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s.174 Duty of reasonable care, skill and diligence - Coggle Diagram

- - - - The objective minimum standard is capable of being raised but cannot be lowered.
    - - MD who are running the whole business.
      - Non-executive directors who are not involved with management but oversee what the MD and other directors are doing.
      - Or a company with one person as the marketing director, one as the sales director etc. If one person is the marketing director they are carrying out the function of a director of marketing in relation to the company.
- - - - The second scenario is where there is the abdication of responsibility to other directors without exercising any residual supervision by an inactive director of a family business (See Re Brian D Pierson (Contractors) Ltd [2001] 1 BCLC 275; Re Galeforce Pleating Co Ltd [1999] 2 BCLC 704; Re Park House Properties Ltd [1997] 2 BCLC 530).
        
        In Re Westminster Property Management Ltd, Official Receiver v Stern (No 2) [2001] BCC 305 at [197] a property development company had collapsed with multi-million pound losses and the two directors before the court in disqualification proceedings were a father and son. With respect to the son, the court considered that ‘he was not conscious of his position or duties as a director, that he never undertook those duties except as dictated by his father (for example, to sign cheques or accounts) and that he applied his mind barely, if at all, to the consequences of his position as a director’. He was disqualified for four years for this abrogation of his duties as a director.
      - A third scenario is where financial and accounting matters are delegated to a finance director. When a problem subsequently emerges, the other directors tend to claim that they had no responsibility in the matter, given that it was properly delegated to another. Again, the issue is their failure to exercise any residual supervision. Residual duty to supervise
        
        The situation can be illustrated by Re Queens Moat Houses plc, Secretary of State for Trade and Industry v Bairstow (No 2) [2005] 1 BCLC 136.
        
        In this case the court agreed that, with regard to the preparation and content of the financial statements, the chief executive was entitled to delegate those matters to the finance director. Such matters were properly within the finance director’s area of responsibility and competence and the chief executive had no reason to doubt that the functions properly delegated had been properly performed. But many of the matters in the accounts were matters that it should have been apparent to the chief executive, given his business experience and knowledge of the company, were of doubtful accuracy and propriety. He was in breach of his duties, not for having improperly delegated the task of preparing the financial statements, but for failing to exercise his residual duty of supervision when those financial statements came to the board for approval.(See [2005] 1 BCLC 136 at [89]).
        
        In Re Continental Assurance Co of London plc [2007] 2 BCLC 287. Park J there concluded that the board of an insurance company was entitled to rely on the advice of the finance director and the company’s auditors as to whether the company was solvent and the appropriateness of the company’s accounting policies and systems.
        
        The directors did not blindly accept what was put before them, but engaged in detailed and critical consideration of the company’s accounts, ([2007] 2 BCLC 287 at [402]–[403]) while looking for detailed guidance on technical matters to the finance director and the auditors as they were perfectly entitled to do ([2007] 2 BCLC 287 at [287], [403]).
        
        The residual duty to supervise depends on a variety of factors including
        
        the nature of the business;
        
        the nature and extent of the delegation;
        
        the standing and status of the person to whom the matter is delegated;
        
        the remuneration of the director Re Barings plc (No 5) [1999] 1 BCLC 433 at 488.
        
        the nature of the transaction; and the potential risk/losses involved.
        
        In larger companies with complex businesses, whether a director has discharged his individual role involves an examination of the systems for which he personally has responsibility while, at board level, the collective responsibility of the directors is to satisfy themselves that the task delegated and the system instituted is appropriate to the level of risk involved—hence the emphasis in the UK Corporate Governance Code on the collective responsibility of the board for the long-term success of the company.
      - The first scenario is where directors defer to a particular individual on the board such that in effect they delegate all power to him, abdicate their own responsibilities, and exercise no residual supervision.
        
        The dominant director(s) may be someone on whom the other directors are unduly reliant and therefore they are reluctant to challenge or question him.
        
        The other directors may owe him their positions on the board, particularly if they are former employees promoted by him to the board.
        
        The courts are clear, however, that a board must not permit one individual to dominate and use the other directors in this way. As Popplewell J said in Madoff Securities International Ltd v Raven [2013] EWHC 3147 at [191]., it is a breach of duty for a director ‘to allow himself to be dominated, bamboozled or manipulated by a dominant fellow director’ where such involves a total abrogation of responsibility.
        
        In Re Westmid Packing Services Ltd, Secretary of State for Trade and Industry v Griffiths,116 for example, the court disqualified two of the executive directors for breach of their inescapable personal responsibilities by allowing themselves to be manipulated and deceived by another member of the board who was the dominant and controlling influence in the business. Their failure to act allowed the dominant director to use the company’s assets to fund his other businesses by way of interest-free unsecured loans which ultimately proved irrecoverable and brought the company to ruin ( [1998] 2 BCLC 646 at 653).
        
        In Re Landhurst Leasing plc, Secretary of State for Trade and Industry v Ball [1999] 1 BCLC 286 the court disqualified two executive directors who had taken a relatively subordinate role (reflecting the fact that they had been promoted to the board from the ranks of the employees) vis-à-vis the conduct of the affairs of the company by two forceful joint managing directors who were convicted of criminal offences in respect of their management of the company.
        
        The disqualified directors had failed to draw the board’s attention to sham transactions of which they were aware and to ensure that the accounts made adequate provision for bad debts and credit risks.([1999] 1 BCLC 286 at 349 and 353).
        
        As to the boundaries of delegation, Hart J concluded that a director might rely on his co-directors to the extent that (1) the matter in question lay within their sphere of responsibility given the way in which the particular business was organised, and (2) that there existed no grounds for suspicion that that reliance might be misplaced ([1999] 1 BCLC 286 at 346)
        
        However, Hart J continued, even where there were no reasons to think the reliance was misplaced, a director might still be in breach of duty if he left to others matters for which the board as a whole had to take responsibility, for example the responsibilities of the board to approve the company’s annual accounts ( [1999] 1 BCLC 286 at 346, relying on Re City Equitable Fire Insurance Co Ltd [1925] Ch 407).
        
        Sometimes the dominant element is not an individual but an inner group of directors, as in Re AG (Manchester) Ltd, Official Receiver v Watson.
        
        In this case, the court disqualified for six years a finance director and subsequent chief executive who acquiesced in a system under which members of an inner group of directors took all the key decisions without reference to the board as a whole with the result that the other directors were effectively reduced to the role of departmental managers with no serious input at board meetings on issues affecting the running of the company.
      - The final variation on the delegation/abdication point comes with reliance on professional advisers.
        
        There are many circumstances where reliance on professional advice, such as auditors is perfectly proper (Re Continental Assurance Co of London plc [2007] 2 BCLC 287).
        
        See too Green v Walkling [2008] 2 BCLC 332; also Re Pro4Sport Ltd, Hedger v Adams [2016] 1 BCLC 257—director of company in financial difficulties had sought advice from a firm of business advisers and had entered into a transaction to sell the company’s stock on their advice. Subsequently, it was suggested that the terms of the transaction might have been more favourable to the vendor, but the court thought the fact that the director was relying on professional advice was an important factor when assessing whether he was in breach of his duty of care. On the facts, he was not at fault.
        
        Re Stephenson Cobbold Ltd, Secretary of State for Trade and Industry v Stephenson where it was alleged that a non-executive director (who was a cheque signatory) should be disqualified as unfit on the grounds, inter alia, that he had allowed an executive director to use company funds for personal expenditure. The court found that the non-executive director had queried the transactions at issue with the company’s auditors and, in those circumstances, he was entitled to rely on the explanations given by the auditors (that the payments were part of the director’s usual remuneration arrangements) as reassurance that the financial side of the company was being run properly.
        
        On the other hand, excessive reliance amounting to a total abrogation of responsibility can be seen in Re Bradcrown Ltd, Official Receiver v Ireland [2000] 1 BCLC 547. where a finance director relied entirely on professional advisers in respect of a complex transaction, the net effect of which was that the company transferred away its main assets for no consideration. In terms of reliance on professional advisers, the court noted that the issue is essentially one of degree. In the instant case, although the director was entitled to rely on professional advice, he had asked no questions and simply did what he was told, abdicating all responsibility. In those circumstances, the court held that he could not seek refuge in the fact that professional advisers were involved in the transactions and he was disqualified for two years.
    - - The model articles provide that, subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company and they may delegate any of the powers conferred on them under the articles. See The Companies (Model Articles) Regulations 2008, SI 2008/3229, reg 2, Sch 1, arts 3, 5 (Ltd); reg 4, Sch 3, arts 3, 5 (Plc).
  - - - In Re Queens Moat Houses plc, Secretary of State for Trade and Industry v Bairstow (No 2)101 dividends had been declared improperly on the strength of accounts which were misleading and did not give a true and fair view of the company’s affairs.
        
        In disqualification proceedings, the court assessed the defendant director’s knowledge on the basis, first, of objectively considering (as required by CA 2006, s 174(2)(a)) what could be expected of a reasonably diligent person who was the chairman and senior executive director of the company. Secondly, the court subjectively considered (as required by s 174(2)(b)) what could be expected of that director, given his wide business experience and knowledge of the company’s affairs (he had been a director for 20 years) while also acknowledging that he had no formal accountancy qualifications.
        
        The court accepted that, given that the preparation of the accounts had been properly delegated to the finance director, the director was not in breach of his duty in failing to appreciate that the accounting treatment of certain items in the accounts (i.e. technical specialist information beyond his competence) was misleading. Because of his business experience and knowledge of the company’s affairs, he ought to have been aware, however, that the accounts showed inflated turnover and profits (i.e. business information within his comprehension) and were therefore misleading. He was in breach of duty and disqualified for six years.
    - - This case concerned the collapse of a small insurance company in 1992. Large and unexpected losses had arisen which came to the board’s attention in June 1991. In this litigation the liquidators sought contributions to the company’s assets from the directors on the grounds of wrongful trading and/or misfeasance (see 15-18). A particular issue was an allegation that the company applied inappropriate accounting policies which showed the company to be solvent in July 1991 when, had an appropriate accounting policy been adopted by the company, the directors would and should have appreciated that the company was insolvent and they should have taken steps to stop trading. The court found that for the directors to have reached that conclusion would have required knowledge of accounting concepts of a particularly sophisticated nature. Declining to hold the directors liable, Park J rejected any idea that the law imposes such an unrealistically high standard of skill.
        
        ‘In my view, [the directors] would have been expected to be intelligent laymen. They would need to have a knowledge of what the basic accounting principles for an insurance company were … They would be expected to be able to look at the company’s accounts and, with the guidance which they could reasonably expect to be available from the finance director and the auditors, to understand them. They would be expected to be able to participate in a discussion of the accounts, and to ask intelligent questions of the finance director and the auditors. What I do not accept is that they could have been expected to show the sort of intricate appreciation of recondite accounting details possessed by a specialist in the field …’ - [2007] 2 BCLC 287 at [258].
        
        On the facts, Park J found that the directors took a wholly responsible and conscientious attitude both to the company’s position and to their own responsibilities as directors at all times from and after the first crisis board meeting in 1991 when the unexpected losses were reported to them. The directors did not ignore the question of whether the company could properly continue to trade; on the contrary, the court found that they considered it directly, closely and frequently ([2007] 2 BCLC 287 at [107]). case was dismissed.