Why Brexit-related D&O claims are likely to be rare

brexit
banner_mobile

It would not be unreasonable to expect that, almost three years after the EU referendum in the UK, executives would have a clear view on the consequences the decision is likely to have for the company they lead and a plan to manage the potential negative impact of the decision.

But as the political debate and negotiations over the terms of the UK’s departure are still ongoing weeks before the March 29 exit deadline, businesses are left to their own devices with little guidance on what measures to take.

Directors & officers’ (D&O) insurance would theoretically cover lawsuits brought against executives claiming that management did not appropriately prepare the company for the consequences of Brexit and is therefore responsible for a consequent drop of revenue, profits and/or share price. In reality such cases are likely to be relatively few and/or without merit.

The consequences of Brexit for companies in the UK are naturally hard to predict, as it depends on the politically contentious terms of any departure agreement and the future relationship of the UK with the EU. Businesses are likely to face even bigger challenges if the UK exits the EU without a deal. A so-called “no deal Brexit” would likely mean that there would be no 21-month transition period and the UK reverting to World Trade Organisation rules on trade. Tariffs would apply for goods transferred between the UK and the EU. 

Directors and officers can be liable in cases of significant financial loss, a major disruption to business, staff, trading ability or operational disruptions causing additional burdens or financial consequences. In most cases, the effects of Brexit would be included in this. 

“Brexit is just one of the challenges facing boards and policy wordings are designed not to limit or specify the exact source of a claim,” says Michael Lea, Head of Management Liability at Lockton. “The cover applies to a claim arising from any wrongful act or breach of any regulation without specificity,” he explains. 

“We are not aware of any D&O policies that would exclude Brexit situations or limit the cover,” Lea adds. 

We are not aware of any D&O policies that would exclude Brexit situations or limit the cover” 

Most economists agree that the Brexit effect on the economy has already cost Britain between 1.5 percent and 2.5 percent of gross domestic product, according to a Financial Times article from 11 February. 

Recent data suggests that the economy is beginning to reflect Brexit uncertainty. The UK’s gross domestic product (GDP) contracted by 0.4 percent in December 2018, however still allowing for a 0.2 percent expansion in the fourth quarter of the year, according to the Office for National Statistics. Overall, annual gross domestic product growth in 2018 was the lowest since 2012 with 1.4 percent. 

Uncertainty around Brexit has led some companies to suspend investments in the UK or redirect them to a different location. Many firms in the financial sector are also transferring business from the UK to a different country in the EU to ensure market access to EU clients after Brexit. By leaving the EU the UK is expected to exit both the customs union and the single market. 

Professional services firm EY is advising businesses to continue mitigating against a “No-Deal Brexit” in business-critical areas until a majority of members of parliament vote in favour of a legally binding alternative or a “No Deal Brexit” is procedurally ruled out.

Meanwhile, companies’ executives are taking a variety of actions to protect businesses. As Brexit may lead to delays at the border with the EU causing disruption for the import and export of goods, some companies have been stockpiling materials and products. The impact of border delays would be particularly detrimental to the automobile industry which operates on a just-in-time principle with components sourced only when needed to keep the cost low. Some firms are even shutting down production facilities in the UK completely during the period when the UK effectively leaves the EU as a precautionary measure. 

Among firms that are stockpiling goods are Rolls-Royce, Bosch and AstraZeneca for example, according to the Bloomberg Brexit Impact Tracker. For perishable goods, stockpiling is of course not an option. Other companies such as JPMorgan, Schaeffler and Sony are examples of firms moving parts of their operations away from the UK to prepare for potential consequences of Brexit. 

“D&O insurance is not a substitute for due diligence in preparing for Brexit,” Lea says.
“Whilst the policy might provide a robust defence for directors, the company still has a duty to its shareholders to exercise sound business judgement and governance in all areas,” he explains. 
Part of the defence of a firm could for example include engagement with lawyers, consultants or other professional advisors.

Unless a company does nothing at all to prepare and protect the business, D&O claims based on wrong business judgement in relation to Brexit are unlikely, not least because in the UK directors owe a duty to the company and not directly to shareholders. “The management of a UK firm that allegedly did not appropriately prepare for Brexit would have to be sued derivatively via the company itself, which is very unlikely as not only individual executives will have been involved in the Brexit plans but the whole management team,” Lea explains.

Directors of UK companies with US shareholders may be more at risk of litigation but potential claims will be challenging to plead. “It will be hard to argue that a company was not appropriately prepared for Brexit if neither the UK government nor the country are prepared to deal with the unclear outcomes and consequences,” Lea says. 

D&O liability claims are usually driven by alleged failure to comply with regulation such as the General Data Protection Regulation (GDPR), or alternatively, Bribery Act, where it is easier to prove a breach of regulation than for failed business judgement. “In hindsight it’s always easy to identify what the appropriate decision should have been. This would particularly apply to Brexit, where the outcome and the consequences for businesses have been unclear until the exact nature of the UK’s departure from the EU is determined,” Lea says.