Guest Post: Builders and Economic Loss

Posted 6 February, 2010 by Ralph Mylie, Jr., CIC, RPLU
Categories: General Liability, Property

(This post is provided by UK colleague Nadia Lucherini with CMS/Cameron McKenna in Bristol.)

Does a building contractor owe his client a concurrent duty of care in tort and in contract in relation to economic loss? This age-old question was recently addressed by the Manchester TCC in Robinson v P.E. Jones (Contractors). The decision is likely to be of interest to builders as it clarifies the extent of their exposure to claims.

In 1991, P E Jones entered into an agreement with Mr Robinson whereby P E Jones would build and sell him a house. The house featured gas fires in two rooms which were served by chimney flues that P E Jones constructed. In 2006, two years after the gas fires failed a safety test, Mr Robinson started proceedings against P E Jones, claiming that the chimney flues had not been constructed properly.

The claim was well outside the limitation period for a claim in contract. So Mr Robinson was forced to argue that the building company owed him a duty of care in tort.

P E Jones argued that there was no duty of care and that it was an economic loss. The building company argued, relying upon the House of Lords case of Murphy v Brentwood, that a builder did not owe a duty of care in tort to an owner or an occupier where the loss was an economic loss.

In his judgement, Judge Davies sought to reconcile the case law. He stated that the general rule, on which P E Jones sought to rely, that a builder does not owe a duty of care to owners or occupiers is not intended to exclude circumstances where there was a “special relationship of proximity” for example, when the builder is also in a contractual relationship with a client.

In general terms, therefore, the Judge held that, in principle, a builder will owe a tortious duty of care to his client, concurrent with his duty in contract, in relation to economic loss. Practically, this ruling means that claimants are able to take advantage of the remedy, either under contract or tort, which is most favourable to them, making it easier for them to recover economic loss.

However, unfortunately for Mr Robinson, Judge Davies held that P E Jones had, through its Building Conditions, successfully excluded any duty in respect of any defect, error or omission in the execution or completion of the works save for the ten-year period covered by the National House Building Council’s agreement (which was, by that point, time-barred). Judge Davies held that Mr Robinson could not challenge the efficacy of the clause in the Building Conditions as it operated precisely to prevent a duty in tort arising. Mr Robinson’s assertion that the clause fell foul of the Unfair Contract Terms Act 1977 also failed as P E Jones pointed to an exception which states that the Act does not apply to “any contract so far as it relates to…an interest in land.”

This decision acts as a useful reminder that a builder will owe a concurrent duty of care to its client in relation to economic loss. This means that they can be liable in tort long after the expiry of the contractual limitation period in circumstances where discovery of damage happens years down the line. However, the case also shows that a builder can reduce this risk by incorporating a contractual term that limits the tortious duty.

Foreign Corrupt Practices Act — Probes may hit D&O insurers

Posted 17 December, 2009 by Ralph Mylie, Jr., CIC, RPLU
Categories: D&O, Foreign Corrupt Practices Act

Frederic Bourke Jr. was convicted in July by a federal jury in Manhattan of violating the Foreign Corrupt Practices Act (“FCPA”), among other charges, in connection with an alleged scheme to bribe Azerbaijan government officials, and highlights an emerging area of concern for directors and officers liability insurers and policyholders.

The FCPA prohibits paying foreign government officials to obtain or retain business. Mr. Bourke did not pay bribes himself. But he invested $5.7 million with a Czech expatriate, Viktor Kozeny, whom he knew—or should have known—planned to bribe Azerbaijani government officials, jurors found.

The FCPA bars attempted bribes, even if unsuccessful, and jurors found that Mr. Bourke must have known Mr. Kozeny’s intentions. Mr. Kozeny was sometimes called the “Pirate of Prague” for allegedly stealing investor money as part of a similar scheme in the Czech Republic, and two witnesses said Mr. Bourke knew of the bribes.

The case is part of a pronounced effort by the federal government in recent years to enforce the 1977 statute more aggressively. The Securities and Exchange Commission has established a dedicated FCPA enforcement unit, and the Justice Department says it is investigating at least 120 companies on five continents.

According to attorneys who track these actions, the number of SEC and DOJ enforcement actions has increased 500% between 2004 and 2009. This is why the FCPA could become a significant exposure for D&O liability underwriters.

Fines and disgorgement penalties paid in connection with SEC or DOJ probes likely would be excluded from coverage under most D&O liability policies, legal observers agree. But defense costs for such cases likely would be covered by D&O liability policies. Those costs often can be significant and sometimes blow through D&O liability limits.

In addition, professionals involved with D&O say FCPA violations make follow-on litigation—a securities fraud or derivative suit—more likely. In addition to its bribery prohibition, the FCPA also requires companies to maintain adequate internal accounting controls and accurate and transparent records. Violations of this “books and records” provision of the FCPA often provide a foundation for suits alleging that directors and officers breached their fiduciary duty.

Only 31% of companies report having a “comprehensive” FCPA compliance program, according to a September survey by Deloitte Financial Advisory Services L.L.P.

It is expected D&O underwriters will increase their attention and inquiries into a company’s practices in foreign countries with an eye toward FCPA exposure. However, history in our industry tells us that until they have losses, they will ignore the possible risks.

For UK Hotels — A duty to reduce carbon emissions

Posted 8 December, 2009 by Ralph Mylie, Jr., CIC, RPLU
Categories: Climate Change, Legal, Risk Management

(This article first appeared in Hotel Report.)

In April 2010, a new regime designed to improve energy efficiency and reduce the amount of carbon dioxide emitted by businesses will be implemented in the United Kingdom. As well as the large hotel chains, this will also affect owners of unbranded hotels that exceed the relevant electricity usage thresholds and all owners of branded hotels.

To be known as the Carbon Reduction Commitment (CRC) scheme, it is a mandatory scheme and will apply to organizations whether in the public or private sector who have at least one electricity meter settled on the half hourly market and whose annual UK electricity usage exceeded 6,000 MWh which represents an annual electricity bill of roughly $985 million at current rates.

What is the CRC scheme?

Under the CRC scheme, participating organizations must purchase “allowances” sold by the government for each ton of carbon dioxide that they emit.  The initial price will be nearly$20 per ton. So there is a direct incentive for these organizations to reduce their emissions and therefore their energy bills.

Additionally, the better a participating organization performs at reducing its emissions, the higher its ranking in the annual performance league table that the Government plans to publish showing the comparative performance of all participants. Government proceeds from selling allowances will be handed back to those organizations that feature most highly in the league tables.

What constitutes an ‘organization’?

Group organizations will be treated as a single entity under the CRC scheme and all members of that group will be required to participate. There are two main groupings that constitute ‘organizations’:

  1. Corporate groups, i.e. all parent companies and subsidiaries, including subsidiaries of foreign parent companies; and
  2. Franchise groups, which include not only the franchisor’s corporate group, but also all franchisees of the franchisor.

It is important to note that there are significant financial penalties for non-compliance and liability for compliance with the CRC scheme will be joint and several and attach to all entities within the CRC organization.

The implication for the hotel industry

The implications depend on whether the hotel in question is leased, managed or franchised. Whilst a managed hotel is distinguished from a franchised hotel in the hotel industry, any managed hotel that is operated under the manager’s brand will be treated as part of a franchise for the purposes of the CRC scheme.

Leased hotels

Under a standard lease, a hotel operator as tenant is likely to be the counterparty to the energy contract in place as opposed to the owner as landlord.  Under the CRC regime as currently envisioned, CRC liability for energy use will attach to the hotel operator itself if it is a single entity or where the hotel operating company is part of a group, all of the companies in the group (subject to certain exceptions) which together will constitute the CRC Organization.

In the less common situation where the landlord is the energy contract counterparty (perhaps where the hotel is part of a larger mixed-use building), then the CRC liability will reside with the landlord. The commercial lease arrangement between the landlord and the tenant will determine whether the landlord can recover the cost of the allowances through the service charge and/or whether the tenant is entitled to share in any rebates – the CRC regime does not govern this private matter.

Franchised or branded managed hotels

The definition of a franchisee is where the franchisee “presents or equips [the hotel] premises to a standard or specification which results in that premises having an internal appearance which is substantially uniform with premises belonging to other franchisees of that franchisor or of the franchisor itself.” This means that:

  1. The owner of a branded hotel is associated with the operator under the CRC scheme.
  2. The operator’s corporate group will be aggregated with all its franchisees’ hotels for the purposes of determining the ‘CRC Organization’.
  3. The parent of the operator’s group (or the UK group company nominated by the parent) will need to purchase allowances for the whole CRC Organization.
  4. The management agreement will need to determine whether the operator can recover the cost of purchasing allowances as an operating expense and, if so, how rebates given back to the CRC Organization will be re-credited to individual owners.

Unbranded managed hotels

Normally the owner will have the liability to purchase allowances, if it is large enough to qualify. However, if the manager has a single contract for electricity under a group-purchasing scheme for all hotels managed by it, and it pays the bill with a re-charge to owners, then the manager may become responsible for purchasing the allowances. If the manager contracts with the electricity provider, but merely as agent for the owner, then that contract will be considered to be the owner’s and the owner will be responsible for purchasing allowances.

Next steps for owners and operators

Hotel operators, who may be aware of the need to measure their own electricity usage in owned and leased hotels and their head offices, may need to ensure that they are in a position to measure usage of all UK hotels operated under one of their brands, whether on a managed or franchised basis. On the basis that no management agreements expressly deal with this issue, operators should ensure that they agree a protocol with their owners as to how the system will operate in terms of re-charging for allowances and re-crediting of rebates.

Owners of branded hotels should challenge their operators/franchisors to explain what they intend to do to minimize the cost of the scheme by maximizing emissions reductions and therefore the rebates available under the scheme.

There will also be implications for investors, purchasers and developers of hotels who, together with owners and operators, will need to seek advice on how the CRC scheme will affect their involvement in the sector.

Professional Negligence Claims in UK

Posted 30 November, 2009 by Ralph Mylie, Jr., CIC, RPLU
Categories: Professional Liability

UK courts have increasingly been finding that professional negligence claims will become time-barred 6 years after the date of advice, regardless of whether the claim is made in contract or tort.

The Court of Appeal has now confirmed this trend and has expressly recognized that the limitation periods in tort and contract ought broadly to be the same where a claim is essentially contractual in nature.

A professional’s relationship with his or her client is usually contractual in nature.  However, professional negligence claims tend to be made both in contract and in tort.  Often this is done because the limitation period allowed for claims in negligence is perceived to be more generous than for those in contract.

For claims in contract, limitation will run from the date the contract is breached by the provision of negligent advice.  However, limitation for claims in tort will not begin to run until the claimant first suffers damage as a consequence of the negligent advice.  Claimants often use this to their advantage by asserting that they did not suffer damage until long after they received negligent advice, effectively allowing them more time to bring a claim.

Yet the clear weight of case law, to which the Court of Appeal’s recent decision can now be added, shows that claimants very rarely succeed with this argument.

Indeed, the Court of Appeal emphasized that in cases of negligent advice the person relying on the advice will usually have entered into a transaction of some kind which has turned out to be flawed in some way.  The fact that the flawed transaction has been entered into will usually be damage from the claimant’s point of view, meaning that the limitation period in tort begins to run at that point not at some later date when a more tangible loss manifests itself.

Of course, a remaining potential advantage of negligence claims in tort is that the claimant can benefit from an alternative 3-year limitation period running from the date they first acquired knowledge of their potential claim.  However, the case law on this issue is also relatively strict on claimants and only allows them 3 years to investigate whether they might have a claim against a professional rather than allowing them 3 years to issue a claim once they have confirmed the existence of such a claim. 

Accordingly, professionals and their insurers can increasingly expect to avoid claims for advice given more than 6 years ago and claimants who delay in issuing their claims run a real risk of being time-barred.

Guest Post: European D&O Market Primed for Robust Growth

Posted 9 November, 2009 by Ralph Mylie, Jr., CIC, RPLU
Categories: D&O

New laws put corporate directors at risk, sparking demand for protection.

Directors of European companies are more likely than ever to be sued by disgruntled shareholders, according to a new report from Advisen Ltd. As a result, directors and officers liability (D&O) insurance is one of the fastest growing insurance products in Europe, and sales will continue to increase at a brisk pace in the coming years.

Accounting scandals and corporate governance shortfalls have led to new laws across Europe requiring greater transparency and heightened shareholder protections. Additionally, legal systems have been reformed to give shareholders unprecedented access to the courts. These governance and legal reforms expose directors to greater liability, and lawsuits naming companies and their directors have increased throughout Europe. Some recent suits have settled for hundreds of millions of Euros.

“The United States is still the world’s preferred venue for litigating shareholder lawsuits, but more and more suits are being brought in European courts,” said John Molka III, the author of the report. “Increasingly, directors of European companies are demanding insurance protection. The US D&O market has shrunk during the recession, but premium volume is up sharply in Europe.”

Securities regulators across Europe have stepped up enforcement activities in recent years, further exposing corporate directors to liability. Regulators across the globe are sharing information and coordinating investigations, putting additional pressure on multinational corporations. Investigations and other enforcement activities not only are costly for companies, they also can spark shareholder suits.

“Underwriters clearly are concerned about the heightened exposure to claims, but at the same time the threat of regulatory investigations and shareholder suits is creating unprecedented demand for D&O insurance,” observed Dave Bradford, executive vice president of Advisen. “Most of the largest European companies now buy coverage, and a growing number of mid-size firms are recognizing that they too are potential litigation targets. We expect to see double-digit growth in D&O premium volumes in the coming years, driven by both rate increases and a windfall of new companies seeking to purchase D&O insurance.”

Advisen’s 20-page report, European D&O Insurance Market to Benefit from Governance and Legal Reforms, tracks the latest developments in legislation, regulation and litigation reform across Europe, and shows how the rapidly shifting management liability landscape is transforming the D&O market. It offers management liability brokers and underwriters a unique pan-European perspective on the D&O market, while presenting actionable information on a country-by-country basis for marketing, sales, product development and strategic planning purposes. The report is essential reading for risk managers of any company with European operations to understand the emerging liability picture and how the rapidly escalating risks faced by their firms’ directors and officers vary by country.

European D&O Insurance Market to Benefit from Governance and Legal Reforms can be purchased for $499 at The Advisen Corner, http://corner.advisen.com/reports_topical_european_do.html.

U.K. Directors’ and Officers’ Programs Should Be Reviewed

Posted 27 October, 2009 by Ralph Mylie, Jr., CIC, RPLU
Categories: D&O, Risk Management

With legal and economic risks increasing for businesses in 2009, many in the U.K. are expected to look at their insurance programs in more detail.

It’s set to be a tough year for anyone running a business. As well as the difficulties created by the economic slowdown, the introduction of more legislation will heighten the risk of legal action and financial penalties.

For those involved in insuring those risks, 2009 will bring a mixture of challenges and opportunities.

One insurer, Zurich Insurance, says that there’s going to be increased demand for directors’ and officers’ cover this year as more people think about their responsibilities. Yet after seeing prices fall, often substantially, over the last three years, there will be pressure on price as claims start to come through.

Certainly, claims are on the up. At the end of 2008, insurance research firm Advisen revised its forecast for D&O losses, taking it up to $5.9bn from the $3.6bn it had forecast in February. Its revision resulted from “the mushrooming of the credit crisis into a global financial calamity”. It also reflected an increase in securities class-action lawsuits, securities fraud lawsuits brought by regulators and law enforcement agencies, bankruptcies, and shareholder derivative lawsuits.

The number of securities lawsuit filings in the U.S. reportedly has increased sharply in the last two years. There were 119 filings in 2006, 176 in 2007 and 210 in 2008. It is widely held that the statistical average is 200, so we have moved to a position where filings are above that number. Additional concern for some insurers is that it takes three to five years for a lawsuit to reach the filing stage.

See you in court

With new legislation coming into force this year, directors have additional rules to observe. Most recently, the Health & Safety Offences Act came into force on 16 January and will increase the penalties for companies that break health and safety law.

It is not just domestic U.K. regulation that directors need to be mindful of, either. A company can also face legal action from the U.S., regardless of where it is domiciled. A prime example is the German engineering company Siemens, which paid $800m to the US Justice Department and stock market regulator, Securities and Exchange Commission, in December to settle corruption charges. This was on top of the EUR395m it had already paid to German regulators.

There has also been an increase in regulatory risk. The Financial Services Authority and the Serious Fraud Office have become more aggressive in their approach to fraud over the last 12 months. The FSA has beefed up its criminal prosecutor and enforcement teams and sent out a clear message about its intentions by carrying out a series of dawn raids to combat insider dealing.

As well as action from the regulatory bodies, it is believed that there will be more claims brought against former directors this year. There’s been a lot of change in boardrooms and as the new directors settle into their roles, it’s not inconceivable that there will be claims brought against former board members.

And there has been a steep rise in the number of firms going into liquidation, which will also result in an increase in claims. Figures from the Insolvency Service show that 4001 companies went into liquidation in the third quarter of 2008, an increase of 10.5% on the previous quarter and a rise of 26.3% on the same quarter in 2007.

It is not uncommon to see more claims being brought against directors in a recession. If a company goes out of business, people, including the administrator, look to the directors for potential redress.

Colleagues of mine in the U.K. tell me these factors are starting to influence the market, with rates hardening and terms and conditions getting tougher on some cover.

The market is also very divided, with financial institutions facing very different conditions to companies in the commercial market. Rates are reportedly hardening for financial institution business because of the problems in this sector, whether it’s the credit crunch or the alleged Madoff fraud.

The extent to which premiums are rising does vary, with sectors like hedge funds and U.S. banks hit hardest. But while recent press reports have put a figure as high as 50% on the increases, this level of premium hike is still unusual.

But while the financial market may be having a tough time, it’s pretty much business as usual for the commercial market, with the 1 January renewal date passing relatively smoothly.

Insurers are fighting for market share and there’s plenty of competition for commercial D&O business. The loss ratios are low and profits are good. That market hasn’t really been affected by what’s happening in the financial market yet, in large part driven by segments like private companies being largely unaffected.

However, this is expected to change. As many insurers have exposure to both the financial and commercial markets, the problems facing financial customers are likely to have a knock-on effect for commercial customers. No longer is pricing falling, but rather many renewals are reported flat. Some are gradually moving up and it is expected that this will accelerate.

Additionally, Clients are paying more attention to the cover they purchase. Rather than buying purely on price, directors are giving more thought to their purchase and analyzing coverage as part of a broader risk management and corporate governance approach.

With a higher level of claims anticipated, capacity could come under pressure this year. It is likely that, although there will still be plenty of cover to go round, it will not necessarily be as easy to obtain. This will require insurers to adjust their pricing strategies.

Underwriters are still basing their pricing on financial stability and other financial factors, but that this does not give sufficient insight into the business which is why risk management can become an even more critical factor. Claims and bankruptcies can come from anywhere but it is more likely to be those companies that have poor controls in place as well as those with weak balance sheets.

In spite of the greater risks present in the market, new players may also be attracted to the market over the next 12 months. With rates hardening and demand for the product. An underwriter coming into the market now wouldn’t have a history of claims and, with a good risk management strategy, could maintain a clean and profitable book of business. It could be a very good time to be writing D&O cover.

Australia Climate Change and D&O Implications

Posted 17 October, 2009 by Ralph Mylie, Jr., CIC, RPLU
Categories: Climate Change, Uncategorized

(Note:    This post first appeared on my ‘Comprehensive Multinational Post blog on 30 July 2009.)

 

The legislation in Australia for the Carbon Pollution Reduction Scheme highlights the need to consider carefully the scope of D&O insurance policies.

The Bills introduced into Australian Parliament to implement the Carbon Pollution Reduction Scheme will impact directly a large number of entities and their directors and officers. There will also be a broad, indirect impact when emissions trading starts. The CPRS Bills draw attention to key areas of D&O insurance policies.

Liability of executive officers and insurance for pecuniary penalties Under Part 20 of the Carbon Pollution Reduction Scheme Bill 2009, ‘an executive officer will contravene a civil penalty provision if they are involved in a contravention by their company’. This makes executive officers personally liable for misconduct of the company if they have been reckless or negligent. The result may be significant pecuniary penalties imposed on the executive officer.

The Consequential Amendments Bill also extends the liability regime under the National Greenhouse and Energy Reporting Act 2007. Part 4 of the NGER Act will no longer be limited to liability of chief executive officers. It will, like the CPRS Bill, soon apply to a director, the chief executive officer, the chief financial officer and the secretary of a company. This would appear to include non-executive directors.

Traditionally insurers in the Australian D&O market have excluded liability for fines and penalties under D&O policies. Recently however there has been a move by some insurers to provide cover for civil penalties in some circumstances. It may be against public policy to cover officers for civil penalties where there has been a willful or deliberate breach of duty. On the other hand, vital cover may be available for officers who have only been negligent. It is recommended that companies and their directors may wish to consider whether their D&O policy provides cover for pecuniary penalties and whether that cover will extend to potential liability under the CPRS and NGER Act.

The new regulator and insurance for investigation costs

The Australian Climate Change Regulatory Authority Bill 2009 establishes the Australian Climate Change Regulatory Authority, which will be responsible for administering the CPRS, the Renewable Energy Target and the National Greenhouse and Energy Reporting System. Since climate change is one of the Federal Government’s key priorities, it may well become a powerful regulator.

When ASIC launches an investigation, the company and its directors can incur significant costs. The market for D&O insurance covering investigation costs has grown in recent years. Some policies will now cover directors for their costs in responding to an ASIC notice or attending an examination by ASIC, even if they have not been accused of any wrongful act. A more extensive policy may even provide cover when no formal notice has been served but the director is nevertheless required by the regulator to co-operate in some manner. When the Climate Change Authority exercises its powers, directors may need to look to their insurer to cover investigation costs.

Liability linked to the company and insurance for outside directorships and JVs

In its current form the CPRS Bill allows for transfer of liabilities and the nomination of a joint venture company to be the responsible entity. It is possible that a company may be liable for the control of a facility by an entity which is not a member of the company’s group. An executive officer can be personally liable for their company’s contravention of a civil penalty provision in the CPRS. That liability is linked to the company and not the operating entity.

The Government is continuing to consult with key stakeholders about controlling corporation liability and mechanisms to transfer that liability within corporate groups. For directors who hold outside directorships and responsibility in relation to unincorporated joint ventures, however, it may be time to consider carefully the scope of their D&O policy as it applies to these issues. Some policies do not provide cover for outside directorships unless specifically requested. Others may automatically cover directors nominated to the boards of other companies but may exclude joint ventures.

Pollution exclusions

Finally, many insurance policies contain an exclusion relating to liability arising from the release, discharge or escape of pollutants. These are generally broadly worded exclusions. They could go so far as to impact cover which may otherwise have been available for liability under the CPRS.

Directors may wish to have frank discussions with their insurer about cover in relation to the CPRS. At a minimum, directors may want to consider a D&O policy which provides cover for “pollution defense costs”. They may also consider seeking that cover without a sub-limit of liability. A more extensive policy may even cover shareholder claims arising from pollution issues.

Conclusion

Subject to their passage through Parliament, the Bills establishing the CPRS will herald a new era in corporate responsibility. It is yet another reminder of the importance of considering D&O insurance in the context of the company’s broad risk management framework.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.