Director’s Duties & Liability Insurance in Cyprus

This article will examine the role of a Director and his duties and liability insurance and D&O insurance liability accordingly with reference to the relevant case law.

According to Section 2 of the Companies Act, Cap.113, a Director is any person who occupies the position of Director by whatever name called. There is not any specific definition in law describing who can be considered as a Director. Therefore, any of the following persons can be considered as a Company Director:

(a)    Any person who has been formally appointed as a Company Director (de jure Director).

(b)   Any person who has not been appointed as Company Director but he acts like a Director (de facto Director).

(c)    Any person who instructs or directs company’s Directors, who act on advice given by him (shadow directors).

(d)   Any person who has been nominated by a Shareholder (Nominee Director).

According to the English case Hydrodam (Corby) Ltd (1994) 2 BCLC 180 at 183, shadow director means a person in accordance with whose directions or instructions the Directors of the company are accustomed to act.

To establish that a person is a shadow Director of a company it is necessary to allege and prove:

(1)   Who are the Directors of the company, whether de facto or de jure;

(2)   That the defendant directed those directors how to act in relation to the company

(3)   That those Directors acted in accordance with such directions; and

(4)   That they were accustomed so to act.

Referring to the de facto Director, in the same case it was held that to establish that a person was a de facto Director it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a Director.

According to the English case Smithton Ltd v Naggar and other (2014) EWCA Civ 939), ‘‘there is no one definitive test. So there is no test we can apply in order to understand whether someone is de facto, de jure or shadow Director. The question is whether that person was part of the company’s corporate governance system and whether he assumed the status and function of a Director so as to make himself responsible as if he were a legitimate Director. The Cyprus Supreme Court also pointed out the following factors which can provide guidance on the matter:

  • The concepts of shadow and de facto Director are different but there is some overlap.
  • In determining whether a person is a de facto Director, the question is whether he has assumed responsibility to act as a director.
  • The questions must be determined objectively. It does not matter whether the individual thought he was acting as a Director.
  • Whether the company considered the individual to be a director and held him out as such, and whether third parties considered that he was a director, are however relevant.
  • The court must look at the acts in their context and determine their cumulative effect.
  • The fact that a person is consulted about directorial decisions, or asked for approval, does not generally make him a Director because he is not making the decision.

Lastly, in the same case it was held that ‘‘those who assume to act as directors and who thereby exercise the powers and discharge the functions of a director, whether validly appointed or not, must accept the responsibilities which are attached to the office’’ or to their company accordingly.

Therefore, even if a person is a de jure, de facto, shadow or even a nominee Director, he still holds all the Director’s duties and liabilities imposed by Statute and/or common law.

The duties a Director owes to his company fall within three main categories:

(a)    Statutory Duties.

(b)   Fiduciary Duties.

(c)    Duty to exercise skill and care.

Many statutes impose several duties on the companies’ Directors, including Companies Law, Cap.113, Criminal Law, Social-Insurance Law, Anti-Money Laundering Laws, Directives and Regulations, Values Added Tax (VAT) Law of 2000, Assessment andCollection of Taxes Law.

The main duties imposed by the Companies Act, Cap.113 include the following:

(a)   Section 141: keeping of accounting books and records for the preparation of financial statements disclosing the assets and liabilities of the company, sales and purchases and any other transactions conducted by the company as well as amounts paid and received which shall be available for inspection.

(b)   Section 142: preparation of financial statements (or consolidated financial statements if applicable) which shall be presented within 18 months from the incorporation of the company and thereafter, every calendar year.

(c)    Section 151: preparation and submission to the Registrar of Cyprus Companies of the directors’ report (annual return) along with the approved and signed financial statements of the preceding year which shall present the status of the company in terms of shareholding, share capital, directorship e.tc for each year. This is an important duty, as if the company does not submit its financial statements with the Registrar of Companies, then penalties will be incurred, with the Registrar also being entitled to proceed with the forced striking off of the company due to non-submission of the financial statements. Forced strike off of the company ultimately means dissolution of the company.

(d)   Section 185: disclosure of payment of loss of office made in connection with transfer of shares in a company.

(f)   Section 191, obligation to disclose their direct or indirect interest in contracts with the company at the meeting of the board of Directors.

(g)   Section 192, maintenance of a register of directors and secretary at the registered office of the company.

Breach of the above director’s duties constitutes a criminal offence with penalties ranging from a default fine to up to 5 years imprisonment for serious breaches such as false or misleading statement in any return, report, certificate, balance sheet or any other documents (S 373).  In addition the Directors are liable to personally compensate the company in respect of any loss, damage or expenses resulted by the breach of their duties.  

The director owes a fiduciary duty to the company to act in good faith and in the best interests (bona fide) of the company as a whole Frederick Geraint Hawkes v Simone Francesca Cuddy,et al 2009.

There are 6 main principles of fiduciary duty:

a) Loyalty: a director must act in good faith in what honestly and reasonablyconsiders to be the best interests of the company – not the shareholders’ best interests, not third party’s interests and of course not his interest – only the company’s interest must be taken into consideration.

(b) Compliance: a director must always act in accordance with the company’s Articles of Association and must exercise their powers only for the purposes provided by the M&AA and allowed by law.

(c) No secret profits: a director must not use or take advantage of the company’s property, information or opportunities for his own benefit or anyone else’s benefit. He is only permitted to do so if the company’s articles of association contain a relevant provision or if he discloses to the board of directors in a general meeting his interest for such opportunity and company consents to take advantage of it.

(e) Conflicts of interest: in case there is a direct or indirect conflict between director’s interests or duties and the company’s interests, the director must account to the company for any benefit he received. As it has been mentioned above, in case which such benefit or profit is allowed by the company’s articles of association or it has been disclosed to the board of directors and it has been accepted, then the director do not have to account.

 (f) Fairness: a director also has a duty to act fairly between the members of the company.

 (g) Creditors: lastly but not least, a director may be found personally liable for any incurred credit to third party, if he has already known or if he ought to know that the company has no reasonable prospect of paying. A director may avoid such liability if he can prove that ‘‘he has taken every step with a view to minimising the potential loss to the company’s creditors as {he} ought to have taken’’ (S307(v) & 312 of the Companies Act).

So far, the article examined the statutory and fiduciary duties of a director. Now, it will analyse the duty that a director owes to the company to carry out his functions with due care, skill and diligence.

A Company Director is obliged to exercise his powers and carry out his functions with reasonable skill and care. According to the English case, Re City Equitable Fire Insurance Co Ltd [1925] Ch 407¸ ‘‘a Director must exercise the skill and care that may be expected of a person with his knowledge and experience.’’ The court imposed both an objective and subjective test. An objective test, by stating that directors must exercise the skills that they possess. And subjective test, by stating that director must exercise such care diligence, ‘‘which an ordinary man might be expected to take in their circumstances.’’

In the English case Re D’ Jan of London Limited [1993] B.C.C. 646 the court defines ‘‘the reasonably diligent person’’ as ‘‘someone who has both (a) the general knowledge, skill and experience that may reasonably be expected of persons carrying out the same functions as carried out by that director in relation to the company, and (b) the general knowledge, skill and experience that that Director has’’.

Taking into consideration the above, one can conclude that the degree of skill, care and diligence is a mixture of objective and subjective elements. As a minimum standard, the Director must be a reasonable prudent person and as a maximum standard the director who has greater skills must provide the company with these skills and give it the benefit of his experience and knowledge.

There is no specific provision in any Cyprus law, giving the exact level of skill, care and diligence that a Director owes to his company. In the majority of the cases, if the Director acts in good faith and in the best interest of the company then he cannot hold responsible. However, there are some rare cases in which a Director can be found liable for gross negligence (recklessness). 

The liability of a Director has been has been analysed in a previous article. Many laws impose specific liabilities on the directors including Companies law, Cap.113, Criminal Law, Social-Insurance Law, Anti-Money Laundering Laws, Directives and Regulations, Values Added Tax (VAT) Law of 2000, Assessment and Collection of Taxes Law.

Briefly, a company director can be found civil and criminal liable for offences or breaches of his company. Any prosecution against a Director cannot be suspended for the mere reason that the Director of the company is involved as a de facto, de jure, shadow or a nominee director. Therefore, Directors should take preventive measures to avoid any potential liability arising as a result of the directorship.

Such a measure could be the so called Directors’ and Officers’ (D&O) Liability Insurance. Liability insurance is a type of insurance payable to the company directors and officers as indemnification for any loss and/or defence costs that the director/officer suffered, as a result of a legal action brought for alleged wrongful acts in their capacity as directors and officers. In other words, liability insurance covers the directors (and officers) for losses that they suffered during serving on board of Directors of the company. Therefore, the main scope of the D&O insurance is to protect Directors from claims which may occur from Directors’ actions and/or decisions taken during the implementation of their ordinary duties as company Directors.

It is worth-mentioning that the coverage of liability insurance extends to criminal cases, but only if the court found the director innocent and not guilty for the alleged wrongful act/omission.

The insurance liability can be triggered by:

(a)    A negligent act, error, or omission on behalf of the Director, such as inaccurate disclosure or failure to comply with laws.

(b)   Breach of professional duty.

(c)    Wrongful act: the wrongful act is usually defined in the insurance’s policy.

The D&O insurance coverage varies and depends on the company and on the industry in which company is running its business. In the majority of the cases D&O insurance covers defence costs and financial losses. However, in some cases the insurer may exclude from the coverage specific claims resulted from specific acts and/or omissions.

Examples of exclusions are:

  • Intentional wrongful or non-compliant act.
  • A fraudulent act.
  • Acts for personal profit or gain.
  • Acts/decisions which exceed the authority granted to the Director.

The reality is that Directors’ risks are real and they exist. Sometimes Directors are taking tough decisions with serious impacts not only to them and their companies but also to third parties. They have to be informed and updated in several matters, such as compliance regulations, any amendments to laws and of course they must be aware of all their duties and obligations as Company Directors and manage the business vehicle prudently and transparently.

For all the above reasons, there is always the chance for a director to be personally prosecuted. The impact on the director from such prosecution is huge, including but not limited to personal expenses, trial costs, time loss and reputational cost. In such cases, a D&O insurance could at least cover their expenses and trial costs.

D&O can be really useful, even in the case which a Director has been resigned from his position, because despite the resignation, the Director can be held liable for acts and/or omissions occurred during his directorship. It is worth-mentioning that D&O insurance coverage claims only for the period in which the policy is in effect. Claims occurred after that period cannot be covered. However, some policies include a clause extending the coverage for an agreed period of time, for example up to 5 years.

To conclude, taking into account the complexity of the markets and transactions as well as the high regulatory security regarding prudent management and full disclosure on behalf of the Directors, each company has potential D&O exposure. For this reason, Directors will be safer if the company they serve offers D&O coverage or by entering into a C&O insurance agreement themselves. With D&O insurance, Directors will benefit, especially if they choose a suitable insurer, disclosing all required information to them in order for the insurer to be able to protect them in full and draft the insurance documentation accurately. Last but not least, if the insurer monitors and is made aware of the company’s activities and transactions.