Directors’ fiduciary duties: inactivity may be a breach of duty
In a recent case the Court of Appeal has ruled that, where a director commits fraud, his or her fellow directors are in breach of their own duties to the company in allowing the fraud to happen, and cannot defend themselves on the grounds that the fraudster would have deceived them if they had tried to prevent the fraud. The case reiterates an earlier judgement where it was said that it is in itself a breach of duty by the remaining directors to allow themselves to be dominated or bamboozled by one of their number.
Lexi appealed against a decision that two of its directors (M & Z) were not responsible for the misappropriation of funds by the managing director (S), their brother. Over a number of years the managing director had taken almost £60 million from the company through fictitious director’s loans, false facility letters and misapplication of three of Lexi’s bank accounts. The three siblings were part of a close-knit family and M and Z were aware that S had previous convictions for dishonesty and obtaining property by deception. This information was not initially disclosed to the bank or the other directors. Z also failed to monitor the misappropriated director’s loan account, on which she was a named person.
At the original hearing M and Z were acquitted on the basis that they were liable only for monies paid to them and that their inactivity as directors had not caused Lexi’s loss. At this hearing the judge suggested that had M and Z attempted to play a more active role in the company they would have been fobbed off by the trickery of S. The judge had used the ability of S to trick other, non-family, members of the board as a factor in the exculpation of M and Z.
On appeal Lexi submitted that the inactivity of M and Z was a further breach of fiduciary duty. The appeal was allowed, on the evidence provided the Court of Appeal finding that the conclusion reached by the initial judge was incorrect. M and Z knew of S’s convictions and should have asked the appropriate questions to satisfy their fiduciary duties. Had they done so they would soon have realised the extent of the fraud being perpetrated at the company. If M and Z had acted properly the auditors and other directors would have been made aware of the situation, the auditors would have been unable to provide unqualified accounts and the increased banking facilities would not have been available.
The key point was “that any individual who undertakes the statutory and fiduciary duties of being a company director should realise that these are inescapable personal responsibilities”.
The decision emphasises that a court is highly unlikely to accept as a defence to a claim for breach of duty that the individual director concerned played no active part in the company’s management. Lexi correctly asserted that had M and Z each fulfilled their fiduciary duties and common law duties as directors of Lexi the losses arising from S's breaches of duty and misappropriations would have been prevented or not occurred.
Those accepting a position as directors must ensure that they familiarise themselves with, and participate in, the business, particularly the decision making processes. Directors must exercise independent business judgement and be prepared to challenge others on the board - whoever they are. If they disagree with a board decision they should ensure this is evidenced in the company’s minutes. In the final analysis they may have to resign.
Further reading: Lexi Holdings Plc (in administration) v Luqman and Others [2009] EWCA Civ 117
