Directors’ and Officers’ Liability – The Fiduciary Duty

Directors’ duties, particularly for those appointed to regulated entities in the financial services sector are onerous and becoming more so. The duties are informed by legislation including the Companies Acts and various European Regulations, common law provided on foot of judgments handed down by successive court rulings and by numerous Codes of Conduct issued by the Regulator including The Central Bank’s Corporate Governance Code for regulated entities.

An analysis of all of a director’s obligations is beyond the scope of this explanatory note. I will focus on a director’s fiduciary duty to act in what the director honestly believes to be the best interests of the company. This is one of the fundamental fiduciary duties at common law and it applies in the same way to all company directors, whether they hold executive or non-executive positions. A breach of this duty can lead to civil action. It was in a civil action arising from the Madoff affair that Popplewell J. of the High Court in the UK recently explained the principles that a director must know. One of the crucial issues in the case was whether the company’s directors breached their duties by relying too heavily on Mr Madoff’s views.

The duty has been described as a duty to act in what the director honestly believes, (not in what the court believes), to be the company’s best interests. It does not necessarily matter that the court would have acted differently. But if the breach of duty caused significant harm to the company, it will probably be more difficult for a director to persuade a court that he honestly believed it to be in the company’s best interests.

The honesty of the director’s belief is an important element in this test. It can be differentiated from his non-fiduciary duty to exercise reasonable care, skill and diligence which requires an objective test. Popplewell J. explained a number of established principles concerning the scope of the duty to act in what a director honestly believes to be in the best interests of the company:

While it is legitimate and necessary for there to be some division or delegation of responsibility for particular aspects of the management of a company, a director nevertheless owes duties to inform himself of the company’s affairs and to join with his fellow directors in supervising those affairs.  It is a breach of duty for a director to allow himself to be dominated, manipulated or ‘bamboozled’ by a dominant fellow director to the extent that he has abrogated his responsibility entirely.

  • A director must form an independent judgment as to whether acceding to the request of a shareholder (in this case, the requests of Mr Madoff) is in the best interests of the company.
  • A director who has knowledge of a fellow director’s misapplication of company property, but takes no steps to prevent it, will himself be treated as a party to the breach of fiduciary duty.

The crucial point is that a director (whether executive or non-executive) cannot passively allow others to manage the company without supervising the acts or omissions on behalf of the company and without independently reaching his own decision as to whether any act or omission is (in his own honest view) in the interests of the company.

In addition, Popplewell J made the following observations, which are helpful in understanding how directors are expected to comply with this duty in practice, given the commercial realities of serving as a company director:

  • A director is entitled to rely upon the judgment, information and advice of another director whose integrity, skill and competence he has no reason to suspect.
  • The making of decisions by directors often requires the exercise of judgment in relation to which opinions may legitimately differ and therefore board decisions may require a certain amount of “give and take”.   
  • A director is entitled legitimately to defer to and to take into account the views of his fellow directors, provided he believes that his fellow directors’ views have been put forward in what they perceive to be in the best interests of the company.
  • Where a decision as to the commercial wisdom of a transaction is taken by a majority of the board, a minority director is not obliged to respond by resigning or by refusing to be party to the implementation of that decision.  A director is not in breach of his duty to act in what he honestly considers to be in the best interests of the company simply because, if he had been left to himself, he would have done things differently.

Applying these principles to the facts, the Popplewell J found that it would have been unfair and unrealistic to expect the directors not to have attached great weight to Mr Madoff’s views, in deciding what was in the interests of the company. Mr Madoff was both a director and shareholder of the company. To decide that Mr Madoff knew best was not a dereliction of the duty to exercise independent judgment. It was a legitimate recognition that Mr Madoff’s high standing in the financial world which reflected a level of skill and experience which did indeed equip him to know what was best for the company and put him in a much better position to make that judgment than the other directors. Accordingly, there was no breach of duty.

The Judge went on to consider the concept of dishonesty (which he decided in this case were unfounded). He said “that in order to prove dishonesty, it is necessary to show that a director deliberately committed a breach of duty which he did not honestly believe was in the best interests of the company.” The requirement to show a deliberate act can be particularly difficult in claims against directors, especially where the allegation involves a failure to act. Litigants need to be very careful before they allege dishonesty, or assume that, simply because there has been a significant fraud, that the members of the board must have been implicated in it.

Disclaimer
This publication is for guidance purposes only. It does not constitute legal or professional advice. No liability is accepted by Leman Solicitors for any action taken or not taken in reliance on the information set out in this publication. Professional or legal advice should be obtained before taking or refraining from any action as a result of the contents of this publication. Any and all information is subject to change.

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