Shareholder Class Actions
The Liberty White Paper Series
Australia is now the second most likely jurisdiction,
outside North America, in which a company will face
In the aftermath of the HIH Royal Commission, it
has been recommended2 that personal duties and
liabilities under the Corporations Act be extended
beyond directors and officers to corporate officers,
employees and other individuals below board level.
Defence costs in class action suits (for which directors
and officers may be liable regardless of the outcome)
can run into millions of dollars.
Securities Class Actions
The recent collapse of a number of major
Australian compensation claims for losses
corporations both within Australia (HIH
associated with shareholdings have been
Insurance and One.Tel) and overseas
made by shareholders against GIO-AMP
(Enron, WorldCom and Adelphia) has
(settled in August 2003), Telstra and
created an environment requiring much
Concept Sports among others.
greater vigilance in regard to corporate governance and the actions of directors
Bankrolled by litigation funder IMF (Australia) Ltd, the
case against publicly listed company Sons of Gwalia Ltd and its directors alleges that share value was lost as a result of misleading statements and failure to keep the
Today, the greatest litigation threat to corporations
market fully informed in respect of gold reserves.
is posed by "class actions" and other multi-claimant proceedings – actions brought by or on behalf of
Aristocrat, the world's second largest gaming machine
hundreds or even thousands of parties in similar
manufacturer, currently faces a shareholder class
situations seeking significant relief against companies
action, claiming damages of $A190 million, for allegedly
and their directors and officers. Some class actions
misleading shareholders by not keeping them fully
even seek orders from the courts to impose major
informed before announcing earnings downgrades that
changes to the ground rules upon which those
wiped $A2 billion from the company's value in 2003.
The Statement of Claim cites adverse operational events (eg. significant margin pressures in its US operations,
The Hollywood film Erin Brockovich depicted a massive
inadequate risk assessment systems and incautious
tort claim against a California power company for
growth strategies in South America) that should have
polluting the city's water supply, and the media is full
been disclosed to shareholders when they occurred.
of product liability and other tort cases against major corporations in respect of products such as asbestos,
Similarly, a class action by shareholders was brought
tobacco, breast implants, heart pacemakers and weight
against retailer Harris Scarfe who claimed that, in
loss drugs. In Australia, compensation claims
relying on the representations made by the directors,
have been made against:
they acquired shares in the company at a value greater than their true market value or lost the opportunity
– Longford Gas for interruptions to gas/power supplies
to sell shares in the company prior to the shares
– Sydney Water for contaminated water supplies
– Wallis Lake Oysters for various food contamination
– Mobil Avgas for contaminated fuel supplies
However there is also an increasing trend for shareholders to bring class actions against companies and their directors for compensation claims associated with their investment in the company's shares. These actions are commonly termed "securities class actions".
Being Ordered to Pay Compensation
What exactly are class actions?
is only Part of the Problem.
In the United States, where class actions
A crucial, but often poorly understood
have been entrenched in their legal system
aspect of class action risk is the legal
for many years, the term "class actions"
costs involved. The GIO claim was
describes a litigious process where a
worth a staggering $97 mil ion but the
large number of claimants, who may have
defence costs alone came to $15 mil ion.
claims involving common questions of
The shareholder class action against
fact and law against a particular defendant
Aristocrat has been running for several
or group of defendants, combine their
years and has yet to be resolved and the
actions in one proceeding.
defence costs are already running into many mil ions of dol ars. Companies need
In Australia, "class actions" often take the form of "same
to ensure their directors and officers are
interest" proceedings which are commenced under the Supreme Court Rules of the various State or Territory or
covered for defence costs or they may
"representative proceedings" which are brought under
end up paying, even where no liability is
Part IVA of the Federal Court Act 1976 (Cth) or Part 4A
of the Supreme Court Act 1986 (Vic).
What is driving the trend for shareholder class actions? "Same Interest" procedures provide a legal regime Today a vast number of Australians invest in shares,
whereby numerous persons who have the same interest
either directly or indirectly through managed investment
in a proceeding, can have the action commenced or
funds and superannuation. Institutional investors also
continued by one or more of the group who represents
have substantial shareholdings in other companies as
the whole or part of the group.
part of their portfolios.
Traditionally, these "same interest" procedures have
Two recent High Court decisions have made bringing
been narrowly interpreted, requiring the claims of all
class actions on behalf of shareholders and investors
group members to arise out of the same transaction
more attractive by confirming that:
or series of transactions. In recent years, however, a more liberal interpretation of the requirements has
(i) shareholders rank equally as unsecured creditors in
been adopted by the courts4.
the case of an insolvent company (Sons of Gwalia), and
Class actions in the Federal Court are known as "representative proceedings". The provisions of
(ii) the concept of litigation funding (ie litigation funded
the Victorian legislation for class actions procedures
by those who "invest" in legal actions initiated by
are virtual y identical to those of the Federal Court
those who otherwise cannot afford to bring such
although class actions in Victoria are known as
actions) is not against public policy3.
In Part 4 of this series, we will explore in greater detail
The term "class action" in the Australian context is
the factors driving the recent increase
therefore used in a more popular context rather
in shareholder class actions in Australia.
than a strictly legal one.
Used in this popular context, class actions encompass a range of litigious processes at Federal, State and Territory levels and include various forms of representative or group proceedings and, sometimes proceedings involving multiple plaintiffs or defendants. These various forms of litigious processes provide a means by which the claims of many individuals against the same defendant (or defendants) can be brought by a single representative. For the sake of simplicity, we shall refer to all such litigious processes in this series of White Papers as "class actions".
Footnotes(1) There are a number of recent articles
(2) Fol owing the HIH Royal Commission
recommendation that personal duties
(4) In Carnie v Esanda Finance
written by leading law firms of this
Report on The Failure of HIH Insurance,
and liabilities be extended under the
(1994-5) 182 CLR 398, for
country informing us that class actions
the Corporations and Markets Advisory
Corporations Act beyond directors and
instance, the High Court held that "same
have become a significant part of the
Committee (CAMAC) published a
officers to those in senior management
interest" means "a community of interest
Australian legal landscape. See, for
paper ( 2005) which reviewed the
or who otherwise take part in, or are
in the determination of some substantial
instance, the article written by S Stuart
personal duties and liabilities under the
concerned in, the management
issue of law or fact". This more liberal
Clark and Christina Harris of Clayton Utz,
Corporations Act of corporate officers,
approach has al owed "same interest"
"Class Actions in Australia
employees and other individuals
proceedings to become almost as broad
– A Comparative Review"
below board level. The outcome of the
(3) Campbel s Cash & Carry Pty Limited
as proceedings which are brought in the
report was, amongst other things, a
Shareholders in Australia now have available to them
the entire suite of corporate malfeasance claims
and remedies under numerous pieces of legislation.
The Prudential Principle is no longer a barrier to
shareholders who wish to bring a class action seeking
damages for loss of share value.
The class action against the now-defunct Harris Scarfe
Holdings – which went into voluntary administration
in 2001 – successfully met the federal requirements:
namely, the claims of 7 or more persons were shown to
arise from related circumstances and to have given rise
to common questions about the directors' duty of care,
the entitlement of individuals to recover losses, and the
liability of individual directors.
Directors and officers and the company secretaries
who manage the board's legal responsibilities need
to understand the importance of this changed legal
landscape, particularly as it relates to the liability of
The Prudential Principle
Efficiency in the legal process
Until the insertion, in 1991, of Part IV-A
Class actions brought under the federal
into the Federal Court of Australia Act
regime must satisfy the requirements
1976 (Cth), an established principle of
of Part IVA of Federal Court of Australia
law called "The Prudential Principle" had,
Act 1976 (Cth). This part of the Act was
to a large extent, shielded corporations
designed to provide a legal remedy in
from shareholder actions. The principle
situations where many people are affected
provided that a shareholder could not
by certain actions or omissions of another
recover damages from a company merely
and the total amount in issue is significant
because the company in which they have
but each person's individual loss is small
invested had suffered loss.1
and thus not economically viable to recover in individual actions.
This loss suffered by the shareholder, the courts said, was no more than a reflection of the loss suffered by
Securities class actions fit squarely into this scenario. In
the company as a whole.2 In relation to wrongs done to
effect, a class action benefits from economies of scale
the company, it was the company that was the proper
– the larger the number of group members, the lower the
plaintiff to commence proceedings, not its shareholders.
individual costs associated with bringing such an action.
Of course there were exceptions to this principle, fraud being one of them.
The second purpose of the Act was to provide efficiency in legal process. Rather than having a large number of
The Prudential Principle is no longer a barrier to
similar actions brought by a large group of claimants,
shareholders in Australia who wish to bring a class
the class action mechanism provides for a single action
action seeking damages for loss of share value. In
to be brought on behalf of all the claimants.
fact, the Federal Court has recently said that in some circumstances the proper plaintiffs are in fact the
(i) The class must consist of at least 7 persons who
shareholders and not the corporation.3
have claims against the same defendant.
Consequently, shareholders now have available to them
In order to determine whether the first requirement
the entire suite of corporate malfeasance claims as well
is met, we need to look at how the claim group is
as remedies under the Trade Practices Act 1974 (Cth),
described in the Statement of Claim. A useful test in
the Australian Securities and Investment Commission
determining whether the description of the group will
Act 2001 (Cth) and the Corporations Act 2001 (including
satisfy the first requirement is: is the description such
as amended by the Financial Services Reform Act 2001).
that a person, with the assistance of a legal adviser if necessary, can ascertain whether he or she is a member
We have, so far, focused on corporations as defendants
in a securities class action. We should, however, note that corporations can also be plaintiffs in such an
In the case of a securities class action, it is not difficult
action. Such institutional investors may have substantial
for a person to determine whether he or she had
shareholdings in other companies as part of their
purchased shares in a particular company during the
portfolio of investments and their rights to be members
relevant period specified in the Statement of Claim
of a securities class action must not be overlooked.
and thus fall within a particular class. It is not even
Whether or not they choose to opt out of such an action
necessary to identify all of the group members, either
is a separate issue, and will be discussed in Part 3 of
by name or by number.
The word "claim", for the purpose of this first requirement, has a wide meaning and is not limited to a cause of action. It encompasses everything that might lawfully be brought before the court for a remedy.5
(ii) The claims of all persons are in respect of, or arise
– the alleged unreasonableness of the opinion on its
out of, the same, similar or related circumstances.
financial statements made by the directors.
The lowest threshold that must be met to satisfy this
(iii) The claims of all persons must give rise to a
second requirement is that the claims must arise out of
substantial common issue of law or fact.
The third requirement is satisfied if there is a significant
The word "related" suggests a connection wider than
question common to all members of the class.8
similarity or being identical. In each case, we need to determine whether the similarities or relationships
The word "substantial" used in this context does not
between circumstances giving rise to each claim are
mean that which is "large" or "of special significance"
sufficient to merit their grouping as a class action.6
or would "have a major impact on the.litigation" but, rather, is directed to issues which are "real or of
Let's have a look at a couple of examples:
In a class action against Phillip Morris the court found,
In the Harris Scarfe litigation, there was a common
at first instance7, that despite the differences between
question of law and fact as to:
the individuals' claims - their length of time as smokers, the number of cigarettes smoked, their different medical
– whether the directors of the company owed a duty
histories, etc - there was a sufficient relatedness. That
of care to its shareholders to ensure the accuracy of
was because, if the allegations of a breach of Section
statements made in statements and reports required
52 of the Trade Practices Act 1974 or breach of duty
by the Corporations Act;
succeeded, then the claims of all the group members
– whether the duty of a director to exercise care and
would be advanced. Alternatively, if these claims failed,
diligence imposed by the Corporations Act entitled
then the claim of each member of the group would also
shareholders to recover individual losses for its
fail. These circumstances were therefore found to be
– whether the communications made by the directors
(communications to the Australian Stock Exchange,
In the current Harris Scarfe Holdings litigation, the
the securities market and to shareholders, press
company argued that the group members were not
releases, the company's half-yearly report, etc) were
sufficiently related. They pointed to the fact that
communications for which the individual directors
the group could potentially be made up of 11,300
persons who bought and sold shares at different times (over a five-year period) and the probable differential
Requirements for a shareholder class action
reliance each member of the group may have placed on the various representations in the many published
The essential requirements which must be established
documents. They pointed out that the six directors who
before a person can bring an action under the federal
were sued each held that position in the company for a
different length of time and one of them was, for a part of that time, an executive director.
(i) there must be 7 or more persons who have claims
against the same defendant;
Despite this argument, the court found that there was a sufficient degree of relatedness between the
(ii) the claims of all those persons are in respect
circumstances of the various claims, namely:
of, or arise out of, the same, similar or related circumstances; and
– the means by which the company and the directors
informed their shareholders and the market as to
(iii) the claims of all those persons give rise to a
the company's financial performance and financial
substantial common issue of law or fact.
– the ongoing misstatements of its financial position,
its net assets and inventories; and
Footnotes(1) Prudential Assurance v Newman
in relation to conduct which misleads or
(5) Finance Sector Union of Australia v
182 different brands of cigarettes,
Industries Ltd (No 2)
 1 Ch 204.
deceives or tortious rights in relation to
Commonwealth Bank of Australia
77 separate items of public statements
negligent misstatements, then the proper
94 FCR 179 at 186.
and lobbying, different forms of
(2) This principle is based on the ancient
plaintiffs are in fact the shareholders and
advertising, and different forms of
principle of company law cal ed Foss v
not the corporation: Johnstone v HIH
(6) Zhang v Minister for Immigration, Local
statements ranging from bil boards at
(1843) 2 Hare 461; 67 ER 189
 FCA 190; see also Sons of Gwalia
Government and Ethnic Affairs
sporting events to submissions to a
which provided that, in relation to wrongs
Limited (Administrator Appointed) v
Senate Committee, al contributed to
done to the company, it is the company
 FCA 1305.)
show that the circumstances were not
that is the proper plaintiff to commence
(7) Nixon v Philip Morris (Australia)
proceedings, not its shareholders.
(4) Petrusevski v Bul dogs Rugby League
(1999) 95 FCR 453. On appeal,
 FCA 61.
however, the Ful Court of the Federal
(8) Carnie v Esanda Finance Corporation
(3) The Federal Court has recently said
Court disagreed. The court said that,
(1995) 182 CLR 398.
that, where shareholders are seeking
factors such as there being three sets
remedies not dependent on their status
of defendants (each a large tobacco
(9) Wong v Silkfield Pty Ltd
as a shareholder, such as statutory rights
company), over a 39-year period,
199 CLR 255.
Not all class actions are resolved in court. The court
can order a discontinuance based on a number of
different circumstances which are dependent on the
facts of each case.
A person's consent is not usually required in order for
them to be a member of a class action. Class members
may, however, choose to ‘opt out' if they don't believe
that there will be adequate financial return for the risks
they are taking.
When do discontinuances occur?
The court would, however, attempt to give effect to the
The court can order a discontinuance
intention of the Act. It would therefore try, as far as it
of a class action based on an application
can, to allow a class action to continue to the stage where the substantial common issues are resolved.
by a defendant corporation or its directors Once that stage has been completed, the court may
or officers - or on its own motion.1 Under
consider any order or direction under the Act.
the Act, the court has a wide discretion to ensure that class actions are not frivolous, – Fulfilling the legislative intent, of course, works both
ways. The way the Federal Court disallowed the
oppressive or an abuse of process.
continuance of Aristocrat's claim (in October 2005) is a useful example.
The court may order a discontinuance if it believes that:
When framing the definition of "class", lawyers
(i) the proceedings will not provide an efficient and
for the shareholders had defined the class as
effective means of dealing with the claims of the
shareholders who purchased shares in the company
group members, or
during a relevant period and who also appointed that particular law firm as their lawyers. The effect of
(ii) it would be "otherwise inappropriate" for the claims
this definition of "class" was to create, effectively, an
to be pursued in a class action.
opt–in process for members when the Act provides for an opt-out one. The court said that this definition
This may occur, for instance, when the cost of the
created a "fatal flaw" in the proceedings. It had
proceedings, or the cost of distributing any verdict,
the potential to subvert the Federal Court Act and
would be excessive in relation to the costs incurred if
amounted to an abuse of process. The action was
each class member conducted a separate proceeding.2
therefore not allowed to continue on that basis.
The definition of "class" in Aristocrat was later amended (in February 2006) and the offending
– In both Bright v Femcare and Guglielmin v
criterion was removed. The action was then allowed
(the current Harris Scarfe litigation)
the defendant corporations and their directors and officers made an application to discontinue the class action even before defences to the proceedings had been filed.
In each case, the court refused to exercise its discretion on the basis that the application for its exercise was premature.
– Bright v Femcare
– The court made it clear that it
would not always consider applications made at early stages of a class action to be premature. It may not be efficient or effective for the class action to continue if there was:
conflict between the representative party's case and the cases of the represented parties,
or if the only substantial common issues were ones of law on which a decision in the case of one group member would bind the others.
2. Risk of losing – a class member who does not
With a few exceptions, a person's
choose to opt out would automatically receive not
consent is not required in order for them
only the benefit in the final outcome but also the burden. It is all very well if the action is successful
to be a member of a class action. Under
and the members can share in the monetary
the federal regime of a class action,
compensation awarded but what if they lose the
if a person happens to fall within the
case? Losing the case would mean that the class
description of a class, that person is
members would be bound by the outcome and, depending on the arrangements as regards funding
deemed to be included in the class action
for the case, they may have a financial burden at the
– unless he or she chooses to opt out of it.
end of the day.
Until that positive step of "opting out" is
Double edged sword
taken, that person will continue to be part of the action and will be bound by the
The opt-out procedure, whilst initially an advantage for plaintiffs in that it creates a large class at the beginning
eventual outcome of the case.
of the action, also has a number of difficulties:
The opt-out process
– Notices to class members in respect of their right
to opt-out are usually given either by way of direct
The typical ‘opting out' process involves the following:
mailing, advertisements in national newspapers or broadcast on radio or television. This can be a costly
– Once the action commences, the court will fix a
exercise and, so far, these costs have usually been
date up to which class members may opt out of the
borne by the plaintiffs (or their litigation funders), at
least at first instance.
– They do this by providing a written notice to the
– Another difficulty which confronts plaintiffs' lawyers
– The court gives directions as to the manner in which
is the task of convincing class members to provide
class members are to be notified and the procedure
financial support for a class action, especially in the
which must be followed if they wish to opt out of the
early stages. Since class members who are within
action (to ensure members are aware of the action).
the class will obtain the benefit (or the burden) of any
– If any class members do choose to opt out of
judgment in relation to common issues, many class
the action, then they are free to pursue individual
members take the view that they do not need to be
actively involved in supporting the class action.
Why opt-out of a class action?
– The most problematic issue with the opt-out
procedure is that until the class is finally determined
There are several reasons why a member may choose to
and the value of their claims assessed, it is difficult
opt out of a class action:
for the defendant corporation and their directors to assess their potential liability and engage in any
1. Control – a plaintiff shareholder (for instance, a large
institutional investor) may wish to institute its own legal proceedings against the relevant corporation and their directors and officers so that it could control the way in which the litigation is run. The downside, of course, is the costs involved in running separate litigation.
GIO Australia Holdings Limited
Corporations which prepare contingency plans for
The class action that followed, initiated by a former
defending class actions should keep in mind the extent
shareholder Shane King, potentially included 67,000
of the legal manoeuvrings which finally brought an end
shareholders. Following the normal procedure, members
to one of Australia's largest class actions - involving GIO
of the class were notified that a class action was on foot
Australia Holdings Limited (now known as AG Australia
and that they could opt out if they so chose. 17,000
members chose to opt out and 22,000 entered into formal retainer agreements with King's lawyers.
The class action arose out of AMP's takeover of GIO
The rest of the members did not respond.
in 1998/1999. In that case, GIO was defending a class action brought by disgruntled former shareholders
GIO then sought and obtained a court order entitling it
who chose to reject a takeover offer from AMP. GIO
to send another questionnaire to those members who
recommended that its shareholders reject AMP's offer
had not responded and, by this process, another 4,000
of $5.35 per share on the basis that the offer was
members opted out. The other 24,000 members had not
inadequate, unfair and unreasonable. Despite that
responded to the questionnaire.
recommendation, AMP acquired more than 50% of GIO's shares in the takeover bid.
The court was then persuaded by both parties to rule that members of the class may continue to hold that
Subsequently, the minority shareholders who had
status only if they chose to opt-in to join the action.
rejected the takeover offer on the recommendation of
This was a way to "close the class" so as to enable
GIO either sold their shares on the market for less than
the defendants to have an indication of the size of their
the AMP offer or had their shares acquired compulsorily
potential liability if the matter proceeded to trial and it
as part of a scheme of arrangement in which they
would also be relevant in determining the size of any
received only $2.75 per share.
In the end, GIO was able to reduce the potential number of 67,000 members in the class action to an actual number of 23,000. Once the shareholders knew the amount that was being offered by way of settlement ($112 mil ion) and how many people would share in it, the settlement was approved by the court in August 2003.
Extracted from "GIO class action gives corporates a lesson in tactics" by Luke Buchanan of Clayton Utz 13 October 2003.
This GIO case provides an important tactical lesson for
It is interesting to note that, after the court's decision
both corporations and directors on the one hand and
in the Aristocrat claim, the litigation funder for the
plaintiffs on the other.
shareholders in that case, IMF (Australia) Limited, questioned whether or not it was economically viable for
The advantages to corporations
them to continue funding the claim given that they were not able to control the class size to a manageable level.
– Reduces the number of plaintiffs involved.
The funding agreement provided that, in the event of a
– Allows the corporation to assess the size of its
successful outcome, IMF would retain 20-40% of the
judgment, depending on the number of the shareholders
– Makes it easier for corporation to determine a
who were in the action.
At the end of the day, class actions for litigation funders
The advantages for plaintiffs
are no more than business deals - they need to be confident that there is going to be adequate financial
– By knowing the precise number of class members
return at the final outcome. On reflection, IMF must
who have opted in allows them to assess the
have decided that there was sufficient financial incentive
reasonableness of any settlement offers that may be
for them to continue funding the Aristocrat claim as
made by the defendant.
the offending criterion in the definition of "class" was subsequently removed and the class action has been
In view of the GIO settlement, lawyers acting for the
allowed to proceed.
shareholders in the Aristocrat litigation must have wanted to shorten the whole process for "closing the
The recent commencement of the Telstra class action
class" by providing a narrow definition of "class"
also suggests that the inability of plaintiff law firms and
in the Statement of Claim. That attempt to control the
funders of class actions to restrict class members to
class size to a manageable level at the outset
the persons instructing a particular law firm of solicitors
was, however, unsuccessful.
(thus effectively creating an opt-in process) has not reduced the commercial attractiveness of class actions.
The court in Aristocrat said the requirement for class members to instruct the law firm, Maurice Blackman Cashman, which was already representing the applicant shareholders, breached the "opt-out" provisions of the Act. It would mean that shareholders would have to pursue their claims against Aristocrat individually unless they were represented by that firm. It would also have required shareholders to formally "opt-in" to the process which is not a requirement of the Act.
Footnotes(1) Under Part IVA of the Federal Court of
(2) The court's discretion is discretionary
Australia Act 1976 (Cth). Furthermore, the
even where the conditions for the
court has discretion to make any order it
exercise of the discretion are met:
thinks appropriate or necessary to ensure
Australian Competition and Consumer
that justice is done in the proceedings.
Commission v Giraffe World Australia Pty Ltd
(1998) 84 FCR 512. It is therefore difficult to determine the precise circumstances in which a court would exercise their discretion. Much depends on the facts of each case.
There are a number of factors fuelling the increase in
securities class actions in Australia.
Legal commentators have cited the 2003 National
Tort Law reforms and the GIO Settlement as possible
drivers. The removal of the Prudential Principle,
growing shareholder activism, a greater amount
of litigation funding and more rapid information
dissemination has also been identified.
Securities class actions have become part of our
legal landscape just as they are in the American
legal system. Whilst class actions themselves do not
increase the potential liability of those involved they do
increase the need for Directors and Officers to be very
vigilant in how they manage the affairs of the company.
Class actions are not a recent occurrence. There is also a growing trend for the public to view The federal regime which allows them has securities and other financial instruments (such as been in operation since 1992. However,
the mezzanine lending agreements made famous by Westpoint) as products. Shareholders in a
it is only recently that there have been
company nowadays tend to consider themselves as
an increasing number of securities class
consumers rather than participants in a venture. They
actions being brought in Australia. What is should therefore be entitled to the protection which behind this growing trend?
the law provides to purchasers of other products. The continuous disclosure requirement under the Corporations Act reflects this sentiment.4
Factors Driving Securities Class Actions in Australia
5. Litigation Funding
There are a number of possible "drivers" of the growing trend.
Another driver of the trend for class actions in Australia is the availability of litigation funding.
1. National Tort Law Reforms
Some legal commentators have suggested that it
Sons of Gwalia class action is financed
by litigation funder
is partly driven by the success of the major tort law
IMF (Australia) Ltd, a publicly
listed litigation financier.
reforms of 2002 and 2003.1
The reduction in the number of personal injury claims
Aristocrat is another example of class actions funded by IMF.
and medical negligence claims following these reforms may have given some plaintiffs' lawyers an impetus to
– The position has always been that plaintiffs meet the
look for alternative ways to initiate actions.2
costs of any litigation they wish to bring and face
2. The GIO Settlement
the possibility of having to pay the legal costs of the defendant if they are not successful. Accordingly,
The GIO settlement was one of the largest securities
unless the plaintiffs could afford to bring the action
class actions settlements in Australia. It involved a
and were relatively confident of their claim, they
settlement sum of $112 million and a payment of
would not proceed.
$15 million in legal costs to the plaintiffs' lawyers and could have also given an added impetus to
– Unlike the United States, contingency fees (where a
securities class actions.
lawyer arranges with a client to receive a percentage of any damages awarded) are prohibited in Australia.
3. Removal of the Prudential Principle
Such a prohibition does not apply to non-lawyers. Litigation funders can therefore offer to fund litigation
Also, our courts have categorically removed any
in return for a share of the proceeds if the litigation
doubt that shareholders can bring class actions against
is successful. Funding agreements with these
companies typically provide that the plaintiffs will pay nothing if they are not successful in their claims.
The current Sons of Gwalia litigation is a good example of shareholders bringing action on the basis
– IMF started providing funding to litigation in 1997
of misleading and deceptive statements. In the recent
but the funding was then limited to insolvency
judgment by the High Court in Sons of Gwalia Ltd v
practitioners. In 2001, IMF listed on the Australian
, the court made it clear that shareholders
Stock Exchange and began funding commercial
rank equally with unsecured creditors in the distribution
litigation and class actions. There are currently
of the company's assets in liquidation. The court further
four other litigation funders in the litigation funding
said that such shareholders are entitled to sue in their
capacity as members of the public rather than members of the company.
– There has always been a debate as to whether
litigation funding is against public policy and the
4. Shareholders Activism
courts have scrutinised such funding agreements very carefully. Those who argue against such
A vast number of Australians own shares in companies
agreements are concerned that they would amount
– either directly or through managed funds or
to "maintenance and champerty" which, historically,
superannuation. There are also many shareholders who
were torts and crimes at common law.
are large institutional investors who will watch very carefully the performance of their investment portfolio. There is now definitely an increase in shareholders activism.
Maintenance - occurs where a party's costs are paid by
6. Information Dissemination
a stranger who has no interest in the litigation.
Class actions nowadays are attracting vast media
Champerty - is a form of maintenance where the funder,
coverage and community awareness of this litigation
in return for funding the litigation, is entitled to receive a
tool is increasing.
share of the proceeds if the litigation is successful. The rationale was to prohibit the encouragement of litigation,
The more public awareness there is about the
especially for ulterior purposes or at the risk of the
conduct (or omissions) of companies through the
financial rewards colouring the fair conduct of
media and the internet, the more potential material
there is to fuel class action claims.
– Today, both maintenance and champerty have
Where to from here?
been decriminalised in Western Australia and, in
Today we can be in contact with persons
New South Wales, Victoria and South Australia, maintenance and champerty are now neither crimes
at the other side of the world almost
nor civil wrongs.
instantaneously via the use of email communication and other forms of
– The pendulum in the debate seems to have swung
in favour of litigation funding agreements on the basis that their availability increases access to
So what are the implications of increasing interaction
justice for members of society who would not
between, say, plaintiff lawyers from the United States
otherwise have it.
and their counterparts in Australia? What is the Australian legal landscape going to be like in
– There is a perceived public benefit in allowing third
parties to fund litigation for people with genuine claims who would not otherwise have the financial
Securities class actions have become part of our
resources to bring the claim.5
legal landscape just as they are in the American legal system. If we have learnt anything from the American
– This view has paved the way for a much more
experience, it is that class action litigation poses
significant role for litigation funders. Since the Fostif
significant risks to those involved in terms of legal
endorsed strongly the role of litigation funders,
exposure and reputation costs, not to mention the time
it is likely they will seek to exercise a greater say in
and expense involved in defending such actions. Whilst
the litigation they fund.
class actions themselves do not increase the potential liability of those involved – they do increase the burden
– The Fostif case
may also have the effect of giving
on those involved to be very vigilant in how they manage
litigation funders an added impetus to bring class
the affairs of the company.
actions on behalf of shareholders and investors in companies (solvent or otherwise). Having said that, however, we must bear in mind that whether or not litigation funders will agree to provide funding for a class action is, at the end of the day, very much a commercial decision. Commercial viability would be the key factor in deciding whether or not they will invest in funding a particular class action.
Footnotes(1) See, for instance, S Stuart Clark
(2) This is not to say that class actions
(3) We have seen in Part 3 that the
(4) The prohibition on corporations'
and Christina Harris, "Class Actions in
increase the legal burden of corporations
Federal Court in Johnstone v HIH
misleading & deceptive conduct under
and their directors and officers. It simply
FCA 190 said that, where shareholders
the Trade Practices Act 1974 (Cth)
- A Comparative Review", Clayton Utz.
means that there is a greater likelihood of
are seeking remedies not dependent
and also the ASIC Act 2001 (Cth) are
a law suit against them if they have failed
on their status as a shareholder,
good examples of such protection for
in their compliance with the law resulting
such as statutory rights in relation to
in losses to shareholders and investors.
conduct which misleads or deceives or tortious rights in relation to negligent
(5) This view has been affirmed recently
misstatements, then the proper plaintiffs
by the High Court in Campbel s Cash &
are the shareholders and not the
Carry Pty Limited v Fostif
where the court
took the view that the concept of litigation funding is not against public policy.
There are a number of differences between the
Australian and American litigation systems. These
differences include the treatment of contingency fees,
jury trial procedures, awarding of punitive damages
and the way in which legal costs are allocated.
In order to prevent Australia from heading down the
US path of numerous large class actions it is crucial
that corporations and their boards of directors have
a risk management plan. However, despite all the risk
controls it ultimately comes down to balance between
risk management and business judgment.
Are we Destined for a US-style Litigation Landscape?
There has been a dramatic surge in securities class
It is generally thought that jury sympathy occurs when
actions in the United States in recent years. The figures
injured plaintiffs face major corporations with actual or
perceived "deep pockets". It is therefore a perceived advantage to have jury trials.
– 175 actions were filed during 2005– Total settlements increased from US$145 million in
1997 to US$5.5 billion in 2005
– 772 shareholder investor securities class actions
The United States have a system of jury trials.
have been filed in the United States Federal Court jurisdiction since 22 December 1995.
Many commentators regard US class action litigation as
In Australia, class actions are heard by a judge
being widely abused by plaintiffs and their lawyers1.
(or judges as the case may be) and not involving any jury.
According to a survey of Fortune 1000 companies by BTI Consulting Group:
Australian plaintiffs do not have the opportunity to enlist the sympathy of any jury in pursuing their
– Total spending on outside legal counsel reached
claim for compensation.
US$56.4 billion in the United States.
– A typical company in the BTI survey spent US$19.5
million on outside legal counsels' fees, nearly double
the US$10.5 million average only five years ago.
Punitive damages are awarded to punish the defendant
Will Australia Head Down the Same Path?
for the wrongful act committed.
Given the increasing trend for securities class actions in
Australia, should we also expect an exponential increase in the number of securities class actions?
The American legal system allows for punitive damages to be awarded against the defendant.
We take a look at some of the differences between the American and the Australian legal systems to
Very large sums of damages have been ordered in
see whether we are likely to end up with a Directors
the form of punitive damages.
and Officers litigation environment like that in the U.S.
Punitive damages are not usually awarded.
Contingency fees are where plaintiff lawyers agree with their clients that in the event of a successful outcome,
Damages are generally awarded in Australia on
the lawyer receives a percentage of the judgment or
the basis of the compensation principle. The aim
settlement sum awarded to the plaintiffs (plus the
is to put the plaintiff into as good a position as he
expenses incurred by the lawyers). If the claim fails,
or she would have been if the wrong had not been
the plaintiffs' lawyers do not receive any legal fees.
Contingency fees for lawyers are permitted.
The percentage of the judgment or settlement sum is often in the range of 10 to 25%, and even up to 40%.
Such a contingency agreement between a lawyer and client is illegal.
The lawyer can only take his or her "normal" fee plus an agreed uplift which is usually expressed as a percentage of the so called normal fees. This limitation clearly has restricted Australian lawyers from earning the kind of enormous fees that their American counterparts could earn.
Punitive Damages Example –
Phillip Morris USA v Williams
"Fraud on the market" theory has helped to open
In the very recent case of Phillip Morris USA v Williams,
the doors to many securities class actions in the
the jury awarded the estate of the deceased plaintiff,
US in recent years.
Williams, US$821,000 in compensation damages and US$79.5 million in punitive damages! However the trial
judge thought the amount of punitive damages was excessive and reduced it to US$32 million. On appeal
"Fraud on the market theory" has not yet been
to the Oregon Supreme Court, the US$79.5 million was
accepted by an Australian court 3.
restored. The tobacco company appealed against this decision. Ultimately, the United States Supreme Court had to consider the functionality of punitive damages
Loser Pays Legal Costs
and, in particular, whether the award can be made to punish a corporation for injury to persons who were not
part of the litigation.
The losing party does not generally have to pay
In February, 2007, the United States Supreme Court
the successful party's costs.
thought the US$79.5 million was not an appropriate amount and the matter has been referred back to the
There may therefore be instances where actions are commenced before there has been a proper
Oregon Supreme Court for it to consider an appropriate
assessment of the merits of the claim. Given the
amount using a new constitutional formula set by
contingency arrangements, plaintiffs have nothing
to lose (except for expenses incurred).
There is always the chance that the case would be settled – even if the claim has little or no
Fraud on the Market Theory
In the United States, there is now a legally accepted
presumption that the price of shares in an open and developed market is a reflection of all material
The party who loses the case normally has the
information that is publicly available in the marketplace
burden of paying not only its own costs of bringing
about those shares, including false and misleading
the action but also those of the defendant in
information issued by a company.
defending the action.
The theory further presumes that shareholders rely
There is therefore a clear disincentive on the
on the accuracy and truthfulness of the available
plaintiffs' part to bring an action unless they
information in making their investment decisions.
believe they have a real chance of success. Legal costs alone involved in major class actions
Before this theory was accepted, each individual
could easily amount to many millions of dollars.
shareholder in a securities class action against a company had to prove reliance on a particular piece of false information. This complicated the threshold
question of whether the class action gave rise to a substantial common question worthy of prosecution.
While we are definitely seeing a significant increase in the number of securities class actions brought in
How could you show "commonality" when each
Australia. Australian corporations are unlikely to face
shareholder might rely on different pieces of false and
an American litigation environment for class actions in
the very near future.
The "fraud on the market theory"
overcomes the issue
That is not to say that corporate Australia have
of "commonality" of claims that all plaintiffs in the same
nothing to fear. Directors and officers may be sued by
action have to establish in order to bring a securities
shareholders and investors if they have committed a
class action in the United States. It is now not necessary
wrong such as failure to perform continuous disclosure.
to show individual reliance on any one or more pieces
This chance of law suits and the possibility of actions
taken by ASIC has always been there but these rules have been given more "teeth" by the threat of class actions by shareholders and investors.
There are currently a number of significant shareholder class actions on foot in Australia: Sons of Gwalia, Aristocrat and Telstra. The question we need to ask is: what should corporations and their directors and officers do from a risk management perspective?
– It is interesting to note that in 2006, there was a
sharp drop in the number of securities class actions
– Corporations operating in Australia face a
filed in the US – a 38% drop to 110 actions filed. A
plethora of Commonwealth, State and Territory
key reason is the greater care taken by companies
requirements, not to mention their potential liability
in reporting their financial results. Australian
at common law. In addition to imposing liability on
companies and their directors and officers can take
corporations for their breach, these laws may also
comfort in the fact that the risks of potential law
impose penalties on individuals involved in these
suits can be reduced and managed. The practice of
corporations either for their own misconduct (such
having proper processes and procedures in place
as aiding and abetting a corporate breach) or simply
to ensure due compliance with legal requirements is
in consequence of the position they hold or the
just good corporate governance.
functions they perform in the company.5
– Moreover, companies today are seeing their annual
– It is therefore crucial that corporations and
board performance reviews as an opportunity to
their board of directors and officers have a risk
undertake a group-wide compliance review and to
management plan to reduce and manage their risks
ensure optimal effectiveness and efficiency of board
of liability. How do they ensure the information upon
members and operating arms.
which they act is necessary, reliable and accurate? How do they ensure proper compliance with these
From a risk management perspective, consider the
legislative requirements? In the case of information
that is being disseminated to the public, how do they ensure that such information is accurate and timely?
1. What process and procedure has your company got
Since most of the current shareholder class actions
in place to ensure the accuracy of information that is
are based on the grounds of misleading and
being provided to the board and to the public?
deceptive conduct or failure to fulfil continuous
2. How does your company ensure timely compliance
disclosure obligations, it is clearly necessary for
with legal requirements such as continuous
corporations to examine their internal procedures to
see if they can minimise the risks of class actions in
3. Are such procedures objectively reviewed from time
4. Has your company prepared a risk management
– The recent securities class action against the
contingency plan in the event of a securities class
retailer Harris Scarfe is an example of a case
action against your company?
based largely on alleged inaccuracies in the
5. What appropriate insurance do your directors
company's communications to the Australian Stock
and officers have in place to protect their risks of
Exchange, the media, the securities market and to
shareholders. Could these alleged inaccuracies have been avoided?
Clearly, at the end of the day, it is a question of balance between good risk management and
– Not only do directors need to ensure that proper
processes and procedures are in place to provide them with the confidence that they need in the management of the company, they also need to have those processes and procedures objectively reviewed from time to time.
Footnotes(1) See, for instance, "Class Action
himself which may wel exceed the
that the common issues between class
certification in Australia. Once an action
Litigation" by John Emmerig, Blake
compensation payable to the plaintiff",
members predominate over individual
has been properly commenced, it will
issues as is the requirement in the United
continue until the defendant successful y
(c) they are expressly authorised by
States. It is sufficient if there is at least
applies for a discontinuance of the action,
(2) According to established principles
one "substantial" (meaning "real or of
or until judgment or settlement.
in Australia - Rookes v Barnard
substance" rather than "large") common
AC 1129 - there are only three situations
In short, it seems that punitive damages
issue of law or fact.
(5) See, for instance, the Discussion
under which punitive damages may be
wil rarely be awarded in Australia.
Paper prepared by Corporations and
(4) Having said that, we should note that
Markets Advisory Committee - CAMAC
(a) there is "oppressive or unconstitutional
(3) However, there is some question
there is a system of certification that is
- on "Personal Liability on Corporate
action by the servants of the
about plaintiffs' need for this theory in
required in the United States – that is,
Fault" (May 2005).
Australia. Under the federal regime, as
the plaintiffs have the onus to show that
(b) the "defendant's conduct has been
we discussed in Part 2 of this White
the action is appropriately brought as a
calculated by him to make a profit for
Paper Series, there is no requirement
class action. There is no such system of
As the Government moves to crack down on white
collar crime, findings from a growing number of Royal
Commissions and inquiries have led to civil and
criminal proceedings against corporate directors and
officers. Many directors and officers are not aware that
the best form of protection from a risk perspective is
actually a right to indemnity they could seek from the
company (rather than insurance protection). These
indemnities transfer personal liability to the company.
However, no matter how broadly an indemnity is
drafted, it cannot indemnify directors and officers
against every possible liability or the associated legal
costs – indeed a corporate indemnity is only worth
something if the company is solvent. It is therefore
important for directors and officers to also secure
a second line of defence through the purchase of
appropriate insurance protection.
Securities Exposures – An Emerging Pattern
Case Study – Multiplex
– With the collapse of HIH in 2001, and corporate
We are now witnessing legal disputation between
failures since, it has become a political necessity for
ASIC, Multiplex and the Multiplex shareholders who are
the Federal Government to be seen doing more to
claiming in excess of $100 million against Multiplex in
prevent poor corporate conduct and punish white
relation to the ill-fated Wembley Stadium project in the
– Consequently, we are seeing an increasing number
The ASIC inquiry was mainly concerned with Multiplex's
of royal commissions and inquiries into companies'
failure to disclose price-sensitive information about
affairs. The findings have been used as a foundation
the loss sustained in building the Wembley Stadium.
for civil and/or criminal proceedings brought by ASIC
The inquiry resulted in a deal between Multiplex and
and other regulatory authorities against the directors
ASIC whereby Multiplex would pay $32 million in
and officers of those companies.
compensation for investors who lost money as a result of this failure to keep the market informed.
– Directors and officers (for the purposes of this
paper we will refer to them collectively as "officers")
Following the ASIC inquiry, lawyers for the shareholders
required to attend official inquiries need legal
began a shareholder class action against Multiplex
representation to protect their interests even
and compelled ASIC by subpoena to hand over its
though they are not necessarily being accused of
investigation documents. ASIC did not initially object to
wrongdoing at that stage. If regulatory proceedings
providing this access (not surprisingly, Multiplex did) but
ensue, they will incur costs in defending those
is now resisting on the grounds that it would reveal the
sources of information for its investigation. It transpired that two unnamed executives, believed to be directors
– The regulatory proceedings may also result in:
of Multiplex at the time of the ASIC investigation, have personally retained barristers to resist the access to
a) An order against them to pay compensation to
their interview transcripts. At first instance the plaintiff
was granted access. That decision is on appeal. The shareholders' lawyers have now been granted access to
b) An order against them to pay pecuniary penalties
ASIC's transcripts of interview and other select materials
to the regulator.
ASIC had objected to producing.
c) An order banning them from managing
– The current Multiplex case is a good example of
the "spiral" that can take place. What starts out as a regulatory investigation could end up in a multi-
million dollar shareholder class action against the company and its officers. The evidence elicited
– A pattern that has existed in the US for a number
from the regulatory investigation can form the
of years has started to emerge here in Australia. It
foundation of, or at least evidentiary assistance to,
begins with a regulatory investigation by a corporate
the shareholder securities claim.
"watch-dog" into the conduct of a particular company, followed by a regulatory prosecution
– The AWB case is another example where a
or proceeding if some wrongdoing has been
regulatory investigation has resulted in a multi-million
discovered, followed by a shareholder securities
dollar shareholder class action. The case began with
claim against the company and/or its officers.
the Cole Commission of Inquiry into the conduct of AWB (in relation to its dealings with Iraq) under the
– One of the key aspects of this trend is the access to
United Nation's Oil-For-Food Program. There is now
evidence produced at the regulatory investigations
a multi-million dollar shareholder class action being
and proceedings by plaintiff law firms and their
brought against the company by AWB shareholders
litigation funders in order to bring shareholder class
who lost money after the collapse in AWB's share
actions against companies and their officers. By fully
price following the Cole Commission of Inquiry.
cooperating with the regulators, officers potentially put themselves in a vulnerable position when it
– In terms of managing and transferring risk, corporate
comes to potential class actions by shareholders.
officers need to be aware not just of their exposure to securities claims by a class of shareholders but also of the associated regulatory exposures.
Corporate Indemnity – The First Line of Defence
Deeds of Indemnity & Access
– When corporate officers think about their exposure
– To ensure a greater degree of certainty in regards
to personal liability, their foremost thought is usually
to corporate indemnity, it has become common
about insurance protection. They sometimes forget
practice for certain officers to enter into deeds of
that their most obvious (and perhaps best) source of
indemnity and access with the companies they
risk protection is seeking a right to indemnity
work for. These deeds are contracts the company
from the company.
enters into with each individual officer which ideally mirror the indemnity contained in the company's
– An indemnity from the company arguably offers
greater protection than insurance protection, because:
– For instance, they usually:
a) The interests of the company and those of
a) Provide indemnity for liability, legal costs, a right
the individual officer are often (but not always)
to be advanced funds for anticipated legal costs
closely aligned. If an officer is sued, then his or
and a right for the company to take control of
her risk of liability is likely to affect the interests
the action. Unlike the company's constitution,
of the company.
however, such deeds cannot be altered unilaterally
without the prior consent
b ) Indemnities almost always provide much broader
protection than that offered by insurance policies which offer indemnity on the basis of the terms,
b) Entitle the officer to access board papers and
conditions and exclusions of those policies (and
other company records in the event that they
subject to the requirements of the Insurance
are sued. Having access to these documents will
Contracts Act 1984).
be essential to defending any claim.
– While officers are generally entitled to indemnity from – A broadly drafted corporate indemnity may not only
the company when they are carrying out their duties
protect officers against actions brought against
in good faith and are acting honestly and reasonably,
them by third parties but also protect against
it is usual for the constitution of a company to
actions commenced by the officers when defending
provide a right of indemnity to both current and
allegations (for instance, defamatory imputations)
made against them.2
– Conventional D&O Insurance policies will not provide
cover for actions commenced by an officer against
– The Corporations Act 2001 (the Act) provides that
a third party. These policies are generally designed
a company may provide an indemnity to its officers
to provide cover for claims made by third parties
subject to the limitations set out in section 199A (see
against the officers in their capacity as officers of the
discussion below) and the powers of a company are
enshrined in its constitution.
– Becoming an officer brings with it an increasing
– A company is therefore legally entitled to provide
exposure to personal liability so protection against
an indemnity to its officers within its constitution.
that exposure should be a key consideration
The Act has been amended in recent years to allow
when deciding whether to become a corporate
companies to provide broader indemnities - so it
officer. Securing an appropriate indemnity from the
is important for officers to review their company's
company is something that should be negotiated
constitution to ensure it provides an indemnity as
and finalised before one accepts the offer. If the
broad as that permitted under the Act.
company has not addressed this issue as part of the offer or is not aware or prepared to address the
– Whilst this is an important step in the process
issue it should ring warning bells in the ears of the
of managing personal risk, it is also important to
potential corporate officer.
understand that a company's constitution can be amended in certain circumstances. There is therefore a risk that the indemnity could be amended or even removed at a later date. Such a change could happen after an officer has left the company and without their prior knowledge.
Limitations on Corporate Indemnity
Indemnities to Middle Management
– When becoming an officer, most people ask for a
In light of the report by the Corporations and Markets
full indemnity from the company – that is, they want
Advisory Committee (CAMAC), released in April
the company to reimburse them for any liability and
2006 (titled "Corporate Duties Below Board Level")
associated costs and expenses incurred if and when
which, amongst other things, recommended the
they are sued for carrying out their duties on behalf
extension of the obligations of directors and officers
to "any other person who takes part, or is concerned, in the management of that corporation", corporate
– The reality is that, no matter how broadly a deed of
indemnities should be reviewed to ensure that they
indemnity is drafted, the Act limits the extent
cover those who take part in or are concerned in the
to which companies may indemnify their officers.
management of the company.
– Corporate indemnities do not and, in fact, cannot
What does this mean?
indemnify officers against every possible liability and its associated legal costs. Section 199A of the
– It means that corporate indemnities should no longer
Act prohibits indemnities to officers for liability to the
be limited to officers who report directly to the board
company incurred as an officer of the company. So,
if the person bringing the claim against the officer is the company itself for, say, breach of a director's
– Companies should consider whether there are any
duty, then the deed of indemnity cannot operate to
managers, external consultants, consultants or
protect the officer.
advisers who take part in or are concerned in the management of the company.
– Section 199A of the Act also prohibits a company
from indemnifying its officers against:
For instance, a national sales manager of a major
corporation, whose dishonesty or negligence
a) A liability for a pecuniary penalty order or a
could cause substantial harm to the company, could
compensation order made under the Act.
be liable for a breach of statutory duty even though he or she is technically not an "executive officer" of
b) A liability which did not arise out of conduct in
good faith – that is, it arose out of conduct in bad faith.
– Instead, it extends to those activities involving a
segment of the company's overall business. It covers
c) Legal costs incurred where:
a wide range of activities relating to management of a corporation, each requiring an involvement of
The officer is found to have a liability for which
some kind in the decision-making process of that
they could not be indemnified.
There is a finding of guilt in respect of criminal proceedings.
– From a commercial perspective, companies may
Orders sought by ASIC or a liquidator where
not wish to provide indemnities to all persons who
the grounds for such orders have been
are concerned in or take part in the management of
The court denies relief, in connection with proceedings for relief under the Act.
For instance, they would probably not wish to indemnify all external consultants and advisers.
– The efficacy of deeds of indemnity depends, of
They must, however, consider the situation and
course, very much on the solvency of the company.
make a judgment call as to the extent to which
If the company is insolvent or does not have
they would provide corporate indemnity to those
adequate funds to back the indemnity, then that right
who take part in the decision-making process of
to indemnity is virtually worthless.
– It is therefore important for officers to secure a
second line of defence by purchasing appropriate insurance protection to act as a "back-up" against the risks of personal liability.
Footnotes(1) See: Treasury's Discussion Paper
(2) See, for instance: Whitlam v National
(3) This example was given by Justice
entitled "Review of Sanctions in
Roads and Motorists' Association
Austin in the case of ASIC v Vines & Ors
Corporate Law", issued in March, 2007
NSW SC 766; however that decision
 NSWSC 738 where his Honour
which is expected to be finalised in
was overturned by the Court of Appeal,
said that management is not confined to
November this year.
whose interpretation was that the
indemnity was not sufficiently broad.
Directors and officers have become far more exposed
to personal liability over the past few decades.
Directors' & Officers' Liability (D&O) Insurance can
protect directors and officers against shareholder class
actions by transferring personal liability risk.
It is vital, however, that the limitations and exclusions
of D&O Insurance are understood. This means that as
management teams become more exposed to personal
liability, it will become important for directors and
officers to undertake a new, more vigilant approach to
Risk Transfer - Insurance Protection
There are several types of insurance policies which
In general terms, D&O Insurance covers past, present
may provide the kind of protection directors and
and future directors and officers of the company for:
officers need in terms of transferring their risks of personal liability.
1. Their legal liability to pay compensation to
The most well known type of insurance is Directors' &
Officers' Liability (D&O) Insurance – D&O Insurance is
2. Legal costs associated with defending a claim
most frequently purchased and acts as the cornerstone
made against them alleging a "Wrongful Act"
for the transfer of management liability risk.
committed by them in the performance of their duties as directors or officers of the company.
There are, however, a number of products that can be purchased in addition to D&O Insurance. For example:
"Wrongful Act" – D&O policies usually define this very broadly to mean any act, error or omission committed
– Personal D&O Insurance – a policy usual y
or allegedly committed in the capacity of director or
purchased by individual directors to cover their risks
officer of the company. Most current shareholders class
of liability in respect of multiple board positions. Its
actions in Australia typically allege some form of failure
benefits are two-fold:
to disclose material information (see the Telstra claim
that settled in November 2007), misleading conduct or
1. It provides the insured with their own limit
misrepresentation to shareholders. All of these are likely
to fall within this definition.
2. It can act as a safety net in the event that a
– Given the breadth of the "Wrongful Act" definition
company is unable or refuses to indemnify the
and other key policy definitions such as "Claim" and
director, or a corporate D&O policy does not
"Loss", it would be fair to say that, at first glance,
respond to a particular claim.
the insuring clauses of most D&O policies available in the Australian market are likely to respond to a
– Prospectus Liability Insurance – offers protection
shareholder class action made against directors and
more pertinent to risks associated with particular
officers insured under the policy.
securities claims. This type of policy is designed to cover the company and its directors and officers in
Limitations & Exclusions
the event of securities claims being made against them arising out of a specific capital or debt raising
However, like all other types of insurance, D&O policies
transaction. Prospectus Liability Insurance is
have their limitations and exclusions. Directors and
becoming increasingly popular, particularly for larger
officers need to be aware of what they are.
Indeed, as a matter of prudent risk management,
It has the benefit of ring-fencing a higher risk
activity from the corporate D&O insurance
programme. As a separate policy it also has the
1. Peruse the terms and conditions of their D&O
advantage of providing a separate limit of liability
cover before they join a company.
over a policy period of up to 7 years. Furthermore, the premium can be capitalised as part of the costs
2. Make sure that they read the policy before it is
of the transaction.
renewed each year.
They then can be fully aware of the extent of their exposures in the event of a claim being made against them and they can then manage that risk accordingly. Finding the gaps in a policy after a claim has been made is clearly not ideal.
D&O Policy Exclusions
– Fines & Penalties Exclusion
D&O policies contain a number of common exclusions
Another risk that is typically excluded in D&O
which may operate to exclude part or all of a
policies is the liability for fines and penalties that
shareholder securities claim. Some of the major ones
may be imposed on directors and officers. Fines and
are as fol ows.
penalties are usually excluded either by way of a specific Fines & Penalties Exclusion or by way of
– Major Shareholder Exclusion
a "carve-out" within the definition of the word "Loss" in the policy wording.
Most D&O policies contain some form of Major
Shareholder Exclusion. Generally the intention
As discussed in Part 6 of this White Paper Series,
behind it is to prevent parties with significant equity
regulatory proceedings are often a pre-cursor to a
in the company from benefiting by bringing a claim
securities claim. If, as a result of those proceedings,
against the directors and officers for a wrongful act
a director or officer is ordered to pay a civil penalty,
which they themselves were party to or had the
then this liability will not be covered by the policy
opportunity to prevent.
(even in the absence of any intentional wrongdoing) by virtue of this exclusion.
However, some Major Shareholder Exclusions currently in use in the marketplace have the potential
It is, however, increasingly common for D&O policies
to operate well beyond this intent. For instance, the
to provide an extension in respect of pecuniary
exclusion could operate to exclude a claim brought
penalties but it is usually sub-limited and the cover
by a shareholder who was not a major shareholder
is often restricted to penalties imposed in certain
of the company at the time the relevant "Wrongful
countries or under certain legislation.
Act" was committed. Clearly, a major shareholder is unlikely to be in a position to influence the decision-
– USA & Canada Jurisdictional Exclusion
making of the company when it was not a major shareholder - yet, depending on the wording of the
One exclusion that is often overlooked in respect
exclusion, it could still apply.
of securities exposures is the USA & Canada Jurisdictional Exclusion.
Even if the exclusion does not go beyond its original intent, directors and officers need to be aware
Even though an Australian company may only be
that claims (and not just securities claims) brought
listed on the Australian Stock Exchange, it is not
against them by major shareholders are unlikely to
uncommon for their shares to be traded on the
be covered under the company's D&O policy. Careful
New York Stock Exchange as American Depository
perusal of the policy wording is therefore crucial.
Receipts or "ADRs".
– Prospectus Liability Exclusion
As a result, directors and officers are exposed to regulatory actions which might be taken by the US
It is also common for D&O policies to contain a
Securities and Exchange Commission. They are also
Prospectus Liability Exclusion. These exclusions can
exposed to claims by aggrieved ADR investors who
operate retrospectively and/or prospectively.
are entitled to sue them under US securities laws. US securities laws are renowned for being some
As the name suggests, they are intended to exclude
of the world's toughest. This exclusion would likely
any claims made against the insured persons
prevent the policy from responding to these actions.
that arise out of the issuing of a prospectus for the purchase or sale of the company's securities.
– Pollution Exclusion
Shareholder class actions typically claim compensation for loss caused by fluctuation in the
Another exclusion to be aware of is the Pollution
value of the securities purchased or sold by those
Exclusion. Directors and officers should examine the
shareholders. If the shareholders purchased or sold
precise wording of this exclusion and consider the
their securities pursuant to a prospectus (rather than
extent of their exposure.
in the course of open market trading), and the policy contains a Prospectus Liability Exclusion, then it is
This exclusion may operate to exclude cover for a
possible that the policy will not respond to the claim.
securities claim if the underlying cause of the loss in shareholder value is connected with the release of pollutants into the environment.
What are the potential exposures of directors and officers if a securities claim is based on an allegation of their failure to act in response to climate change or a failure to grasp the impact of emissions on the business?
Are greenhouse gases a "pollutant"?
To ‘C' or not to ‘C' – that is the Question?
In April this year, the United States Supreme Court, in a
– When an insurance policy offers an extension of
5-4 decision, ruled that greenhouse gases are indeed a
cover, it is natural to assume that this is a good thing
pollutant. The court did not order the US Environmental
which will benefit the insured. Ironically, it is not
Protection Agency to regulate greenhouse gases, but
just the exclusions in a D&O policy that need to be
the court did direct the agency to take a new
assessed – some extensions of cover need serious
look at the gases.
consideration, too. D&O Insurance was originally conceived to protect a company's directors and
From a prudent corporate governance standpoint,
officers against personal liability. So, when a D&O
management must put in place a proper process for
policy is extended to cover parties other than the
disclosing the potential impact of global warming on
directors and officers, it should raise questions as
the business (for instance, are there tourism assets
to whether that extension is appropriate.
that could be adversely affected by greenhouse gas emissions?)
– For instance, when a D&O policy offers an extension
known as Entity or Company Cover for Securities
Claims (often referred to in the insurance market as "Side C" cover), insured directors and officers need
Most current D&O policies provide an Inquiries
to know that this cover has the potential to cause
Extension which covers the costs incurred by directors
some serious problems.
and officers when they are required to attend regulatory inquiries.
– Side C cover basically provides protection for
the company as opposed to claims against its
However there are some "pitfalls" directors and officers
directors and officers. Whether it is appropriate to
need to be aware of:
have the company covered under a D&O policy really depends on what those buying the policy believe the
– As an official inquiry usually pre-dates any claim
primary purpose of the policy to be. If they believe
(as defined in the policy), it would be unusual for
the primary purpose of the policy is to protect
the inquiry to be alleging any wrongdoing by the
the directors and officers alone, then extending
director or officer. Yet some D&O policies require
the policy to cover the company would not be
an allegation of a "Wrongful Act" as defined in the
appropriate. If they believe that it is appropriate
policy in order to trigger the extension. This is a
to include protection for the company, then that
serious restriction of cover which should be avoided.
decision should be made with a clear understanding of the issues that can arise.
Other restrictions of cover that may appear within an Inquiries Extension that should be
The more significant of these issues are summarised as
– The restriction of cover to legal costs (as opposed to
(i) Insufficient Limit of Liability
non-legal costs which may also be incurred).
D&O Insurance is almost always subject to an aggregate limit of liability. This means that the
– The costs of actually attending the inquiry (significant
one limit of liability is provided to cover all claims
costs can be incurred in preparing for the attendance
against all insureds during the policy period. One
at the inquiry).
characteristic of securities claims or shareholders' class actions is that they usually involve large
It is also not uncommon for insurers to seek to sub-limit
compensation claims and involve massive legal
the cover provided under this extension.
costs. A claim by directors and officers under their D&O policies as a result of such actions has the tendency to exceed the limit of liability provided by the policy.
If a securities claim is made against the company as well as against the directors and officers, it becomes even more likely that there will not be enough "money in the kitty" to cover all of the claims against all the insured parties.
To include the company as an insured in the D&O policy means that the insured directors and officers may be sharing an already inadequate limit of liability. Directors and officers need to be aware of their exposures to personal financial risks in such instances and bear this in mind when deciding whether or not they wish to have Side C cover.
(ii) D&O Policy a Corporate Asset
With conditions in the D&O market continuing to soften,
Most claims against directors and officers arise
insurers are not only reducing premiums but also looking
when the company goes into liquidation. If the D&O
to gain a competitive advantage by offering an array
policy includes Side C cover, this raises the prospect
of new coverage extensions. In this context, it has
of the liquidator claiming the policy as a corporate
become almost standard practice for insurers to offer
asset. This is what happened in the Enron case and
Side C cover – some insurers even have it as a standard
it resulted in the insurer being unable to advance
extension or insuring clause automatically provided
defence costs to the directors and officers. Whilst,
within the policy.
as far as we are aware, this situation has not yet arisen in Australia, it is clearly an issue that must
Most of these new extensions do offer some benefit to
the insured directors and officers but for the reasons stated above, Side C cover needs to be treated with a
(iii) Proof of Debt Claims
great deal of caution.
The effect of the High Court decision in the Sons of Gwalia case is that, in an insolvency situation,
If a decision is made to purchase this cover, careful
shareholders are now able to sue for misleading and
consideration needs to be given to increasing the policy
deceptive conduct to recover their loss and rank
limit, or agreeing a pre-set allocation of the limit to the
alongside unsecured creditors in doing so.
Side C cover. Purchasing a separate "tower" for the Side C cover may mitigate some of the problems mentioned
This raises the prospect that shareholder Proof of
above in the event of a securities claim.
Debt claims and the external administrator's costs in assessing those claims may be covered under Side
C of the company's D&O policy. In that event, the policy's limit of liability may be eroded even before
– The exposure of corporate directors and officers to
claims are made against the directors and officers.
personal liability has been steadily increasing for
This means directors and officers are left exposed to
several decades and the increasing frequency of
personal risks of liability.
shareholder class actions and associated regulatory
actions in recent years in Australia is just another
(iv) Order of Payments
manifestation of that trend.
When there is an insufficient limit to cover the claims that are made against multiple insureds, issues will
– Whilst the law surrounding shareholder class actions
arise as to how the limit is to be allocated and who
in Australia is at an early stage of development (for
is to be paid first. Some D&O policies address this
instance, at the time of writing, the "fraud on the
issue by having "Order of Payment" clauses which
market" theory is being run for the first time in the
state that the directors and officers will get "first bite
Aristocrat trial), it is likely this trend will continue into
From a practical point of view, however, being able
– The recent CAMAC proposals (see the April 2006
to take the "first bite of the cherry" may not provide
report by the Corporations and Markets Advisory
much comfort given the timing of the various claims
Committee entitled "Corporate Duties Below Board
that come before the insurer. It is not often easy to
Level") suggest that this exposure to personal
prove the precise order of the claims made under the
liability will extend below board level to those
policy. The inclusion of Side C cover may not only
involved in any aspect of managing a company.
increase the chances of an insufficient limit scenario. It is also likely to make the order of payments by
– What does all this mean? It means that the
insurers even more difficult.
exposures of company management, at all levels, to personal liability will, in all likelihood, continue to
(iv) No Skin in the Game
increase. More importantly, it means that past efforts
One unforeseen side effect of providing Side C
to identify, control and transfer this risk are unlikely
cover is that, when faced with a securities claim far
to suffice and a new level of risk management
exceeding the policy limit, companies have had no
vigilance will be required.
motivation to defend the claim and have instead prevailed on insurers to settle the claim for the policy limit. For directors and officers who feel they have done nothing wrong and who have their professional reputation on the line, this is clearly not ideal. The potential conflict of interests in such cases provides another reason for companies and their directors and officers to think carefully before including Side C cover in their D&O policies.
For more information on The Liberty White Paper Series please contact Richard Head on 02 8298 5800
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