Non-executive directors beware - wilful blindness is no excuse!

We are regularly instructed by directors of companies in financial difficulty who are seeking advice and reassurance about their role, how to properly discharge their duties and how to limit their potential exposure for any losses caused.

The starting point is that all directors owe certain duties which are set out in the Companies Act 2006:  

• Duty to act within powers (s.171)
• Duty to promote the success of the company for the benefit of members as a whole (s.172)
• Duty to exercise independent judgement (s.173)
• Duty to exercise reasonable care, skill and diligence (s.174) – this is determined both objectively (i.e. what should a reasonably diligent director have done?) and subjectively (i.e. what should a director with this particular person’s knowledge and experience have done?)
• Duty to avoid conflicts of interest (s.175)
• Duty not to accept benefits from third parties (s.176)
• Duty to declare interests in proposed transactions or arrangements with the company (s.177)

When a company is on the verge of insolvency, the directors’  duty to promote the success of the company becomes a duty to act in the best interest of creditors as a whole. Where the directors know or ought to have known that the company could not avoid insolvent liquidation or administration, and they allow the company to continue to trade and/or incur losses, they could be liable for wrongful trading.

These duties are not diluted by virtue of an officer being ‘only’ a non-executive director.

In some circumstances (such as in FCA-regulated or listed companies), non-executive directors are put on the board of companies with specific functions (such as chairing audit or remuneration committees), in addition to their general duty to challenge and provide an independent oversight of executive directors. Non-executive directors can therefore play a vital role in ensuring businesses are properly run. When considering whether or not a director has exercised reasonable care, skill and diligence, regard should be had to both what a reasonably diligent director ought to have done and also what a person with that particular director’s knowledge, experience and skill should have done in the circumstances.  Accordingly, where non-executive directors are given specific responsibilities they will be judged to have a heightened knowledge and awareness of that area of the business, and their potential liability could be increased accordingly.

The scope of potential liability for non-executive directors is therefore just the same as for executive directors. The recent High Court case below is a timely reminder of the need for all directors to keep themselves appraised of the running of the company and to scrutinise the actions of their fellow directors.

Secretary of State for Business, Innovation and Skills v Akbar [2017] EWHC 2856 (Ch)

In this case, disqualification orders were sought against the directors of a company who had sought to profit from tax avoidance schemes using employment benefit trusts (EBT schemes).

Facts

The Secretary of State sought disqualification orders under the Company Directors Disqualification Act 1986 against the defendants, who had been directors of a family company (the “Company”).

The Company was run by the first defendant (G) with the help of his son who was not a director. The second and third defendants were brothers of G; they were businessmen who dealt with some of the creditors of the Company but they claimed that they largely left the running of the Company to G. The fourth and fifth defendants were the wives of the second defendant and G respectively; they were directors in name only and had no involvement at all in the business.

In 2012 the Company underwent a major reorganisation. At that time, a debt of roughly £1 million owed to the Company by a related company was extinguished under a series of transactions relating to the EBT scheme and an equivalent sum was distributed to G through the purchase of gold bullion for his benefit. The Company in effect transferred the benefit of the £1 million receivable to G.

In May 2013, the Company entered creditors' voluntary liquidation. Disqualification proceedings were brought on the basis that each of the defendant directors had failed to act in the Company’s best interests when they caused and/or allowed it to enter into the gold-bullion transactions at a loss to creditors. At the time, the Company owed seven creditors the total sum of £465,634.27.

Decision

As a result of the reorganisation, the Company was in grave financial difficulty. To distribute £1 million of assets under the EBT scheme was a breach of the directors’ duties under section 172 of the Companies Act 2006 or, at the very least, it cast serious doubt on the competence of G to run and manage a company such that he ought to be disqualified.

In considering whether disqualification was appropriate for the other defendants, the judge relied heavily on the principles from the cases of Secretary of State v Chohan [2013] EWHC 680 and Re Bradcrown [2001] BCLC 547. In Chohan, the court commented that "responsibility’ is not confined to direct executive responsibility for the particular misconduct, and a failure to engage in proper supervision, review or scrutiny of the activities of delegates or fellow directors may suffice." In addition, in Bradcrown the court found that "each director owes duties to the company to inform himself about its affairs and to join with his co-directors in supervising and controlling them; a proper degree of delegation and division of responsibility is permissible … but not total abrogation of responsibility, and the Board of Directors must not permit one individual to dominate them and use them”.

Accordingly:

• G was disqualified for the reasons set out above;
• the second and third defendants were disqualified for failing to engage properly in supervising and monitoring G regarding the distribution; and
• the conduct of the fourth and fifth defendants (the wives of G and the second defendant) was “abysmal” and a “complete dereliction in the performance and understanding of their duties”. They were disqualified because the neglect in performing their duties contributed to the EBT scheme distribution to the detriment of creditors.

Comment

As confirmed by the above case and contrary to commonly-held belief, non-executive directors owe the same duties and responsibilities as executive directors. Whilst some delegation or division of responsibility amongst the board is permissible, directors cannot completely abrogate their responsibility and simply defer to other members of the board. Non-executive directors are obliged to stay informed as to how the company is being run and to challenge executive directors on decisions being made; a lack of awareness means they are not properly able to discharge their duties and will not provide them with any defence in any claim for breach of duty.