Remember the collapse of Farepak in October 2006 and the resulting furor when over 100,000 customers lost deposits to secure their Christmas and other food and retail vouchers?
A lot of that outrage was directed at the board of Farepak and its parent company, European Home Retail. It is fair to say that since October 2006, many of the group’s former directors have been well and truly crushed through the litigation mill.
They have been involved in investigations, enquiries and proceedings. These include an investigation commenced by the liquidators, wrongful trading proceedings (also commenced by the liquidators) and most recently directors disqualification proceedings commenced by the Secretary of State.
In June 2012, the disqualification proceedings collapsed in spectacular fashion. Fourteen days into trial, the Secretary of State took the decision to discontinue the proceedings.
The Judge in the case took the unusual step of issuing a statement not only exonerating completely the directors concerned but also issuing some harsh criticisms of the action brought by the Secretary of State and of the conduct of the Bank of Scotland. HBOS (as they were referred to in the case) were Farepak’s bankers prior to its insolvent liquidation.
What lessons are to be learned from all of this?
Lesson One: Don’t Assume You Won’t Get Sued Even if You’ve Done a Good Job
At the risk of stating the obvious, just because you’ve acted competently and not breached your fiduciary duties or duties of skill and care as a director, there is no guarantee that you won’t find yourself in the eye of a very unpleasant storm.
The directors’ costs incurred in the directors disqualification proceedings alone are expected to be in the region of £6m. On any view, that is a huge sum.
In the absence of D&O insurance, the only realistic way in which these directors could have defended themselves would have been to have found lawyers willing to take on the conduct of their defence on a “no-win no-fee” basis.
Some of the directors sued in the Equitable Life litigation went down that route when the insurance funds ran out. Whether it would have been possible to secure such funding against the unlimited firepower of a State-sponsored prosecution may be open to question.
Why Were the Costs so High?
The Judge in his statement shines some light on the question why the costs of the disqualification proceedings were so steep. He was openly critical of the way in which the Secretary of State introduced the evidence against the directors in the disqualification proceedings.
According to the judge, the lead statement containing the case against the directors “…went to 1,087 paragraphs and was 435 pages long. It had attached to it thousands of pages of exhibits.”
The Judge commented further that:
“It transpired during the case that many of the deponents to the [ statements] did not even know what was in their exhibits…” “They swore to them and they of course all verified them in giving evidence in this case but it is completely unhelpful for example to have a single exhibit running to 700+ pages, appended to a [sworn statement] which a deponent does not readily understand and which does not tell the defendants what is the purpose of the large exhibit”.
The Judge concluded:
“In the present case, the defendants in my view would have been overwhelmed in this case but were saved from that by the clearly huge efforts of the defendants’ respective teams in challenging the way in which the evidence was put forward”.
In other words, equality of fire power is a necessary prerequisite for a proper defence both to genuinely complex case and cases (such as this seems to have been) which were rendered unnecessarily complex by the introduction of large quantities of documents.
Lesson Two: Be Wary (if you can) of Situations Where a Company is Teetering on the Edge of Insolvency (Especially if you are a Bank)
This may sound like a blindingly obvious assertion. After all, any well advised and adequately trained director will know that if the company on whose board he or she sits runs into financial difficulties, the likelihood of personal liability exposure increases considerably.
In the first place it becomes vitally important to have an accurate and up-to-date picture of the actual financial position. Depending on the quality and quantity of accurate accounting information this may not always be possible (especially in smaller companies), but without it a director cannot really chart a safe course through these dangerous waters.
Secondly, the balancing of the duties owed by the directors to the company through its shareholders with those which they assume to the company’s creditors (including any banks) in times of financial stress is a challenge even for the most competent and financially literate directors. The position becomes even more complex when different creditors (i.e. unsecured and secured) have different rights and interests in the eventual outcome of the financial crisis.