An English Court’s Steadfast Refusal to Apply Hindsight Offers Cheer to Directors

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I am conscious that all too often I post blogs which highlight some new threat of liability or exposure for directors.  So it is nice to be able to report some good news for a change in the form of a claim for negligence and misfeasance against four directors brought by the liquidators of a UK company which has recently been comprehensively defeated.

When I tell you that the claim was for £33m and was against the former directors of Bernard Madoff’s London operation, Madoff’s Securities International Ltd. (“MSIL”) it is all the more remarkable. Indeed what most struck me in reading the meticulous 115 page judgment of the trial judge, Mr Justice Popplewell, following a 6 week trial is the care and vigilance taken by the trial judge against the understandable temptation to apply hindsight.

The Madoff Case

It’s worth reminding ourselves of the scale of Bernard Madoff’s frauds. On 29th June 2009 he was sentenced to 150 years in jail and ordered to forfeit no less than $ 170 billion! It is also worth noting that among the defendants were Mr Madoff’s brother and two sons. The claims were brought by the liquidators of MSIL on the grounds that the directors were all in breach of duty in making or permitting the company to make payments to third parties in furtherance of Madoff’s frauds. The liquidators did not clam that the directors knew that these payments or transfers were fraudulent nor did they allege that they should have suspected this was the case. Instead it was claimed that they should have realised that the “true nature” of the payments was that they constituted an unlawful distribution of capital to Bernard Madoff himself and that they failed adequately to question or analyse their true nature before authorising them.

Mr Justice Popplewell considered the duties owed by directors in the context of payments by MSIL to third parties. The judge emphasised that these directors

…in common with the rest of the financial world… believed Bernard Madoff to be a man of unquestioned probity whose high reputation and status was justified by his apparently formidable history of financial trading and investment.

He then proceeded to conduct a detailed review of the payments relied upon by the liquidators in light of the oral evidence of the directors before turning to the relevant law. He summarised the position as follows: “It is a breach of duty for a director to be dominated by, bamboozled or manipulated by a dominant fellow director where such involves a total abrogation of this responsibility…”

Duties of a Director

It is well established that a director owes a fiduciary duty to act in the best interests of the company. This is the core duty of a director. Although it will often be necessary for there to be division and delegation of responsibility for particular aspects of the management of a company, each director nevertheless owes inescapable personal responsibilities and has a duty to inform himself of the company’s affairs and join with his fellow directors in supervising them. It is therefore a breach of duty for a director to allow himself to be dominated, bamboozled or manipulated by a dominant fellow director where this involves a total abrogation of his responsibilities but, in fulfilling his responsibilities, a director is nevertheless entitled to rely on the judgment, information and advice of fellow directors whose integrity he has no reason to suspect. A director is not in breach of his core duty to act in what he considers in good faith to be the interests of the company merely because if left to himself he would have done things differently.

  • A director also owes a fiduciary duty to exercise the powers conferred on him for the purposes for which they were conferred. Although the duty will often overlap with the duty to act in what a director honestly considers to be the best interests of the company, the duties are separate and it has been held that a power has been exercised for an improper purpose notwithstanding that the director bonafide believes it is being exercised in the company’s best interests.
  • A limited company that is not in liquidation may not return assets to its shareholders except by way of a reduction of capital approved by the court.
  • A director has a duty by virtue of his office to exercise reasonable care, skill and diligence. The standard of care required of a director is to be determined not only subjectively by reference to his particular knowledge, skill and experience but on general, objective criteria. The duty is not a fiduciary one. If the director is employed under an employment contract it will also be an implied term of that contract that he will exercise reasonable skill and care.

Judging the Directors

The judge found that the directors in the present case had acted honestly and reasonably in making the payments. They had exercised their powers for the purposes for which they had been conferred and had believed that the payments were in the interests of the company. On the facts the directors had not been in breach of their fiduciary duty to act in what they considered in good faith to be the company’s interests.

 

About Francis Kean

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

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