Non-executive directors – do your duty, or risk disqualification!
In a recent court case the non-executive chair of a private company was disqualified from acting as a director after the High Court found he had fallen short of his duties as a director.
The courts must disqualify the directors of an insolvent company if their conduct makes them unfit for involvement in the management of a company. A key element of a director’s duties is to exercise reasonable care, skill and diligence. Under this duty, the director must exercise the care, skill and diligence of a reasonable person with:
- The general knowledge, skill and experience that may reasonably be expected of a director (the objective test); plus
- The general knowledge, skill and experience that the director in question actually has (the subjective test).
In 2012, XE Solutions Limited (XES) entered into 28 business transactions. An HMRC investigation found that these deals involved fraud. As a result, XES ceased trading in 2015 and went into liquidation in 2016. Disqualification proceedings were then brought against four directors of the company.
The High Court judge held that three of the directors knew of the connection between the deals and the fraud and were therefore unfit, disqualifying all three of them.
By contrast, the fourth director, B, was not aware of the fraud. The judge’s assessment therefore related to his competence, not his probity. Prior to joining XES, B had 30 years of management experience, had won a Public Investment Award and was a Fellow of the Chartered Institute for Securities and Investment. B’s functions included ensuring that the business was properly run, preparing the company as a clean investment vehicle, and protecting the shareholders. As a non-executive director, he claimed, in keeping with his role as a non-executive director, to have taken no active part in XES’s day to day management, delegating this responsibility to the other directors.
The court found that B had nevertheless fallen short of his duty to exercise reasonable care, skill and diligence. Up until a meeting with HMRC in 2013, he was unaware of the deals, despite having signed off on XES’s accounts, which included 27 of the 28 deals. B had also failed to investigate the reasons behind the leap in XES’s turnover. He recalled being told that it related to trials, but he had failed to inquire as to what these trials involved. Further, B had declined to engage with HMRC on numerous occasions; he met with them only once between the beginning of their investigation and XES going into liquidation, and repeatedly failed to look at relevant paperwork and reply to correspondence from HMRC.
Ultimately, B was disqualified for a period of 4 years.
The judgment is a reminder that a director cannot get by on simply knowing his duties and acting honestly; he must also ensure that he properly discharges said duties and being a non-executive director doesn’t reduce the scope of these duties. While B was a truthful witness and knew what was expected of him in his capacity as non-executive director, he had failed to properly investigate XES’s affairs despite various warning signs. It was not enough that B worked part-time and had no operational involvement. His role as a director and therefore protector of shareholders coupled with his experience and qualifications increased the expectations on him under the subjective test, and he had fallen short of this higher bar. All directors should be diligent in ensuring that they properly discharge their duties, while remembering that, if they have exceptional skills or experience, a higher standard of conduct may be expected of them.