The present situation with COVID-19 means there are unique challenges being faced by every board of directors, executive team and senior manager. The pandemic is a reminder that good company structures, risk-management frameworks, and thorough and consistent management are crucial. The goal should not be to predict every future event or outcome, but rather to have structures and plans in place that are resilient and allow sensible decision-making in the event of a major disruption or crisis. Whenever there is a major global event, recession, or specific company issue this is what companies fall back on.
Here are our suggestions for D&Os to consider:
Capital raisings
Ensure any emergency capital raisings are covered, consider ring-fencing cover with a stand-alone prospectus policy. Ensure haste doesn't outstrip due diligence and thorough disclosure.
- If you are raising capital make sure you have D&O cover for the prospectus and disclose any capital raisings to your broker. Many companies have Prospectus Exclusions of some type so it is important that you obtain cover for any new capital raising.
- Consider taking out a stand-alone Prospectus Liability policy. For large or higher-risk capital raisings this ring-fences the D&O (and entity) exposure for such risk and ties in the cover (typically for seven years) to give you certainty that protection is in place for the statute of limitations of the capital raising.
- Do not let urgency outstrip the need for due diligence and thorough disclosure.
Some companies need urgent capital injection to survive and certain regulators have relaxed rules on capital raising to meet such requirements. The easing of equity capital raising rules focuses on aspects such as increasing the cap on how much a company can raise in a given period, offering an opportunity to existing shareholders, and specifying how quickly a raising can proceed.
It is important to note that access to faster capital raisings should not mean a wholesale reduction in due diligence. There is little point surviving severe short-term financial issues to then walk straight into a D&O shareholder action - as many companies did following the global financial crisis in 2008.
The issues to be considered will be varied and include:
- Setting the implied value of the company (it may be hard to attract capital at present due to the fast pace at which company values are moving).
- Calculating how much capital the company needs to weather the storm. D&O claims can arise when a company raises insufficient capital and later collapses after running out and being unable to raise further capital at a critical point.
- Forecasting prospects and disclosing all material changes and uncertainties (difficult as some of them would never have been contemplated).
- The financial viability of the company.
It remains important to engage as early as possible with shareholders and to ensure that well-respected advisors are employed.
Privacy/Cyber liability
Directors and Officers (D&Os) need to ensure appropriate IT posture is rolled out and data-handling procedures are adequate for the new remote-working environment.
- IT structure and the handling of confidential information is critical as companies race towards fully remote operations.
- Employees using their own devices and standard protocols being ignored or modified present a real threat.
- D&Os should manage the need to remain online whilst maintaining appropriate controls.
- Be fully aware that cyber criminals are already targeting these vulnerabilities
Over the last five years there has been a sea change in terms of D&Os' expected knowledge and management capability of data privacy and cyber issues. This transformation has been accompanied by an adjustment in management structures and changes to board compositions and senior executive teams to include such positions as Chief Information Officer and Chief Technology Officer. The situation with COVID-19 will be a major universal test of how much D&Os have risen to the challenge in terms of knowledge and awareness.
One of the big challenges of the crisis has been the speed of change, with shutdowns happening quickly and decisively. Whilst many companies have some secure remote working capabilities, many companies were ill prepared to have their whole workforce (or the majority of it) work from home. Some risk exposures are easy to identify, such as security issues with employee-supplied devices. However, there will inevitably be more complex exposures unfolding, so being fully engaged with the IT security and data-privacy teams is vitally important.
With regard to Cyber policies, companies should consider notifying their brokers of material changes to the disclosed security arrangements and processes. Whilst most insurers are taking a constructive approach, it remains to be seen if they will pay a multi-million-dollar loss in the event that the breach was due to a non-disclosed change in procedure or IT structure.
Trading whilst insolvent
Unfortunately not all companies will survive. When considering taking on debt, raising capital, or taking on other liabilities, seek expert advice if in doubt. Your personal liability is at stake, so it is not worth taking a risk.
Unfortunately, not all companies will survive the current crisis. As D&Os try to wrestle with the situation, it is important that they understand all regulatory obligations and avoid trading whilst insolvent. A bid for company survival is less important than your personal liability.
Insolvent trading is deemed to have occurred when a D&O allows the company to incur a debt at a time when the company is insolvent where, at the time that the debt was incurred, there existed reasonable grounds for suspecting that the company was, or may become, insolvent as a result of incurring the debt.
When it comes to deciding whether to incur additional debt or continue to trade, understandably D&Os may struggle with the complexities of the existing situation. They should remain impartial and engage expert accountancy and law firms as required.
Continuous Disclosure Requirements
The fast-paced changes and uncertainties make continuous disclosure a challenge, however, D&Os need to confront this issue, investigate all relevant areas and highlight impacts requiring disclosure.
For listed companies this is a particularly challenging time. What to disclose, how frequently to update the disclosures, and how to disclose are all important considerations.
Some aspects Boards may consider for disclosure are:
- Immediate financial impacts: these include levels of cash at bank, cash-flow issues due to lack of payment from customers, and upcoming renewal of debt facilities.
- Revenue drivers: whilst this is a routine consideration, companies will need to stay ahead of disclosing known changes and provide context to such changes. Changes may be driven by supply issues as well as demand and some companies will experience issues with major contracts. Some companies will have to focus on dramatic financial expansion and certain companies such as pharmaceuticals, supermarkets, and medical industry manufacturers will see 'spikes' in revenue. These firms will need to update the insurance market for what might be only a short-term uplift or where there are changed consumer patterns (such as hoarding), which may lead to diminished future demand.
- Supply chain disruption: companies might already know that supply delays may extend beyond the current lock-down period.
- Counterparty exposure: critical counterparties might be financially failing, unable to deliver goods/services, or be known to be dishonouring contracts.
- Government or regulatory intervention: companies unable to operate or that have had resources redirected into other services for a period.
- Direct COVID-19 exposure: some companies will have employees exposed to COVID-19, leading to a direct impact on the business.
Unfortunately, the frequency of required updates can be high. As D&Os of listed companies are aware, the question of how often to update the market comes down to the substance of the changes and additional information to hand. At present some clients have shareholders demanding daily forecast updates.
How disclosures are made is an important consideration, given the pace of change. An example of a common issue is where a company makes public disclosures followed by an analyst briefing several days later. During this period the situation may have developed further. Care regarding what information is disclosed at an analyst briefing is very important.
Consideration needs to be given to equal access of information for both shareholders and the market given the restrictions on the general public attending in person and receiving first-hand information. Companies need to post on-line transcripts of all related calls, provide timely dial-in details for conference calls, and make voice and video recordings of calls.
Companies should be wary of private briefings. There have been several D&O claims in recent years in respect to providing market-sensitive information to selected shareholders in closed-door sessions. It is more important than ever to be vigilant in this respect in the current business climate.
Disclosures to Insurers of Material Change(s) in Risk
Some policies, in particular D&Os Liability policies, have 'material change in risk' conditions. Ensure a thorough disclosure of any material changes to insurers, through your broker.
Some Management Liability policies (that have D&O cover) contain material change(s) in risk conditions. We are not an advocate of such conditions due to their invariably broad and ambiguous nature.
If you have D&O cover with such a condition, then you should strongly consider providing an update to your insurer, via your broker, to ensure that you do not fall foul of such a condition.
Employment Practice Liability
Speed of restructuring and cost cutting may lead to increased Employment Practise Liability (EPL) claims against D&Os. Early employee consultation, flexibility, and following formal procedures should reduce claims.
The current environment for employee management and engagement must be one of the most challenging in living memory. The sheer pace of the government-mandated regulation and changes, and the inevitable restructuring required by some companies in order to survive, is mind boggling.
We expect to see an upsurge in employment-practice claims - both against companies and D&Os.
The key to companies navigating successfully through this mire will be early and honest engagement, empathy, and flexibility where possible as well as following formal procedures, and engaging human resource and employment consultants where necessary.
Notification of Claims/ Circumstances
Notify early and notify often. It may already be appropriate for some D&O's/companies to notify under their D&O policies. We are starting to experience blanket COVID-19 exclusions and, in that situation, notification is essential to ensure any future claims are linked back to that original notification.
COVID-19 has the potential to produce many different types of D&O claims. Some will be made in the days ahead and others will evolve over time as the situation develops. What is important is that these claims and circumstances have appropriate cover under a policy. Our advice: D&Os should notify early and often.
When it comes to claims made against D&Os, this is usually straightforward. Engage your broker who will in turn notify your insurer and you will receive a response accordingly.
D&O policies also allow for the notification of circumstances that D&Os believe will likely give rise to a claim. If there is an act, error or omission, or event that D&Os believe could give rise to a claim they have the right to notify that as a 'circumstance' under the policy.
If D&Os are considering making a 'notification of circumstance', they should do so. There is also little downside to making a notification. If it is declined by the Insurer (generally for not being specific enough) then under most good D&O policies D&Os should be able to notify that claim in the future.
Finally, it is possible that some insurers will apply policy restrictions to D&O renewals as they seek to ring-fence the exposure in their portfolio to restrict future losses. This could be a COVID-19 specific exclusion or a more common exclusion, such as an insolvency exclusion if they are concerned about the future viability of a company. If a COVID-19 exclusion is applied, it is essential that a notification is made under the current policy to ensure the best chance of having cover if a claim does arise from COVID-19.
If you have any queries, please contact your Lockton Account Manager.