As directors of X Limited (Ltd), Brendan, Adam and David’s duties of care in the management of the company are determined by equity, common law and statute. A company is usually managed by its directors who are responsible for the management of the company in ensuring that the company complies with the duties imposed by the Companies Acts. A director is identified as an officer of the company and is defined as ‘any person occupying the position of a director, by whatever name called’. Directors may either be de facto as identified by their actions but not legally appointed or de jure as identified by law. Although not aptly appointed, shadow directors are recognised to have an influential authority over appointed directors or more explicitly as defined by Justice Harriet Harman as “the puppet masters controlling the actions of the board of directors.”
A company is generally managed by executive and non executive directors who act cooperatively as a board. Executive directors are involved in the daily administration of the company and non executive directors help in improving the company’s performance and accountability. A director should not demonstrate mala fide in their obligations. Director’s duties are stipulated throughout sections 171 to 177 of the Companies Act 2006 (CA 2006).
In this case, the directors concerned have held different positions according to which the standard of care will now be examined. But at the outset, it can be said that all the three Brendan, Adam and David did not exercise the standard of care, skill and diligence. As per section 174, directors are expected to bestow reasonable care, skill and diligence as can be expected of a person with general knowledge, skill and experience in discharging the functions of the management of the company.
This is a reflection of the subjective and objective test laid down in section 214(4) of the Insolvency Act 1986. The provision of the CA 2006 is more rigorous which has marked the end of subjective test prescribed by the case law in City Equitable Fire Insurance Company Ltd Re (1925). Consequently, this provision gives a minimum standard on objective basis in the case of an ordinary person and this standard can be raised on subjective basis depending on the special skill and knowledge possessed by an individual director of a company. The CA 2006 is silent as to whether this is a common law duty or equitable duty but section 1783 suggests that it is not a fiduciary duty. Section 1703 stipulates that this duty is owed to the company and not to the members of the company. Moreover, section 174(2)3 recognises a director to be a reasonable diligent person. This could be either as a minimum on an objective basis imposing a two-fold criterion for the statutory duty where the general knowledge, skill and experience is that of which may be reasonably expected of an ordinary person acting as a director, or conversely on a subjective basis where the general knowledge, skill and experience is that of an actual director.
In Elgindata Ltd. Re (1991) signifies this importance as it was held that members could not expect that a Managing Director should have had the standard of general management and that quality of management involved general risks in investing.
In the present situation concerning X Ltd it is evident that Brendan, David and Adam were all de jure directors as they were appointed in such position holding the designation and responsibilities of a director. Adam would be considered as a non-executive director as he only participated in general board meetings. On the other hand, Brendan and David would be considered as executive directors as they would have dealt with the daily administration of the company. Brendan, David and Adam would be expected to have acted in accordance with the director’s duties, stipulated in section 171-177 of the Company Act 2006. Furthermore, common law establishes that the duties owed by executive and non-executive directors are of no disparity and are held equally liable for any wrongful act in discharging their duties.
Adam is full-time working partner of an accounting firm and acts only as an ordinary director who can only attend board meetings for an annual fee. It is evident that Adam has been inattentive in his duty to employ the relevant care, skill and diligence required by a person of his knowledge and understanding. However, taking the objective test9 into consideration Adam would have not been in breach of his duty as he could not have exercised more care than he had bestowed. But under the subjective standard Adam would have been negligent in performing his duties as a director, as he is expected to have a better knowledge of the company’s administration being a qualified accountant and should have been able to recognize such indiscretion in the business when the company’s financial controller, Sereka, had given him continuous advice.
Adam did question Brendan at the behest of the company’s financial controller who also could not ascertain true position for want financial position suspected by her to have been withheld by both Brendan and David. However, Adam simply believed in the words of Brendan and David in that the accounts were correct and for the annual report of October 2007 which showed fall in profits. Adam could argue that he had no cause for concern because of the justification given by Brendan in that it was due to the added cost of expansion and that profit would increase next year. But it was only when the profits fell further in the next year’s report for 2008; Adam became alarmed and questioned Brendan and David. By then, it was all over and the liquidation process could not be stopped. Subsequently, Adam could not be held liable for being negligent in performing his duties as a director as demonstrated in case of Marquis of Bute.
Although, Adam knew that he was appointed only at the insistence of the Bank, that being a person with a financial qualification to monitor the performance of the company to be appointed as a precondition for the loan, he still had admittance to the company’s records and accounts in which the irregularities would have been revealed. Thus, by having breached his duties he could be held personally liable for the company’s losses and for approving disingenuous accounts. Adam could be held negligent though he may not be accused of being a party to wrongful trading punishable under Insolvency Act 1986.
Had he been asked by the Bank to give a clean chit to the company’s financial position before granting the loan, he would have found out the truth. Had he been in collusion with Brendan, he would be guilty wrongful trading. He joined the company as an ordinary director for which he held a duty in keeping himself informed of the company’s financial position. He also joined the company assuming the audit report of the previous reports disclosed true and fair view of the financial position of the company. He is supposed to have in fact relied on audit reports which did not show any adverse inference. The auditors must have been in collusion or the Brendan must have indulged in systematic suppression of facts to the auditors also. Hence, Adam has the defence of having relied on the previous audit reports and even if he had found out the real depiction and took necessary action when the financial controller reported to him about this, he could not have stopped anything untoward which had already occurred.
Subsequently, he can only be charged for negligence and the punishment will be of lesser degree than that of David both in the matter of disqualification directorships and wrongful trading.
In relation to Brendan, it is evident that he did not act with the standard of care, skill and diligence as expected of him as a director. Therefore, it would allow the liquidators of the company to declare Brendan liable for the losses incurred by way of court order under the Insolvency Act 1986. Though liquidation in the near future had become apparent to Brendan, he continued to conceal the losses of the company. He had evidently shown misfeasance in managing the company’s finances and thus, resulted in breaching his duty. He could have easily prevented this from happening by consulting an accountant, such as Adam, to reduce the chances in taking the company into losses.
Consequently, in concealing the company’s losses it authorized the company to attain additional finances in the form of share capital from Merilla and a £10 million loan from the bank. This indicated that his actions were intentional and of a fraudulent nature. The company had undergone liquidation long before the administrators were aware of this and thus, his conduct would make him liable to be disqualified as a director of any company for a period between two to fifteen years in agreement with the Company Directors Disqualification Act 1986 (CDDA 1986).
Furthermore, under section 6 of the CDDA 1986, a court is required to disqualify a director of a company who has become insolvent if it is satisfied that, due to the conduct of the director, he may not be in a vigorous position to manage another corporation. He may not even be permitted to act as a promoter during this period. To establish whether a director is in a fit position to manage a company or not, the court must refer to part II of Schedule 1 of section 9 which stipulates that “Any misfeasance or breach of any fiduciary or other duty by the director in relation to the company”. This would be sufficient for Brendan due to his action in concealing the company’s losses.
It was affirmed in West Mercia Safetywear Ltd that directors are required to preserve the welfare of creditors of insolvent companies and to prevent in acting in a way that would place creditors in a worse situation than in insolvency. Section 174 of the CA 2006 imposes a duty on directors to exercise reasonable care, skill and diligence and a breach of this duty could result in damages being honoured.
Subsequently, Brendan and any other director(s) who are in breach of their duties would be held liable to compensate the company’s losses along with the bank loan and share capital invested by Merilla plus any interest incurred.
In relation to David, he has been the director along with Brendan since the beginning but is only technically qualified and has relied on Brendan for commercial and financial decisions. He can be said to have exercised the standard of care, skill and diligence expected of him as only a technical person. But it is not known whether it was due to bad quality of products or bad commercial and financial decisions that the company incurred losses. If the former is the case, he cannot be said to have exercised the required standard of skill and diligence expected of a technically qualified person. In Re Barings plc it was expressed by the courts that directors have a continuing duty, to attain and preserve the company’s business knowledge to ensure that directors do not breach their duties. Equally, if a director was to rely on someone else, such as Brendan, to execute the daily management of a company, that person must act honestly. In light of this, David could escape liability as the decision in Dovey v Cory expressed that it was reasonable for the director to rely on the general manager and chairman and therefore, he was held not to be negligent. However, in some circumstances it may not be appropriate depend on another.
Nevertheless, it had turned out that David was aware of the bad financial as might have been informed to him by Brendan at the time of selling shares of Merilla as well as taking a loan from the Bank. Even at the time when the financial controller complained to Adam, she was intimidated by both Brendan as well as David. Hence, David is guilty of wrongful trading and breaching his fiduciary duty along with Brendan, under section 214 of the Insolvency Act 1986. He is not guilty of fraudulent trading since the circumstances show that it was not their intention to defraud the Bank or the new shareholder and they had hoped to bail out the company out of its crisis. The liquidator can only take against him for wrongful trading and hold him liable jointly and severally along with Brendan to contribute equally rewarding damages to the creditors first and then to shareholders in order of priority after meeting any other priority debts.
If only he had known of Brendan’s concealment of losses and if he had genuinely felt such a practice had been proper in the commercial sense in the hope that things would turn out to be better, he may not be accused of fraud but only negligence. In Re Cardiff Savings Bank, Marquis of Bute’s case (1892), the president of the bank only attended one board meeting in 39 years and was held not liable for the bank’s losses that resulted due to the irregular conduct of its trustees and managers. The basis on which the decision was taken by Stirling J was the ‘intermittent theory of director’s duties’ according to which a director must exercise care at the meetings at which is personally present and that he does not owe duty to attend any meeting specifically or any meeting at all. Courts were concerned that directors as commercial risk takers should not be held on par with trustees answerable for performance standards.
Although it is not apparent whether a duty of care, skill and diligence is an equitable or common law duty the duty is owed to the company and not to its members. In Dorchester Finance v Stebbing the courts illustrated that a breach of duty against a director is brought by the company itself. Therefore, a liquidator may bring an action on behalf of a company for breaching its duties.
Furthermore, if David or Adam had noticed the activity after the first years financial report was produced showing losses, then the courts may disqualify the directors as they would have failed to understand and recognise the responsibilities of a director in relation to the financial dealings of the company. However, to try to escape liability Adam and David could argue that they trusted Brendan to deal with the finances of the company but they could still be disqualified from becoming directors in the future.
The directors of a company usually decide whether or not to bring an action for breach of duty however, the actual claimant is the company itself as illustrated in Foss v Harbottle. In cases of insolvency the administrator or liquidator may bring an action for breach of duty under the company.
As a general rule for insolvency directors are not liable to the company and the creditors collectively. Hence, creditors cannot sue the directors for breaching their duty to them, as illustrated in Yukong Line Ltd v Rendsburg. Nonetheless, directors are required to consider the welfare of those who are involved in the daily management of the together with the creditors. Due to the fact that Brendan and David encouraged Merilla to invest in shares with a company that was heading towards insolvency, they would not be able to convince the courts that they only owed a duty to the members as a general body and not the shareholders. Therefore, they would be guilty of wrongful trading and not fraudulent trading. Because of this reason, Merilla may be able to sue Brendan and David for concealing crucial information regarding the company’s losses and encouraging her to purchase 26 percent of shares within the company.
Additionally, liquidators may apply to the court to claim damages of a director who has acted fraudulently or has been wrongful in their business and could be held personally responsible for the company’s losses. Thus, a director may be disqualified from his position.
As illustrated in the Re Duomatic case, the only solution for David and Adam to escape liability would be if the courts were to consider that they acted honestly and reasonably in the situation they were in, under section 1157 of the Companies Act 2006.
William was an ex-employee of the company as a senior manager and was appointed director of the company along with Adam. He meets with WDP in a party and not during the course of business of the company. But WDP offers to him as a representative and more importantly, as a director of that company of X Ltd, the contract for supply of new equipment on lease. William has misused the business access he had through X Ltd for setting up of his business though his excuse is X Ltd was in the red. The question arises whether the new business would have mitigated or averted the fall of X Ltd.
It was only in the summer of 2008 that he learnt of the new opportunity and he availed of it only after duly resigning from X Ltd. In all probability the new business would not have been a windfall for X Ltd and most probably X Ltd would not have been able to supply the equipment. Hence, William cannot be said to have not exercised the required standard of care, skill and diligence to perpetuate the fortunes or well being of X Ltd. It was only after learning of the bad position of the company; he resigned and made use of a business opportunity.
It is worthwhile to examine whether it is matter of conflict of interest. As the Director of X Ltd, William owed a fiduciary duty to the company as does any director to any company. A director may not take part in a deal where their personal interest could conflict their duty to the company and thus, they cannot gain personal profits from their position. This is identified as the ‘no conflict rule’ which was delivered by Lord Herschell in Bray v Ford. It was held that a director with a fiduciary duty to the company cannot make profit unless stated otherwise. This indicated that the rule was not flexible and was reiterated in Bristol and West Building Society v Mothew. This was further reiterated in Cook v Deeks where three out of four directors were held liable for not purposely showing their interest in a transaction of the company. Additionally, section 317 of the former Companies Act (1985) made it an offence for a director to not disclose any information relating to a transaction that they had a person interest in. Directors’ duties, in relation to declarations of interests and conflicts of interests, are now expressed in the recently introduced Companies Act 2006.
Whether it can be called a breach of fiduciary duty for one’s own benefit, diverting an economic opportunity otherwise belonged to X Ltd, is another question. It is a corporate opportunity and considered an asset of X Ltd which should not be appropriated by the existing directors. William may argue that during the period he was a director of X Ltd he was not bound into contract with WDP and therefore, he should not owe a duty once he has submitted his resignation. However, this would be contrary to section 170 of the CA 2006 which stipulates that a person who is no longer a director still has a duty to the company in accordance with section 175 where property or information was utilised whilst he was a director. Because William had utilised information for supplying IT equipment whilst he was a director of X Ltd, he may be liable to breaching his duty to the company.
An identical case can be found in CMS Dolphins Ltd v Simonet (2001) where CMS claimed that his former MD Simonet breached his fiduciary duty and duty of fidelity by virtue of his employment contract with CMS by diverting a maturing business opportunity to a new company started by him after resignation. It was ruled that though a director is not precluded from resigning from the company however disastrous it may be to it, he was not justified in diverting a maturing business opportunity to his own company and it amounted to misuse of CMS’ property for which Simonet was liable. It would be therefore, amply clear that William has been in breach of fiduciary duty to X Ltd irrespective of the probability that it may not have fetched any benefit to an already insolvent company. Had he disclosed to the company that he was resigning due to the bad status of the company and also taken a no-objection certificate to make use of the business opportunity which anyway was useless to it, he would not have been liable.
In Bhullar v Bhullar (2002) the courts expressed that someone who is approached personally in confidence is to take the position as a director is still liable to owe a duty to the company, as in the case of William. Additionally, William would not be able to escape liability on the grounds that the information he gathered, whilst being a director at X Ltd, was not misused. As there is no indication of WDP refusing to do business with X Ltd, William would not be able to use the defence that he did not deflect any potential business prospects between WDP and X Ltd. This was illustrated in the case of Foster Bryant Surveying Ltd and Anor v Bryant where the court of appeal held, that the director did not breach his fiduciary duty as he did not deflect any potential business prospects.
As mentioned earlier, if the no conflict rule outlined in Bray and Ford is breached, a director may be held accountable for the profits obtained. Furthermore, William could be held accountable for any profits obtained from executing the transaction, as illustrated in Regal (Hastings) Ltd, where the directors of a company had taken advantage of an financial opportunity and were thus, held liable for the profits attained. Although it is unclear as to whether William’s initial communication with WDP was on a business outlook or a personal one, he could still be held liable for the profits attained.
The underlying principle is that a director is expected to act in the best interests of the company. He is therefore not allowed to further his interests or that of a third party at the expense of the company. It must be a strict liability so that excuses like ‘the company was in anyway insolvent’ or ‘in doubtful insolvency’ cannot be raised. This is because directors can deliberately make it insolvent and then do things to further their interests. It must therefore be the view that a director cannot indulge in such diversionary actions whilst the company is alive and when he is in charge. It must be noted that when William came into contact with WDP, he had no inkling of impending liquidation. Given the opportunity, there is no guarantee he would not have diverted this economic opportunity even if X Ltd had no problems as happened in the few cases discussed above which had all been the cases of well functioning.
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