as they do with other corporate decisions that come before the board. But they are not entitled to exercise their business judgment to pay an indemnity to a director who did not meet the conduct threshold. For that reason the decision whether or not to pay an indemnity is often deferred until the quality of the director’s conduct can be clearly established, which sometimes requires a judicial decision.

The sitting directors might be held liable to the corporation if they pay an indemnity that, while not prohibited, is not in the best interests of the corporation at the time of payment. Having a by-law or, better still, a contract in place to make indemnification mandatory wherever it is permitted by the statute helps to protect the sitting directors against this exposure. The decision to enter into the contracts can be justified with regard to the interest of the corporation in attracting and keeping qualified directors at the time the contract is entered into. When it comes time to pay the indemnity (or to advance defence costs) the sitting directors are entitled to take into account the mandatory terms of the indemnification by-law and contract which the company has already entered into and is now being called upon to perform.

Is the director at risk of having to pay the deductible?

D&O policies, like other insurance, typically require the insured to assume losses up to an agreed sum (the deductible) which often, but not always, applies to defence costs. The deductible is often substantial, in the order of $100,000 or more. There is also often a higher deductible for securities claims. Typically the policy declarations show a deductible of zero, or a low amount, for the Side A coverage, where the insurer indemnifies the individuals directly. But a much larger deductible is often shown against the Side B coverage, where the insurer reimburses the corporation for indemnifying the individuals. Larger deductibles are often seen in policies for corporations issuing securities in the United States.

This does not necessarily mean that, if the corporation does not indemnify the individuals, no deductible applies. Many policies contain one form or another of “presumptive indemnification” provision. These provisions cause the deductible to apply to the individuals where the corporation is legally permitted to indemnify the individual but does not choose to do so. If the insurer takes the view that the corporation can indemnify the director, and the corporation takes the view that it cannot, or cannot do so yet, until the nature of the director’s conduct is determined, then the director could be left without a ready source of funding for defence costs, within the deductible layer.

Presumptive indemnification provisions make it all the more important that individual directors and officers have enforceable rights of indemnification from the corporation so that they will not have to bear the deductible. It is important to review presumptive indemnification language closely. Among other considerations, the policy should clearly provide that if the company is legally permitted to indemnify the director but cannot afford to do so because it is insolvent, the deductible will not apply against the director.

For full answers to all questions, click here to download

The asset backed commercial paper crisis rocking the world's financial centres begs two questions: Where were the boards of directors during the lead-up to this crisis? And, why weren't they able to effectively carry out their most crucial role of making their organizations more accountable and effective?
Those questions are well worth asking, as long as we recognize that the oversight role puts a heavy load on directors, most of whom are outsiders and many of whom are part-timers.

To ensure their boards meet this challenge, governance experts are relying on annual board self-assessments — primarily questionnaires that explore issues of process, disclosure, effectiveness and trust.

Unfortunately, board assessments can do more harm than good — particularly when certain key risks are ignored. As a result, many board assessments are not fully engaging the directors who use them. They are not eliciting and disseminating all the information they could. And they are not creating sustained performance improvements. What’s going wrong? Here are the seven deadly sins of board self-assessment.
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Link to full document

This notice provides guidance to an issuer on disclosure of expected changes in accounting policies relating to an issuer’s changeover to International Financial Reporting Standards (IFRS) as the basis for preparing its financial statements. This guidance applies to disclosure relating to each financial reporting period in the three years before the first year for which an issuer prepares its financial statements in accordance with IFRS.

No later than in its MD&A for the year beginning three years before an issuer's changeover date (December 31, 2008 in the case of an issuer that will change to IFRS for its financial year beginning January 1, 2011), the issuer should discuss key elements and timing of its changeover plan including the impact of IFRS on accounting policies, information technology and data systems, internal control over financial reporting, disclosure controls and procedures, and business activities. The disclosure requirements become more detailed as the changeover date approaches. Annual and Interim MD&A disclosure requirements for two years and the year before changeover to IFRS are also highlighted in the Staff Notice.

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By Douglas M. Branson
December 2006

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Published: 2008, NACD/Pearl Meyer & Partners, LLC

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