Don't keep it on the down low: data breaches, mandatory notification, personal liability of directors, and D&O policies

By Fred Hawke, Irene Drossinos

15 Feb 2018

Contravention of the mandatory data breach notification regime which comes into effect on 23 February 2018 may lead to personal liability for directors and officers - and their D&O policies might not be of much use.  

A new mandatory data breach notification scheme will take effect on 23 February 2018 by amendment to the Privacy Act. Although it does not specifically impose personal liability on directors and officers for breaches, regulators have been using a "stepping stone" approach to sheet home personal liability in other areas. Would their D&O policies cover this? That would depend very much upon the specific terms of the policy, especially its exclusions.

The mandatory data breach notification regime at a glance

The mandatory data breach notification regime will require certain entities to notify the Office of the Australian Information Commissioner (OAIC) and any potentially affected individuals of an "eligible data breach".

The entities which must comply with the data breach notification scheme includes most Australian Government agencies, private sector organisations with an annual turnover of more than $3 million, entities holding personal information, credit reporting bodies holding credit reporting information, credit providers holding credit eligibility information, and tax file number recipients holding that information.

The requirement to notify will be engaged when the entity becomes aware that there are reasonable grounds to suspect there has been an eligible data breach.

Serious or repeated failure to comply with the Privacy Act, including contravention of the mandatory notification regime, may result in civil penalties of up to 10,000 penalty units for corporations (approximately $1.8 million).

Personal liability of directors and officers - regulators' "stepping stone" approach

While the Privacy Act grants Courts the power to impose civil penalties for contraventions of the data breach notification scheme on corporations only, in recent years regulators have successfully used a "stepping stone" approach to personal liability of directors and officers. This approach involves two steps:

  • bringing an action against the company for an alleged contravention of the relevant legislation; and
  • once corporate fault has been made out, "stepping" to a finding of personal liability for a breach of directors' duties.

In its simplest form, the "stepping stone" approach to managerial liability involves an argument along the following lines:

  1. a company in a legal person. As such, it can act only in the person of its members, as a body;
  2. the members delegate their power, to cause the company to make decisions and perform activities, to the Board and Management;
  3. the Board and Management, therefore, constitute the mind and governing will of the company;
  4. ergo, if the company commits a breach of legislation, it must be the responsibility of the Board and/or Management.

That of course is a gross oversimplification and begs the question of the ambit of a corporate officer's duty of care and diligence, under section 180 of the Corporations Act 2001 (Cth), entirely. Responsibility does not equate to breach of duty and the step from (3) to (4), alone, does not suffice for a finding of managerial liability. Nevertheless, in the case of a major legislative contravention, it legitimately may be asked how the company came to be placed in such a situation.

Breaches of the Privacy Act and non-compliance with the new mandatory notification regime could lead to the personal liability of directors and officers in the following ways:

  1. directors and officers may be found to have breached their duty of care, skill and diligence by not enabling and causing the company to comply with the regime. As a matter of effective corporate governance, directors and officers will have to ensure that processes are put in place which:
    • ensure that all reasonable measures to avoid a data breach are implemented and maintained;
    • enable the company to determine whether an eligible data breach has occurred; and
    • efficiently activate a notification procedure if an eligible breach has occurred.

    A failure to implement effective procedures to comply with data protection obligations and the breach notification regime might constitute a breach of the duty of care, skill and diligence which would, in turn, result in the personal liability of a responsible director; or

  2. ASX Listing Rule 3.1 requires a company to disclose "market sensitive" information to the ASX, once it becomes aware of information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity's securities. While a single civil penalty of $1.8 million may not have an impact on the share price of larger corporations, it is not yet clear whether a failure to notify affected individuals will be treated as a single or as multiple contraventions of the notification scheme by a Court. The potential exposure of a company could, therefore, be in the order of many multiples of 10,000 penalty units if a large number of individuals are affected by the data breach, which could significantly impact share price. Directors can be personally liable for a company’s failure to observe continuous disclosure requirements, to persons who have traded in the company's securities during the "period of concealment" when price-sensitive information was withheld from the market.

You should ensure your Directors & Officers Liability policy covers you

A corporate's cyber-related risks, both direct losses and liabilities, are expected to be insured against separately from other operational risks, so will often be excluded from cover under its other policies, including the D&O. It is necessary to look closely at the terms of any such exclusions, whether their potential applications may be wide enough to preclude cover for claims against directors and officers involving the privacy protection and data breach notification regime. Given the significant potential risks to which directors and officers are exposed in a data breach incident, it cannot be assumed that these risks are insured.

If cyber-related breaches of duty are excluded from the D&O cover, the company needs to consider the terms of its cyber insurance contracts: whether the cover extends to individual corporate officers and what degree of protection is afforded to them. Insurance brokers and specialist insurance lawyers can both provide assistance in this regard.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.