This article by Brent Haywood, Partner and Solicitor Advocate in our Dispute Resolution and Litigation team, featured in the Friends of The Scotsman.
Non-executive directors are increasingly finding themselves on the receiving end of insolvency litigation. It’s therefore essential they understand the duties and liabilities they’re taking on when they join a board. Too often they don’t.
There are many reasons to become a non-executive director (or NED). It’s good for the CV, interesting work, a way to support other entrepreneurs, and a useful stepping stone if you’ve given up a full-time day job but aren’t ready for a life of year-round leisure.
It’s also flattering to be asked. And if you hesitate, you may well receive assurances that it’s not much work – just four board meetings a year and they keep the paperwork minimal. If you do hear this, be wary.
It’s a common misconception that being a non-executive director carries less responsibility or work than being an executive director.
In one sense, this is true. Unlike executive directors, non-execs do not run the business day to day. However, they do have the same rights, duties, obligations and liabilities as other directors.
Without going into the minutiae of the Companies Act 2006 or the case law on the topic, all directors have a statutory duty to exercise reasonable care, skill and diligence. There is extensive case law on what ‘reasonable’ means, and it may depend on the knowledge, skill and experience of individual directors in individual cases. But this certainly doesn’t mean that being a non-exec carries lower levels of accountability or liability.
The same applies with other types of directorship too – ‘nominee’ directors, ‘independent’ directors, ‘de jure’ directors and the like. When it comes to liability, the law makes no distinction between them.
I’m not telling you about anything new here. There haven’t been any recent game-changers in terms of legislation or court cases. But we are seeing an increase in insolvency litigation against directors. Litigation financing firms are acquiring debts when a company goes into insolvency, and then pursuing directors to recover them.
Let’s take a typical scenario: a small company has big aspirations for growth and the CEO brings a non-exec onto the board, charged with using their entrepreneurial experience to help grow the business.
The non-exec might be doing all that they are asked to do by the board but visibility around the numbers might not be what it could be. The CEO’s answers to her questions seem fine and there doesn’t seem any cause for concern.
But then one day, the CEO stops answering emails and then the business suddenly spirals towards disaster, soon insolvency practitioners are called in. Worse, it turns out there are a couple of creditors who are substantially out of pocket.
Danger looms for our non-exec. When insolvency looms, directors – of any kind - owe duties not just to their company and shareholders but also to creditors and non-execs can be unexpectedly in the firing line. Litigation financing firms are increasingly active in the insolvency market, and liquidators, who might be otherwise reluctant to pursue non-execs, are happy to assign claims in return for a share of the spoils. The company might be in liquidation but our non-exec is being sued for breach of directors duties.
We’re not talking about high finance or multimillion-pound Ponzi schemes or fraudsters here. This could be happening to your next-door neighbour or someone you know from the sports club.
We’ve seen directors being pursued in these situations for anything from £20,000 to millions of pounds. Even if paying £20,000 won’t make a ruinous dent in their finances, their reputation may be trashed, with knock-on effects for other aspects of their career.
With all this in mind, there are three important lessons here for anyone considering a non-executive directorship. Firstly, be careful about taking on directorships.
Secondly, being a non-exec should never just be an ego-boost, a pastime, or the guarantee of a good lunch every quarter. Be terrier-like in carrying out your duties.
Thirdly, you need directors and officers (or D & O) liability insurance, covering you for legal costs as well as liabilities. Whilst the organisation should provide this for you, it’s worthwhile checking the policy to see what it does and doesn’t cover.
None of this cancels out the benefits and attractions of being a non-exec director, whether it’s for a private company, public company, social enterprise or other organisation. It’s still a fascinating way to use and develop your experience. But you need to go in there with your eyes open and enough space in your diary to carry out your duties. And, given the increasing prevalence of litigation, a good insurance policy too.
