The Centro case and the wider implications to directors’ and officers’ insurance

It would be fair to say that the Centro decision continues to resonate within and around the business of corporate governance and the ability of directors and officers to transfer personal liability for risk associated with their roles.  Certainly there are implications arising from the Centro decision going forward regarding the ability of a company and those who have corporate responsibility to transfer the risk in the insurance market, particularly insurance for directors and officers (D&O insurance).

In penalty submissions ASIC recommended to the Court that the Court impose corporate bans of up to three years and monetary fines on the directors as a measure of deterrence.  Not surprisingly the directors are arguing that the attention the case has brought has meant that deterrence has been served.  It is open to the court to hand down declarations alone without bans or fines.    

It is not the purpose of this commentary to review the Centro decision.  However, the central messages of the decision and the practical measures that can be taken by companies and those with corporate responsibility to reduce personal liability can be found in the article entitled 'Centro case – the central messages' by Mr Leigh Warnick.

A usual method of risk management for directors and officers is to have in place a Deed of Indemnity to transfer risk to the corporation to the full extent permissible by law. There are certain recent developments in this area of law that can be found in the article entitled 'Indemnities for directors' by Mr Tony Chong.

In addition to a Deed of Indemnity, a D&O insurance policy is taken out by the corporation on behalf of those who have corporate responsibility.  Past, present and future directors and officers have a level of protection against personal liability for legal costs, fines, penalties and damages. 

It is not surprising to hear that insurers are reflecting on the Centro decision, the possible penalties that might be imposed and perhaps the likely prospects of an appeal with a view to taking a longer term view of managing their own risk exposure in this particular market.  Although, at this stage it is difficult to envisage how or even if insurers will tighten up the wording in D&O insurance policies to exclude or restrict the type of risk exposure found in the Centro decision.  However, there are methods that insurers may use to manage the severity of their own future risk exposure.

Justice Middleton made it very clear in his judgment at paragraph [14] that the '…role of a director is significant as their actions may have a profound effect on the community, and not just shareholders, employees and creditors.'  It is unlikely that the courts will retreat from this view and in that regard corporations may well consider putting in place practical steps to not only reduce the risk of an adverse finding in the event of an ASIC claim but also importantly facilitate renewal of D&O Insurance in the forthcoming renewal periods.

Directors and officers may well find that their qualifications individually and collectively as a Board come under close scrutiny by an insurer at renewal of the D&O insurance policy. 

The Centro case informs us that the Corporations Act 2001 requires directors to form an opinion regarding the financial statements themselves.  They may rely on internal and external advisors to assist in forming their opinion, however that reliance ought not to be taken too far.  The basis of forming their opinion requires the director and officer to engage a critical mind during the process.  The errors in the financial statements were obvious to Justice Middleton.   Indeed, Justice Middleton although not deciding in this case, suggests at paragraph 206 of the judgment that directors should have a degree of accounting knowledge and understanding of the terminology.  At the renewal of a D&O insurance policy a corporation that does not satisfy a standard of education of its directors and officers might find that it is faced with an increase in the premium and possibly a restriction in cover.

Corporations may take the prudent view that well before renewal of the D&O insurance policy their directors and officers engage in a recognised course in accounting either to learn the basics or refresh their understanding and qualifications.  This is not dissimilar to the concept of professionals undertaking ongoing education to meet professional standards and professional indemnity insurance requirements.  

It ought not to be assumed by a corporation that just because a director has the appropriate qualifications that will suffice.  The directors in the Centro case were described as intelligent and experienced men of the corporate world.   A Board may well undertake its own critical internal review of the composition of the Board and the contributions of each individual director and officer on the board.

A review of a corporation’s internal procedures and management processes may be needed.  That review will include a critical analysis of the ability to control the amount of information and timing of the information put before the board.  If procedures and the implementation of the procedures are inadequate, then a corporation may well be penalised at renewal of the D&O insurance by way of increased premium or restricted cover. 

It ought to be foremost in the minds of the corporation, directors, officers and insurance brokers that the completion of the proposal form at renewal is likely to require a higher degree of accuracy and disclosure in light of the Centro decision.  Prospective measures put in place now may go some way to reassure a corporation’s D&O insurer that the risks, in practical ways have been reduced.  Of course proposal forms that are not completed with honesty and completeness may well give an insurer an avenue to reduce its liability to zero in the event of a claim.

A corporation’s ability to respond proactively to the result of the Centro case will likely assist at renewal of the D&O insurance.

For more information, please contact:

Iain Freeman                                                         Christine Arthur
Partner                                                                  Senior Associate
(08) 9288 6759                                                      (08) 9288 6706