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UNCERTAINTY SHROUDS DIRECTORS’ DUTIES

John Doyle is a lucky man. Michael Burt is not. The DTI applied for a directors’ disqualification order against Mr Doyle when his company collapsed with £128,000 ($186,00) debts in 1998. The DIT sought a similar order against Mr Burt when his company made loans that were designed to facilitate the purchase of its own shares.

The courts accepted that both men had no knowledge of the activities that had brought about their companies’ financial turmoil. In Mr Doyle’s case, the court also decided his failure “to pay sufficient attention to ….. the accounting and financial information put before him” did not amount “to incompetence of the degree necessary to justify a disqualification order”.

Yet, the fact that Mr Burt “did not trouble …..to read [the company] accounts” was held to be “serious incompetence”. Mr Burt was disqualified for three years. Mr Doyle was not.

These decisions reflect the law’s uncertainty concerning company directors’ duties. This uncertainty is a result of the fact that the foundations of company law were laid down in the 19th century.

Despite reforms such as the Companies Acts of 1985 and 1989 and the Insolvency Act 1986, they are no longer considered up to the task in the age of Robert Maxwell, consumer rights, government regulation and multinational corporations.

Therefore, in March 1998, the DTI launched a fundamental review of company law (the CLR). An independent steering group comprising various company law experts has managed the review. The steering group is due to publish its final report by the end of July. Draft legislation in a White Paper, incorporating the steering group’s recommendations, is also on the way.

At the heart of the steering group’s recommendations will be a “Statutory Statement of Directors Duties”, including a duty of “care, skill and diligence”. The steering group’s March 2000 consultation paper Developing the Framework stated:

“A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both the knowledge, skill and experience which may reasonably be expected of a director in his position and any additional knowledge, skill and experience which he has.”

This wording differs from the subjective test for a director’s common law standard of care. In Re City Equitable Fire Insurance Co (1925), Mr Justice Romer stated that a director only need exercise the degree of skill that may reasonably be expected from a person with his knowledge and experience.

The steering group’s wording, by contrast, adopts the dual objective and subjective test of a director’s knowledge for wrongful trading under s 214(4) of the Insolvency Act 1986.

Under s 214(4), a director may be personally liable to contribute to the company’s creditors’ claims from his own assets if he knew, or ought to have known, that there was no reasonable prospect of his company avoiding insolvent liquidation, but continued to trade.

The director must both exercise (1) the degree of skill, knowledge and experience that may be reasonably expected of a person carrying out the same functions and (2) the degree of knowledge and skill that he himself has.

Lord Hoffman, in Norman and another v Theodore Goddard (1992) and Bishopsgate Investment Management Limited v Maxwell (No 2) (1993) stated that a director’s common law duty was, or should be, that set out in s 214(4).

The Law Commission’s 1998 consultation paper Company Directors: Regulating Conflicts of Interests and Formulating Statement of Duties agreed with Lord Hoffman and provisionally recommended that the s 214 test should be the general standard of a director’s duty of care.

The CLR steering group, in Developing the Framework, sated that they were “foll9owing exactly on the substance” of the commission’s proposals and these had been “very widely welcomed in consultation and we regard the case for them as made out”. Barring any Whitehall farces, it seems highly likely that the statutory statement will be in the steering group’s final report.

“So what?” Directors & Officers underwriters might ask. After all, the steering group’s recommendations are unlikely to be enacted before 2003. Moreover, company directors are already subject to various duties arising from a growing body of domestic and EU environmental, consumer protection and employee rights legislation.

The significance of the statutory statement can, however, be found in the words of the steering group, namely: “This proposal would clarify the law and apply the same standards as are applied to professional negligence elsewhere”.

At the moment, D & O claims are infrequent albeit they tend to be large. The growth in consumerism and environmentalism, demonstrated by the “anti-globalisation” movement, could increase the frequency and size of D & O type claims.

The “professionalisation” of directors proposed by the CLR Steering Group’s would enhance this trend. In the future, D & O cover may become as commonplace, and as vital, as professional indemnity cover.

Gary Meggitt “Insurance Day” July 2001