Corporate: directors under the spotlight

In the words of one Equitable Life director, commenting to the Higgs Review of Corporate Governance on the role of a company director, “who is going to do the job if they can get sued out of existence"? Is the situation really so bad as to warrant such a comment?

Common law duties

A director’s duties at common law have existed, largely unchanged, for more than a hundred years. A director has a duty to act with reasonable skill and care in the performance of his duties. For many years this was regarded as a subjective standard, i.e. the court looked at the director’s behaviour in light of his own particular skills and qualifications. More recently, this has developed into a combined subjective and objective test, i.e. what might reasonably be expected from a person carrying out the same functions as that particular director. Directors are not required, at common law, to take any particular part in the running of the company’s business but, where they do involve themselves, they have to act in accordance with that duty. In the case of Bishopsgate v Maxwell, Ian Maxwell was not generally liable for his failure to attend to the affairs of one of the Maxwell Group companies but he was liable for losses caused where he involved himself by signing a document under which assets were unlawfully transferred out of the company.

In addition to the duty to act with skill and care, there are fiduciary duties placed on the director, the most important of which is to act in good faith in the interests of the company as a whole. Consistent with this principle, directors also have a duty to avoid conflicts of interest, not to make an unauthorised or undisclosed profit from their position as a director, to act in accordance with the company’s constitution, and to treat shareholders fairly.

These duties are owed to the company itself and it is only the company which can sue a director for breach of duty. This is an important limiting factor in the ability of shareholders to launch class actions against directors. When the company cannot, or will not, bring an action because it is controlled by those who have wronged it, shareholders can pursue an action in the company’s name and at the company’s expense.

Another potential problem for the director is a shareholders’ action under section 459 of the Companies Act 1985. The shareholders must establish that they have suffered unfair prejudice as a consequence of the conduct of a director, in which case the court may sanction an action in the name of the company against the director. Applications under section 459 are more common in relation to the affairs of small private companies where the directors are also the principal shareholders but imaginative lawyers can use the section to good effect.

Directors can also face claims from shareholders, where they have made statements or conducted some activity in their personal capacity. In a recent case, the House of Lords held that a director who had committed a fraud was personally liable and he could not “use the device of acting as a director to escape any liability to his victims".

Future reforms

It has long been recognised that the common law duties of directors are unclear and, to an extent, outmoded. A White Paper was published in 2002 under which it is proposed that directors’ duties be codified in a statutory statement. There will be a list of general principles which, while similar to the old common law principles, are intended to remove much of their uncertainty. The duty to act in the company’s interests as a whole will be modified so that directors must take into account all material factors, which will include the company’s business relationships with its employees, customers and suppliers.

Changes in the regulatory climate

Regulatory developments are also creating an increasingly hostile climate for directors. This is happening as a result of a number of pressures. The DTI has become much more active in bringing disqualification proceedings against directors. More than 5,000 directors have been disqualified since 1997 and 900 directors were disqualified between March and September 2001, a 24 per cent increase on the same period in the previous year. The Competition Act and the Data Protection Act place new duties on directors; the Enterprise Act, when it becomes law, will impose personal criminal liability on directors where they have been involved in anti-competitive practices in their role as directors. Health and Safety Executive prosecutions are also on the increase.

Then there is the US long-arm jurisdiction in the form of the Sarbanes/Oxley Act, which came into force in July 2002. The Act has been passed in a hurry as an attempt to clean up corporate America in the wake of the Enron and WorldCom scandals and the Act is likely to apply to those UK-based businesses which are listed on one of the US exchanges. Directors of such companies will be required to certify the accuracy of any company report containing financial statements; there will also be whistleblowing regulations on those advising such companies. Both the long arm and the whistleblowing aspects of the proposed legislation are causing understandable concern to directors of dual-listed companies.

Conclusion

Directors are justifiably concerned that they may be sued out of existence but they can attempt to reduce the litigation risks by:

• Asking questions and obtaining up-to-date and reliable information;
• Avoiding concentration of power in the hands of one or two directors;
• Implementing internal risk management strategies, such as internal audit risks analysis;
• Delegating effectively;
• Ensuring adequate training;
• Considering how each proposed action can be justified as being genuinely in the interests of the company.

For further details please contact Tony Marks at [email protected] or tel +44 (0)20 7367 2508.