The truth about directors’ duties in the U.K. and the business judgment rule

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Between 1742 and 2017 it seems there have been 130 cases in which the discharge of directors’ duties in the specific context of the business judgment rule has come under scrutiny by the English courts. In 82 of these, the claimants were successful whereas in 48 the defendants prevailed. You might think, both in terms of absolute numbers and success rate that these results aren’t too bad from the director’s perspective but they’re not the whole story.

Over the summer I took part in some very interesting research run by the Centre for Business Law and Practice, School of Law University of Leeds and the University of Liverpool Management School.

The team, led by Professors Joan Loughrey, Andrew Keay and Terry McNulty shared their preliminary findings with a selected audience at the end of November 2018.

The research

One objective of the research was to assess the extent to which a tacit or implied business judgment rule exists in English Law. As you may know, in the U.S. and other common law jurisdictions, there is an express business judgement rule. This creates a viable defence for directors under which judges are, in effect, prevented from going behind the business judgments exercised by directors in order to substitute their own. Does this system operate here?

The key finding

A key finding of the research is that, unlike in the U.S., judges are quite prepared to examine the efficacy of business judgments exercised by company directors. Instead the focus of the English courts is far more on the process by which the business judgment was reached as well as the judgment itself. The approach most commonly taken is to scrutinize board decisions with a view to establishing:

  1. Whether the directors have taken appropriate steps to inform themselves of the relevant facts;
  2. Whether they have sought appropriate expert advice if necessary;
  3. Whether they were entitled to rely on any such advice;
  4. Whether they acted responsibly.

They emphasized that the courts do not apply a box ticking mentality for which regulatory and corporate governance regimes are justly criticized from time to time. Instead they examine the overall architecture of directors’ decision making. In other words, courts concern themselves with the deeper context and process of decisions, including the workings of the board and how decisions are made.

A more detailed analysis of these findings can be accessed here.

The breakdown of claims

By far the biggest predictor of claims against directors, according to the research, is company insolvency. A significant majority of claims against directors involve company insolvency. Almost all the cases were to do with small private companies rather than large public ones. (This may not accord with the public perception).

The claims against directors fell into the main following categories:

  • Breach of duty of care
  • Wrongful trading
  • Failure to promote the success/ act in the best interest of the company
  • Failure to act in the best interest of creditors
  • Unfair prejudice
  • Directors Disqualification Act

The claims trend

In terms of the claims trend, both in terms of claimant success rate and total numbers, the litigation landscape is unquestionably worsening for directors. The researchers divided their findings into the following time periods marked by significant director liability legal precedents and/or events:

Pre-1924 (before the City Equitable decision) 26 cases
1924-1991 (Norman v Theodore Goddard) 13 cases
1992-1998 (Barings) 17 cases
1999-2007 (Financial crisis) 30 cases
2008-date 44 cases

Conclusion

In a sense, the fact that courts show themselves to be above all concerned with the deeper context and process of decisions including the workings of the board should be a source of comfort for directors. It tends to affirm the long held view that directors are often able to make decisions which, while with the benefit of hindsight turn out to be wrong, are not culpable. Having said that, civil cases against directors are definitely growing and the increasing size and availability of ligation funding is likely to function as an accelerant in this process. Moreover, the interplay between the steady growth in civil litigation funding against directors and the faster growth (especially post financial crisis) of regulatory enforcement actions against senior managers must also be a cause for concern for board members. The theme of personal accountability at board level does not sit comfortably with the careful judge-led approach to the review of board decisions described by the research.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Claim & Risk Control, Directors & Officers, Featured Post, Insurance and Risk Management, Risk Culture | Tags: , , ,

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