CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
– Indemnity. To help insulate directors from the risks associated with their positions, issuers may agree to pay for costs associated with civil, criminal or investigative proceedings against a director for honest and good faith actions taken on behalf of the corporation. 47 However, unless this promise is secured against a tangible asset, it may not provide adequate protection when the corporation becomes insolvent. In those cases, the obligations to the directors will be considered against other debts, and they may only return cents on the dollar or nothing at all. After a corporation begins insolvency or restructuring proceedings, directors may be protected through a court ordered “D&O Charge” if they agree to keep their positions. 48 – Trust fund. The corporation may choose to set up trusts to fund potential indemnity obligations. During insolvency or restructuring proceedings, funds held in a D&O trust remain available to directors and officers. Since the funds are held on behalf of directors, they remain out of creditors’ reach. Directors should be mindful of when funds were placed in the trust, since payments made after the corporation became insolvent may be reversed. 49 – D&O insurance. D&O insurance serves a similar purpose to a corporate indemnity, although the corporation pays premiums to a third party that carries the risk of proceedings against directors. As with other types of insurance policies, the terms, conditions and scope of coverage can vary. Directors must ensure that they are familiar with the terms of the policy and that premiums are up-to-date. If coverage has lapsed, it may prove difficult or very expensive to obtain protection after the corporation has started experiencing financial difficulty.
POTENTIAL LITIGATION RISKS Directors may also be subject to personal liability in situations in which the corporation itself is not liable. The two lawsuits that a director is most likely to face arising from their positions are oppression and derivative actions. Oppression actions may be brought by any relevant corporate stakeholder, including employees and creditors. 50 A party or group bringing the oppression action needs to prove two elements: (1) it had a reasonable expectation, and (2) that expectation was violated by conduct that was “oppressive,” or was “unfairly prejudicial” or “unfairly disregarded interest.” 51 When considering if a stakeholder has a reasonable expectation, the court will consider: commercial practice, the nature of the corporation, the relationship between the parties, past practice, steps the claimant could have taken to protect itself, agreements and representations, and the fair resolution of conflicting interests between stakeholders. 52 Directors may be subject to personal liability in situations in which the corporation itself is not liable. The two lawsuits that a director is most likely to face arising from their positions are oppression and derivative actions.
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