Years ago, I wrote about how difficult it was for companies dealing in bitcoin to obtain an operating account at a Canadian bank “Bitcoin Businesses and Canadian Banks: The ‘Catch 22’ Dilemma.” Unfortunately, six years later, the situation in Canada hasn’t improved. This has made life difficult for entrepreneurs as they can’t really get off the ground without an operating account at a bank or credit union. In the course of my work with cryptocurrency companies, I’ve uncovered another very important utility which is proving difficult for Canadian cryptocurrency companies to secure; director and officer liability insurance (“D & O Insurance”). In this article Matthew Burgoyne explains director and officer duties and liabilities under Canadian law, why D & O Insurance is so important, and the difficulties facing cryptocurrency corporations who wish to obtain D & O Insurance.
Duties of Directors and Officers
The concept of the corporation as a legal entity separate from its employees, founders, officers and directors is a basic tenant of Canadian corporate law. Further, it is a general principle of corporate law that employees, officers and directors are not personally responsible for the debts of a corporation. The corporate laws of every province and territory impose standards upon directors and officers which, if not met, will expose the directors and officers to personal liability. In Alberta (similar to the other provinces), every director and officer shall:
(a) act honestly and in good faith with a view to the best interests of the corporation; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
(a) is a fiduciary duty, which holds a director to the highest standard of care, while (b) is often referred to as the duty of care. Failure to comply with either duty can subject the director to personal liability.
Liabilities of Directors and Officers
There are important policy reasons why directors and officers should be protected from liability. Arguably, directors should be free to run the business, operations and affairs of a corporation in a creative, decisive manner without the fear that any action they take could lead to personal liability. Limitation of liability promotes healthy risk taking by directors and management which hopefully leads to economic benefits for a corporation. However, the breach of certain duties can have far reaching consequences affecting everything from the safety of workers to the environment, which has led government to create legislation imposing personal liability on certain key figures within a corporation.
There are many Canadian laws which impose liability on directors and officers in various situations. Some of the most frequently encountered in Alberta include the Business Corporations Act, the Employment Standards Code, and on a federal level, the Employment Insurance Act and the Income Tax Act. Directors may be personally liable where a corporation fails to make contributions to a pension plan, where a corporation fails to pay employee wages, or where a corporation fails to withhold obligations for taxes and other source deductions associated with wages and vacation pay.
Under Alberta’s Occupational Health and Safety Act, officers/management who oversee the occupational health and safety of the workers employed by the corporation are obligated to ensure the safety of workers, or face fines, in principle, of $1 million or more as well as a term of imprisonment of up to one year.
Corporate Bylaws and Indemnification Agreements
In an effort to protect directors and officers from liability, corporate bylaws often mandate that provided directors and officers act honestly and in good faith with a view to the best interests of the corporation, in the event they are sued as a result of their activities in the course of their employment, the corporation will indemnify them against costs related to the settlement an action or the satisfaction of a judgment. In other words, the corporation will pay to defend directors and officers who are sued simply for doing their jobs.
A corporation may also enter into an indemnification agreement with a director or officer, providing a similar type of broad indemnification as can be contained in the corporate bylaws. A major difference between indemnification under the by-laws versus an indemnification agreement is that an indemnification agreement can’t be unilaterally terminated without the consent of the other party. By-laws, on the other hand, may be changed by a corporation at any point in time provided the appropriate director and/or shareholder approvals are obtained.
Why is D & O Insurance necessary in light of the above protections? The answer is, simply, that the corporation may not have enough money to defend the directors and officers. This is compounded by the fact that when directors and officers are being sued, chances are the corporation is being sued as well, and the corporation may not have enough funds to defend itself as well as pay the legal costs of the directors and officers.
D & O Insurance and the Problem with Cryptocurrency
In my experience, some members of the insurance industry do not understand cryptocurrency and, therefore, see it as too high risk to insure. As an example, I can recall debating with an insurance broker about why bitcoin isn’t a ponzi scheme. I remember another instance where I spent an hour on the telephone trying to explain stablecoins to an insurance underwriter, who couldn’t understand why Canadians would ever want to buy and use a stablecoin.
I have a client for which a broker advised that his office had approached 12 conventional D&O Insurance markets, plus London, and all declined. The broker contacted an offshore insurance market that seemed to have experience in “blockchain”, but the company ended up being unlicensed in Canada so my client would have been subject to a penalty tax if coverage was taken up with them. Hardly an ideal set of options! However, as discussed below, in some cases insurance companies may be justified in feeling apprehensive about providing D & O Insurance to cryptocurrency companies.
I believe cryptocurrency companies (in Canada, but anywhere really) are getting a double whammy right now. Firstly, due to Covid-19, many insurance companies are reluctant to provide D & O Insurance in general due to a concern about Covid-19 “event-driven” litigation. Many companies, particularly in the travel, entertainment and restaurant industries, are barely staying afloat amid continued lockdowns and social distancing. Shareholders, employees and even customers are looking to hold corporations, including their management, liable for losses and damages.
Secondly, there is the current murky state of the law governing. Regulators are still trying to solidify their positions on a number of key securities laws related issues. Cryptocurrency exchanges who act as fiat ‘on-ramps’ and ‘off-ramps’ are the target of anti-money laundering watchdogs. Regulations are still being amended, and until there is some more definitive legal clarity, there will continue to be litigation. Indeed, in the last six months, there has been a flurry of lawsuits targeting corporations active in the cryptocurrency space. As Kevin M. LaCroix writes in The D & O Diary, Plaintiffs File a Slew of Cryptocurrency-Related Securities Suits, April 3, 2020 was a pretty big day for securities class action lawsuits in the US. On April 3, 2020, eleven total cryptocurrency-related securities lawsuits were filed in a single day, which is likely unprecedented.
The lawsuits were all filed in the Southern District of New York,and they targeted four crypto-asset exchanges and seven crypto-token issuers. The four crypto-asset exchanges are: Bianace (complaint here); Bibox (complaint here); KuCoin (complaint here); and HDR Global Trading, Ltd., the operator of BitMEX (complaint here). The seven crypto-token issuers are: Tron Foundation (complaint here); Block.one (complaint here); BProtocol Foundation (complaint here); Civic Technologies, Inc. (complaint here); KayDex Pte Ltd. (complaint here); Quantstamp, Inc. (complaint here); and Status Research & Development GmbH (complaint here).
Significantly, as Mr. LaCroix notes, in addition to the defendant corporations, each of the complaints targets certain directors and officers of each of the defendant corporations.
Final Thoughts and Suggestions
Given the double threat increasing the potential for costly litigation against directors and officers, one can appreciate why insurance companies and underwriters are taking a bit more of a cautious, analytical approach when it comes to providing D & O Insurance quotes to any company, let alone a cryptocurrency company. In the absence of D & O Insurance, corporations should strongly consider revising their bylaws to ensure those bylaws contain indemnification provisions protecting directors and officers, or entering into separate indemnification agreements with directors and officers. Cryptocurrency entrepreneurs can prepare themselves for an application for D & O insurance, by doing the following:
- making sure financial statements are prepared and audited, unless the audit requirement has been dispensed with by the shareholders. Unaudited financial statements should still be professional prepared;
- compiling details of any private placements (i.e. share issuances or debt issuances) undertaken by the corporation;
- ensuring the company’s website is functional and professional; and
- preparing biographies for the directors which include a description of past positions which they may have held in other businesses.
D & O Insurance is complex. One should always engage a qualified insurance broker to work with when considering purchasing D & O Insurance. Here are some key issues (not an exhaustive list, but a good start) to be aware of when considering a D & O Insurance policy, as explained to me by David Blain, a client executive in Calgary with BFL Canada:
- the insuring agreement (“Side A”) which provides protection for directors and officers should be non-rescindable and there should be excess coverage, over and above the $1MM typically included as a base coverage;
- check the definition of “Insured” in the policy, as independent contractors may be excluded, which isn’t ideal. One should look to obtain the broadest coverage possible;
- is there a “hammer clause” in the policy, that is, a clause which states that if the insurer agrees to make a settlement but the insured does not agree to it, and a larger settlement is obtained in court, then the insured must pay the difference between what was originally offered to and accepted by the plaintiff;
- can the insured select their own lawyers? One should pay attention to the notice of claim requirements and reporting clauses;
- there must be a duty to defend in the policy;
- check the language around the payment of costs in the event of a lawsuit, with or without a deductible; and
- review any exclusions of coverage. Some exclusions can be ‘bought out’. Always ensure the coverage limits are reasonable for your business.
The cryptocurrency industry in Canada still has a way to go before it is accepted into the mainstream. It is difficult for a cryptocurrency company to obtain D & O Insurance. D & O Insurance is very important to obtain as there are several laws in Canada which impose personal liability on directors and officers who fail to meet the standards imposed upon them under those laws. Ideally, as a corporation commences operations it will have an adequate D & O Insurance policy in place, but in the absence of a proper D & O Insurance policy, crypto-entrepreneurs can still limit personal liability via a properly drafted set corporate bylaws or an indemnification agreement.
Source: Mcleod Law LLP