Personal Accountability and Corporate Control: The Role of Directors' and Officers' Liability Insurance

DOIhttp://doi.org/10.1111/j.1468-2230.1994.tb01982.x
Date01 November 1994
Published date01 November 1994
Personal Accountability and Corporate Control: The
Role of Directors’ and Officers’ Liability Insurance
Vanessa Finch
*
Introduction
Individual company directors are increasingly being looked to when things go
wrong in corporate affairs. Not only may directors be sued for breaches of
fiduciary duty or for misrepresentation, but recent statutes have greatly increased
the potential civil and criminal liabilities of directors and officers. Under the
1985
Companies Act, the director or officer can be charged with over
200
kinds of
infringement and further offences are provided for in health and safety,
environmental, data protection and financial services legislation. The personal
exposure of directors was added to significantly by the
1986
Insolvency Act and by
the
1986
Company Directors Disqualification Act. Further legislation on
environmental and financial services matters is expected from Europe and this is
likely to add to directors’ burdens.
Balancing such potential personal liability is the availability of company-funded
directors’ and officers’ insurance
(‘D
&
0’
insurance). This was facilitated by
section
137
of the
1989
Companies Act which amended section
310
of the
1985
Companies Act to provide expressly that a company may purchase and maintain
insurance for its directors and officers against liability for negligence, default,
breach
of
duty or breach of trust in relation to the company.
This article examines the role and operation of this combination of individual
liability and insurance. It looks at the place of such a combination within the
scheme of corporate control and considers,
inter
alia,
the answers to two
questions. First, is insurance the ingredient that makes accountability through
personal liability work or the factor that undermines that accountability? Second, is
a more selective approach to personal liability called for? In concluding, I argue
that the rise of insured individual liability represents a new and perhaps worrying
approach to the fundamental dilemmas of corporate design.
Part A of the article reviews the rationales for making personal liability a
significant plank within the scheme of corporate control and considers the
problems and costs associated with individualistic approaches. Part
B
looks at the
role of insurance in making personal liability operate as a mechanism of
accountability and explores the broad arguments for allowing company-funded
insurance. Part C discusses factors affecting the availability of insurance cover
generally and considers the susceptibility of the insurance market to periods of
crisis. Experience in the United States and the Commonwealth is drawn upon in
this analysis. Part D considers the development
of
‘D
&
0’
insurance in England’;
its anticipated role, form, availability and uptake; and whether the English
*Law Department, London School
of
Economics and Political Science.
I
would like to thank the following
for
their help: Rosemary Whitfield-Jones and Paul Dingli
of
Gan
Minster Insurance; George Davies and Adam Piper
of
Sedgwick International Broking Services; Edward
McLaughlin of the Wyatt Co; Paul Fenn; Judith Freedman; Ian Ramsay; Robert Baldwin and Pamela
Hodges.
1
This article looks at the English rather than the
UK
position, since English law
is
the subject
of
analysis. Some references
infra
will be made
to
the
‘UK’
insurance industry since
data
on the industry
is collected on a
UK
basis. References to England should
be
read as including Wales throughout.
0
The
Modern Law Review Limited
1994
(MLR
57:6.
November). Published by Blackwell Publishers,
108
Cowley Road, Oxford OX4
IJF
and
238
Main Street, Cambridge. MA 02142, USA.
880
November
19941
Personal Accountability
and
Corporate Control
insurance system can be operated in a manner that avoids potential pitfalls and
heeds lessons from other countries. Part E looks at the prospects for insured
individual liability within the scheme of English corporate governance, considers
potential reforms and explores alternatives to
‘D
&
0’
insurance.
A
Why
Make
It
Personal?
If
it is assumed that the rules of company law should,
inter
afia,
encourage wealth
creation yet discourage corporate wrongdoing,2 what is the case for pursuing
such ends by using rules imposing personal liability (civil or criminal) upon
directors and managers? A number of general arguments point to the value of such
liability. In the first instance, retributive principles may demand the direct holding
to account of those responsible for some kinds of conduct
-
as, for example,
where criminal actions are carried out intentionally. The retributive stance thus
urges that the state avenge wrongful acts3 and sees the resulting deterrent effect
as an important but ancillary benefit.
If,
however, the behaviour at issue is not
highly blameworthy individual misconduct but actions that are either less
obviously reprehensible or less within the control of the individual (perhaps
because they result from joint activity by a number of actors), the case for
individual liability weakens. Sanctions or civil liabilities are less likely to prevent
misconduct if the person sanctioned is capable of exerting only limited control over
the activity and, if individuals are criminalised or made civilly liable in these
circumstances, there
is
a danger of undermining the moral force of the criminal or
civil justice ~ystem.~
A second, and related, argument emphasises the need to deter wrongdoing and
urges that flaws in enterprise-based controls and in market-based constraints on
directorial wrongdoing (such as the market for corporate control and the market
for directorial services5) may require the use of personal liability rules. The
principal limitations to enterprise liability6 are:
asset insuflciency
-
when firms
lack the assets that would be required to make good the damage caused by
wrongdoing;
sanction ineficiency
-
when the legal system cannot impose, or
judges are unwilling to impose,’ costs on the firm that are sufficiently high to
deter wrongdoing (eg because of penal considerations or because liquidation may
On wealth creation, profit maximisation and the public interest, see Parkinson,
Corporate Power
and
Responsibility
(Oxford: Clarendon Press, 1993) ch
1.
See
Osterlie, ‘Limits on a Corporation’s Protection of its Directors and Officers from Personal
Liability’ (1983) Wisconsin LR 513,534-535; Mueller,
‘MensRea
and the Corporation’ (1957) 19
U
Pitt LR 21; cf Posner,
Antitrust Law:
An
Economic Perspecrive
(1976) 223-226.
See Stone, ‘The Place of Enterprise Liability
in
the Control of Corporate Conduct’ (1980) 90 Yale
U
On the market for corporate control, see Manne, ‘Mergers and the Market for Corporate Control’
(1965) 73
J
Pol Econ 693; Eisenberg, ‘The Structure of Corporation Law’ (1989) 89 Col LR
1461
-
1521; Franks and Mayer, ‘Capital Markets and Corporate Control: A Study of France,
Germany and the UK’ (1990)
10
Economic Policy
191 -231; Bradley, ‘Corporate Control: Markets
and Rules’ (1990) 53 MLR 170. On the market for directorial services, see Crain
er
al,
‘On the
Survival
of
Corporate Executives’ (1977) 43
S
Econ
J
1372, 1374; Fama, ‘Agency Problems and the
Theory of the Firm’ (1980)
88
J
Pol Econ
288,
295.
Kraakman, ‘Corporate Liability Strategies and the Cost of Legal Controls’ (1984) 93 Yale
U
857. See
also Parkinson,
op
cir
n
2
supra,
pp 354-361.
Chard,
Illegal
Corporate Behaviour
(1979); Osterlie,
op
cir
n
3
supra,
at 533; Coffee,
“‘No
Soul
to
Damn:
No
Body to Kick”:
An
Unscandalized Inquiry into the Problem of Corporate Punishment’
(1981) 79 Mich LR 386, 391
-
393. On alternative to fines,
for
example, equity fines,
see
Coffee,
ibid
pp 413
passim.
1, 31-32.
0
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1994
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Law
Review
[Vol.
57
result, affecting ‘innocent’ parties such as the firm’s employees, suppliers,
consumers and distributors)8; and
enforcement insuficiency
-
which occurs
when a legal system is unable to detect or prosecute a significant proportion of
offences (due, for example, to resource, evidential and legal limitations). Personal
liability may provide high levels of deterrence and may overcome some of the
problems that are encountered in prosecuting
corporation^.^
Potential personal
liability may, moreover, encourage directors to provide information to those
investigating company failings in the hope
of
offsetting their own liability.
In addition, it can be argued that for a series of reasons it may be extremely
difficult to prevent corporate misconduct by punishing only the firm.1° Thus,
individual managers may indulge in misconduct perceiving wrongdoing to be in
their
interests, even in circumstances where the potential cost to the firm exceeds
the potential corporate benefits. Short-term effects such as promotion or
concealment of error may be sought. Even where enterprise liability is great, the
firm may be poorly positioned, for informational, organisational or other reasons,
to prevent directors from securing such short-term gains. Directors may, indeed,
feel relatively immune from sanctions by the firm
-
where, for example,
loss
of
office would be
so
generously compensated as to hold no terrors.” Modern
corporations may, moreover, find ways to steer operations and apply pressure to
achieve results whilst leaving questions of
modus operundi
to middle management
-
this structure gives control but insulates headquarters from, particularly
criminal, responsibility for operational decisions. Where sanctions against the firm
are modest, the company may actually endorse wrongful conduct by directors and
the incurring of civil or criminal liability. It may be able, moreover, to press the
director to behave in errant ways. To middle managers, the prospect of dismissal
or demotion may mean more than the potential civil or criminal liability of
themselves or the company
-
particularly when they envisage a higher probability
of being held to account by means of internal rather than external review
mechanisms.
l2
Market-based constraints on directorial wrongdoing may be ineffective not
merely because of problems of information, collusion within the
firm
and
fluctuations within the market, but through a focus on aggregate performance
rather than individual acts and toleration of wrongdoing in the face
of
other
‘successful’ actions. Such constraints may, indeed, not inhibit certain forms of
misconduct at all. Thus, the market for corporate control may not exert pressure
where wrongdoing enhances profits and share prices
-
for example, illegally
polluting a river proves an attractive alternative to expensive filtration.
It is, of course, desirable to encourage those involved with companies to monitor
potential wrongdoers and bring pressure to bear to avoid harms.
A
further
~~~ ~~ ~~ ~
8
See Osterlie,
op cit
n
3
supra,
at 533; Stone,
Where the
Law
Ends:
The Social Control
of
Corporate
Behaviour
(1975); Coffee,
‘No
Soul
to
Damn:
No
Body
to
Kick,’
ibid
401.
9
On
corporate criminal liability, see,
inter alia,
Fisse, ‘The Attribution of Criminal Liability to
Corporations: A Statutory Model’ (1991) 13 Sydney LR 277; Fisse and Braithwaite, ‘The Allocation
of Responsibility for Corporiite Crime: Individualism, Collectivism and Accountability’ (1988)
1 1
Sydney LR 468; Foerschler, ‘Corporate Criminal Intent: Toward a Better Understanding of Corporate
Misconduct’
(1990)
8
Cal LR 128; Wells,
Corporations and Criminal Responsibiliv
(Oxford, 1993);
Bergman,
Disasters: Where the
Law
Fails
(1993); Leigh,
The Criminal Liabilify
of
Corporations
in
English
Law
(London, 1969); Law Commission,
Involuntary Manslaughter
(194)
Consultation Paper
No
135.
10
See Coffee,
op cit
n
7
supra,
at 393.
11
See Parkinson,
op
cit
n
2
supra,
pp
133, 355.
12
ibid
pp
399, 410. See also Shomis,
The
Oppressed Middle: Politics
of
Middle Management
(1981).
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