The Russian insurance market is very young but rather dynamic. In just about two decades it has transformed from a state monopoly into a diversified market place offering a wide range of insurance products for many types of businesses and individuals alike. Traditionally strong in classic insurance lines (fire, commercial property, construction all risks, marine, etc) it has developed completely new areas of insurance such as, for example, directors and officers liability insurance the concept that was barely known in Russia until not so long ago. This article looks into the recent history of the directors and officers liability regulation and insurance as well as outlines the prospects of increased regulation in this area.
D&O liability insurance
Currently, the Russian D&O liability insurance market is limited to those Russian corporates which have already placed their shares or other secutiries on the capital markets outside Russia or are planning to do so in the near future. There have also been few examples of big Russian companies (like Sberbank) buying D&O insurance policies for their directors to cover mostly domestic risks.
At the moment, D&O insurance is not popular in Russia for mainly two reasons. First, as mentioned below, Russian directors and officers are rarely sued due to poor corporate governance legislation and low level of shareholder protection. Another reason is the Russian insurance legislation that is not designed to embrace such line of insurance. There have been debates around classification of this type of insurance which is important in the Russian legal environment. While a concept of civil liability insurance exists, Russian law requires it to be written fully in favour of the affected thrid parties, so a director cannot receive compensation for his legal costs. In such circumstances, if the company wants to insure its costs associated with indemnification agreements with its directors, it obviously cannot do so under a civil liability insurance policy but can arguably insure such costs under a financial risks policy. So, insurance companies have to sell combined civil liability and financial risks policies and such policies are not an easy sell both from the practical and legal perspective.
Current situation with claims against directors
So far lawsuits against directors have been more an extravagancy rather than a matter of routine. The reason for this seems to be the lack of proper corporate governance culture and shareholder protection. However, there have been some precedents when significant sums of money have been awarded against directors in Russia but they mainly relate to bankruptcy of financial institutions. The first examples of such cases were seen after the banking crisis in Russia in 2004. The cases that have been reported in the Russian press mostly relate to 2006 when directors of insolvent banks were sued for significant amounts. For example, few directors of Dialog-Optim Bank were found guilty of stripping the assets of the bank and were required to pay over 1 bln roubles (over EURO 25 mln at the current exchange rate). As a more recent example of a claim against a director of a Russian company listed outside Russia, one can mentioin the claim against Mechel steel plant, a Russian mining and metals company and its directors brought in 2009 in the U.S. by shareholders accusing the company of not keeping investors up to date on a damaging 2008 antitrust probe and of making false financial statements.
Until recently, the main exposure for the directors has been the listing of the company they work for on varios stock exchanges. The number of IPOs has dried up but it is expected that Russian companies will come back to this idea in the near future and there have been some examples of this already (e.g. UC RUSAL’s listing in Hong Kong). So, it is reasonable to expect that directors may again require protection against risks related to public offerings of securities. Also, the current economic crisis has caused more bankruptcies in the financial sector and there have been some reports on potential claims against directors of such bankrupt financial institutions.
Class action introduced
However, the most immediate source of claims against directors and officers in Russia could, perhaps, be found in the dramatic changes that are going on in the Russian law in respect of corporate governance and directors liability. These changes have not yet been analysed deeply enough to appreciate that they could potentially open the floodgates for suits against directors.
It has all started with a relatively small amendment to the procedural rules introducing a possibility to bring a shareholder class action. A year ago the rules of civil procedure were changed and the concept of an opt-in class action was introduced. Today a shareholder or a bond holder may file a claim against a company and/or its directors and offer other shareholders or bond holders to join the proceedings as plaintiffs. Matters of fact established by a decision of the court on such claim will create a precedent for other courts considering claims against the same defendant on the same grounds and cannot be challenged.
The above changes represent a significant shift in the Russian procedural rules. The new rules came into force late October 2009. It may be expected that the amount of claims filed under the class action procedure will be growing, although there have been no reported cases so far, as they apply not only to claims arising out of corporate law but may also be used for filing claims against financial advisors, financial brokers, asset management companies, mutual funds, etc.
Corporate governance reform
Other changes that are expected relate to corporate governance. Draft laws are being discussed that purport to better define the duty of care, good faith and caution that directors must perform in relation to the company they work for.
Currently, the duties of directors are set out in the Civil Code and special legislation on joint stock and limited liability companies. Article 53 of the Civil Code provides that directors must act in good faith, reasonably and in the interest of the company and are liable to the company and its shareholders for damages caused by their faulty actions or failure to act. The law is unclear as to what represents bad faith or unreasonable behaviour and directors face claims very rarely, mostly because the plaintiffs must prove lack of good faith on the part of a director, the amount of damages and a causal link between unreasonable behavior of the director and the losses. Russian law does not recognise a concept of fiduciary duty that directors owe to the company which makes it very difficult to seek any recovery from them.
The Government has introduced to the State Duma a draft law that would mean a major change in the regulation of the duties of directors and officers and their liability making them hugely exposed.
The draft provides that a director or an officer has been at fault and, therefore, liable for damages if he has acted unreasonably or in bad faith. The draft provides for certain criteria that should help establish when a director or an officer acts unreasonably or in bad faith. For example, a director or an officer acts unreasonably where he has taken a decision without regard to all information available to him or has not taken steps that are usually taken to obtain such information. A director or an officer acts in bad faith if he was aware of a confict of interests; realised or should have realised that he was acting to the detriment of the company’s interest. Also, a director or an officer acts in bad faith if he does not perform his duties without a cause or if his actions or a decision he supported contradicts the legislation or the charter of the company.
As can be seen, while purporting to define certain parameters and to make the rules more clear, the draft law potentially opens a new area of ambiguity. In general, Russian law often has inherent contradictions and is not clear in many cases, so it may be easy to argue that a corporate decision violates the law thus giving rise to claims against the director. To make things worse, the draft law shifts the burden of proof on the director requiring him to demonstrate that there has been no evidence of unreasonable or bad faith behaviour.
The draft law widens the list of potential defendants in disputes related to placement of securities. At present, liability for misrepresentation of facts and circumstances in the course of a public offering rests with those persons who signed the prospectus. In any event such persons include the general director and the chief accountant but may also include the auditor and/or the financial advisor. The draft law provides that members of the board that voted for the approval of the prospectus may also be held liable for losses caused by any wrong or incomplete disclosure of information in the prospectus.
While the proposed amendments significantly expose directors and officers they also allow to have indemnification agreements between the company and its directors. The draft introduces a possibility for the company to indemnify its directors against any legal costs inculding defence costs in civil, administrative or criminal procedures.
Finally, the draft introduces another procedural change related to the allocation of legal costs. It says that in case of a shareholder derivative action the court may impose the legal costs of the plaintiff on the company even in the case of the successful defence by a director. However, this will not be possible if the court establishes that the claim was filed by the shareholder with a sole purpose to abuse his rights.
Changes to D&O liability insurance regulations
The draft law is a rather comprehensive document that purports to cover various aspects of corporate governance and risk management including D&O insurance.
The draft declares that a company may purchase liability insurance for its directors and officers. It also requires material terms of the policy to be approved by the shareholders meeting.
Another big step forward is a suggestion that the company may have indemnification provisions in its contracts with directors and officers. The draft law allows the company to indemnify its directors for legal costs associated with claims made against them. Such indemnification provisions or indemnification agreements must be approved by the general meeting of shareholders.
Another important change is a proposal to allow the company to insure its risks associated with its obligation to indemnify its directors thus making side B cover possible under Russian law.
Perhaps, the most controversial proposal is to classify D&O liability insurance as contractual liability insurance. According to the Civil Code, contractual liability insurance is possible only if it is explicitly provided for by the law. So, the draft law provides that as directors and officers have contracts with the company, they bear contractual liability towards the company. While this may be right in light of the other changes that require the company to have such contacts with its directors, this concept will not work if claims are made by third parties (e.g. investors or shareholders). Directors do not have contractual relationship with such persons and, therefore, their liability towards such persons cannot be insured under the contractual liability insurance policy.
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