It is well established that non-U.S. companies that raise capital in U.S. markets may be exposed to U.S. securities claims - against the company itself and its directors. This is one of the “costs” of doing business there. The claims are often for very significant sums, although they seldom go to trial and ultimate settlement amounts, excluding the occasional “mega settlement”, are usually more modest. The costs of defending claims can be very significant; hence the need to protect directors of such companies via D&O insurance. Companies can also indemnify directors in some countries (e.g. the U.K.).
In recent years the U.S. Plaintiffs’ bar (a wellresourced and sophisticated group of law firms specialised in bringing class actions) has been trying hard to find novel ways to attack the directors of non-U.S. companies, notwithstanding overall U.S. securities claims against non-U.S. companies are down on pre-2021 levels. These efforts were the subject of commentary in 2020 and 2021.
In this article we discuss two such areas and highlight recent developments in the U.S., which bring positive news for non-U.S. companies, their directors and D&O insurers, and may influence whether the drop in these claims is a temporary blip or the start of a broader trend.
The costs of defending claims can be very significant; hence the need to protect directors of such companies via D&O insurance.
U.S. Derivative Claims Against Non-U.S. Company Directors
The first way the U.S. Plaintiffs’ bar has attempted to expand the universe of claims against non-U.S. directors in the last few years is by bringing derivative claims against them, particularly in the New York State courts.
In many countries, an individual or minority shareholder has a right to act on behalf of the company to bring claims against the company’s own directors for breach of their fiduciary duties, known as a “derivative action”. This right was developed to ensure the directors (who might also be majority shareholders) could not block a legitimate claim the company might have against them. Most jurisdictions place procedural controls over their use by shareholders; otherwise, the right could easily be abused. For instance, in the U.K., the court must give permission for such claims to proceed based on some strict provisos, and in practice, it rarely does.
A claim for breach of fiduciary duty by or on behalf of the company must be made under the laws of the country of incorporation. This makes sense because, for example, directors of a U.K. company only owe duties to that company under U.K. law, not under any other.
However, the question of what law applies to a claim is separate from where the claim can be heard. U.S. shareholders have used the existence of derivative action rights under New York law to invite New York courts to accept jurisdiction over derivative claims against non-U.S. companies whilst applying the law of country of incorporation to the substantive claim. In this way, using the example, a New York court would hear the derivative claim against a U.K. company whilst applying U.K. law to the question of the directors’ liability. Several such cases have been brought against global companies incorporated outside the U.S. Whilst the claims themselves are against the directors, the company is usually also a defendant because it has not brought the claim itself and needs to be bound by the court’s decision whether to allow the claim to proceed.
The concern with this trend for non-U.S. companies, their directors, and D&O insurers, is that (1) U.S. shareholders are more litigious than their international counterparts, and so this could see an increase in volume of such claims; (2) it is easier to bring derivative claims under New York procedure than in other countries (such as the U.K.), and (3) the amounts claimed, and the defence costs, are potentially much higher than if such claims were brought in the country of incorporation. This has caused D&O insurers to make dire predictions about the trend.
Non-U.S. companies and their directors who are subject to these claims usually contest jurisdiction of the U.S. courts because, as they are claims by the company, they should be brought in the courts of the country of incorporation. Furthermore, suppose such a country would not allow the claim to proceed because of its strict procedural rules. In this case, the claim should not otherwise be allowed to proceed in New York: it gives U.S. shareholders an artificial advantage over shareholders in the country of incorporation. The success or otherwise of the argument comes down to whether, in the country of incorporation, the derivative action procedural requirements are inextricably linked to the substantive issue of liability or whether they are merely a formality. If the former, the New York court will not accept jurisdiction, but if the latter, then it will, and has done in some cases already.
In December 2021, judges in different New York State courts dismissed derivative claims against German company Bayer’s directors and Swiss company UBS’s directors. In the case of Bayer, the U.S. plaintiff’s failure to comply with German derivative claim procedural requirements was fatal to the bringing of the claim in New York because they were not just a formality. In the case of UBS, the court was also influenced by a term in the company’s constitution requiring such disputes to be heard solely in Switzerland.
These cases may well go on appeal, but they represent a welcome win for common sense. In the end, a New York court will assess whether the requirements for allowing a derivative action to proceed in the non-US company’s country of incorporation is a formality or substantive right, so outcomes will probably still be on a case-by-case basis. For instance, a New York court previously found that the procedural requirements for derivative claims were merely a formality in the Cayman Islands, and so it did have jurisdiction.
What we can say with more certainty is that such claims are of a nature intended to be covered by D&O policies, either under Side A because they are non-indemnifiable (as claims by the company), or Side B because they are indemnifiable until there is a liability to the company actually established (as in the U.K.). The company may be covered too where it is a nominal defendant.
These cases may well go on appeal, but they represent a welcome win for common sense.
Non-U.S. companies with unsponsored level 1 ADRs
Companies that actively sell ADRs (American Depository Receipts - negotiable certificates issued by a U.S. depositary bank representing shares of a non-U.S. company's stock) to investors in the U.S. cannot be surprised if they are exposed to litigation by those investors under U.S. securities laws (the Securities Act of 1933 and/or Securities Exchange Act of 1934). These are transactions that take place in the U.S. when the ADRs are traded on an exchange in the case of Levels II and III ADRs, or over the counter for “sponsored” Level I ADRs. A sponsored ADR is where the non-U.S. company specifically arranges for the U.S. bank to issue ADRs on its behalf.
However, what about non-U.S. companies who have not actively courted U.S. investors? This could include where the non-U.S. company’s shares are sold over the counter as Level I ADRs by U.S. banks who bought up the shares without having any “sponsorship” arrangement with the non-U.S. company. The non-US company could understandably argue it should not be the subject of the jurisdiction of the U.S. courts as it did not do anything to solicit the investors there.
Toshiba (a Japanese company) was such a company. In a long-running case, it was held in January 2020 that the issuer of an unsponsored ADR could potentially be liable in the U.S. if: (1) the transaction took place in the U.S.; and (2) the foreign issuer was sufficiently “involved” in that transaction. These are factual tests. The specific details of the stages of the transaction, including conversion of the foreign shares to ADRs, how the ADRs are sold to the U.S. investors, and how involved the non-U.S. company is in the sales process, will together determine whether there is a potential U.S. liability.
In January 2022, the court in Toshiba examined these facts and refused to certify the class action because it decided the relevant transaction had taken place in Japan, not in the U.S. In fact, the U.S. investors had courted the purchase of Toshiba’s shares by instructing the U.S. bank to purchase them on the Tokyo stock exchange on their behalf before subsequent conversion to ADR, and not Toshiba courting U.S. investors. Therefore, it was a Japanese transaction, not a U.S. one, so the claim cannot proceed.
What does this mean? The recent decision is positive news in that whilst it remains possible for the holders of unsponsored Level I ADRs to bring claims against non-U.S. issuers, the specific details of the steps in the transaction and involvement of the non-U.S. issuer will establish whether a court will allow such claims to continue. This may prove an insurmountable bar in many cases. In theory, there remains an exposure where a U.S. bank buys up the shares for conversion to ADR and then courts U.S. investors with the involvement of the non-U.S. company. There are factors that the court will look at to determine this, and Aon can help its non-U.S. clients evaluate whether they may be relevant to them.
Fortunately, whatever the prospects, these claims are of a nature that would be expected to be covered under a D&O policy.
Conclusions
These recent decisions in the U.S. are welcome news for non-U.S. companies with U.S. shareholders and may serve to allay some of D&O insurers’ previous fears. They may provide our clients with arguments against D&O premium rises based on the prospect of more U.S. claims. However, the U.S. Plaintiffs’ bar is well known for finding ways around legal hurdles, so we will continue to watch this space with interest. Whatever the eventual outcomes, the D&O policy remains as important in the directors’ armoury now as it has ever been.