Directors can expect heightened shareholder activism under new Companies Act

Directors and officers, charged with making difficult management decisions in the course of their work, may face heightened litigation once the new Companies Act comes into effect in later this year. Increased litigation may also cost directors millions in their personal capacity.

Key provisions in the new Act will raise directors accountability to shareholders and increase the likelihood of shareholders participating in legal action, particularly if the company and its officers caused shareholders to suffer significant financial loss.

“The scope of persons able to bring an action as well as the basis for liability is now much wider,” says Philip Hobson, Financial Lines Manager at Chartis South Africa.

“This means that anyone, including shareholders and staff members, can sue directors and officers directly, which will heighten their personal liability.”

Currently, a shareholder’s relationship with the company means that they can’t, generally speaking, bring an action against officers directly. They have to request the company to bring a law suit against an officer who committed a wrongful act.

However, directors and company officers are unlikely to bring an action against their colleagues, and therefore shareholders have limited recourse to recover damages from wrongful acts committed by company officers.

“Under the new Act, shareholders will have direct recourse against directors and officers in a personal capacity as long as they can prove they have suffered damages,” says Hobson.

This recourse will now be available to a wider range of persons, not just shareholders. Directors will be personally liable for breaches of their fiduciary duties and may be sued for loss and damages caused to creditors, employees, customers, competitors, shareholders or other stakeholders of a company.

For example, if a director makes a bad decision or acts negligently, causing his company to suffer financially, and this results in retrenchment of an employee, that staff member will be able to bring an action against the company officers directly.

Another significant change in the Act is that it specifically provides for class actions by extending liability to a class of persons. Class actions increase the amount of damages claimed exponentially.

Increased shareholder activism and the extension of liability to a wider class of persons means that South Africa is likely to follow the trend in countries like the US, UK and Australia which all have experienced increased litigation against companies, company officers, and directors.

Australia, for example, which has gone through a similar corporate law evolution, has seen claims against directors and officers double in the last 4 years. In the UK, the D&O insurance market is forecast to grow by 27% to £596 million by 2013.

Directors and officers need to be prepared for the changes in the Act and the wider basis for liability, as their own assets will be in the firing line should an action be bought against them. This means they could face very large monetary damages.

Hobson warns that management should make sure they are properly insured for any eventuality.

“Companies, directors and their insurance advisors aren’t well prepared for the risks that could arise from increased shareholder activism and class actions. Considering the Act provides for personal liability, which could cost directors financially, they need to ensure they are adequately covered.”

TAXtalk: www.taxtalk.co.za