Can Ignorance be a Defence for Directors?

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This headline in the Los Angeles Times of 28th August 2013 caught my attention: Toyota executive testifies in acceleration case: “I am not very technical”. The article is about the testimony of Toyota’s US CEO, James Lentz in a suit brought by relatives of Noriko Uno who allege that her Toyota Camry unexpectedly sped to 100 miles per hour and crashed killing her in 2009.  The Judge has apparently designated the case as a “bellweather case” for hundreds of other lawsuits against Toyota.It is unusual to obtain testimony from the CEO of a large corporation in a piece of civil litigation involving customer or consumer injury or loss. The defendant company usually argues to good effect that the CEO will have little (if any) direct relevant knowledge of the case. It’s not clear why such a submission did not find favour in this case.

Nor is it hard to see why a CEO might be reluctant to submit to cross-examination. In this case for example plaintiffs’ counsel seems to have indulged in a number of rhetorical flourishes including producing various engine parts and asking Mr. Lentz to identify them. He was unable to do so claiming to have focussed more on sales and marketing rather than manufacturing in his 31 year career and Toyota. It was in that context that he made the “I am not very technical” remark.

Mr. Lentz’s testimony reminded me of testimonies given by senior executives of large banks to the House of Commons Treasury Select Committee, following the collapse or near collapse, of a number of them in the spectacular crash of 2008.  For example, the Chairman of the UK branch of a leading investment bank was asked to explain to the Committee how a collateralised debt obligation worked. He was unable to do so and this led to the following comment being made in the sixth report of session (2007-08) into Financial Stability and transparency by the UK Treasury Select Committee:

“… we are surprised that the Chairman of the UK branch of a leading investment bank could not explain to us what a CDO is, a financial product of which he told us that his organisation deals.  The fact that senior board members may not have sufficient understanding of products that their organisations are originating and distributing is a major cause for concern…”

So, to what extent can ignorance constitute a defence for a senior executive once something has gone badly wrong? The classic, if qualified, answer given by English Law to this question is to be found in the judgment of Mr Justice Jonathan Parker in Re Barings Plc (5) where he said:

“1) Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them properly to discharge their duties as directors. 2) whilst directors are entitled (subject to the articles of association of the company) to delegate particular functions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve directors for their duty to supervise the discharge of the delegated functions…”

So there you have it. You cannot, as a director, no matter how senior, delegate away your supervisory function. Whether you have discharged your duty to display appropriate levels of knowledge, skill and experience will depend on the facts of each particular case which will include a detailed examination of that director’s particular role in the management of the company and his/her own individual skills or experience. Indeed, it might not be going too far to suggest that it is, or should be, the very fact specific nature of any such examination and the uncertainty of outcome which it brings that is one of the key drivers in the decision to buy adequate levels of D&O insurance protection.

 

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Auto, Directors & Officers, Executive Risk

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