Guest Post: Corporate Governance Disputes & Liability of Professionals and Non-Executive Directors

[The
following is a guest post from Vinod
Kothari
of Vinod Kothari & Co. He can be contacted at vinod@vinodkothari.com]
The trail of litigation in Newcastle
International Airport Limited vs. Eversheds LLP
[2013] EWCA Civ 1514 ,
decided by the Court of Appeal on 28 November 2013, may be interesting for more
than reason. One is quite obvious – a litigation that might have cost the
plaintiff close to a million dollars in legal costs ended up in just 2 pounds of
damages against the professional firm Eversheds LLP. However, more importantly,
the litigation highlights the new world of professionals’ liabilities – that
companies in time to come will not hesitate to sue non-executive directors,
professionals, or whoever else, for failing to ensure the balance of duties and
self-interest required to ensure proper system of corporate governance.
At the same time, the trail of
litigation points to the ever-difficult regime of legal liabilities of
non-executive directors.
Facts of the case
The litigation has so far been
directed against Eversheds, a solicitor firm that advised Newcastle
International Airport (NIAL). The NIAL board consisted of 2 executive
directors, and 5 non-executive directors. Advised by Eversheds, the
Remuneration Committee, consisting of non-executive directors, approved of new
agreements, drafted by Eversheds, which not only bestowed the executive
directors with a fat GBP 8 million bonus on completion of refinancing of the
debt of NIAL, but also effectively released them from restraints in joining
competing airports at Bristol/Leeds.
In earlier decision by Chancery
Division, in [2012] EWHC 2648 (Ch), the Judges dismissed, with
costs, claim for damages against the law firm. The claims were mainly founded
on the ground that the law firm had taken their brief from one of the executive
directors. Additionally, the advice of the law firm was non-speaking, and the
law firm did not brief the client on the consequences of following their
advice. The claim was dismissed in the following words:  Eversheds “acted in good
faith on the basis of instructions which it was entitled to accept. I accept
that this was not a case where Eversheds treated Mr Parkin in his personal
capacity as the client. It followed his instructions because he was clothed
with apparent authority and Eversheds had no reason to believe that any of his
instructions were unauthorised
.”
Despite holding the law firm
liable for breach of their retainer to the client, the Court imposed GBP 2 as token
damages.
Role of remuneration committee
This litigation may be
particularly significant in advancing the law on the duty of a solicitor to a
client – not only ending up with drafting what one is expected to draft, but
also of explaining, in “user-friendly language” the implications of the advice.
However, equally significantly,
the litigation throws serious charges of inaction, not reading of documents,
etc. on non-executive directors in general, and the remuneration committee in
particular. The Chancery Court had, in no unclear language, held that it was
the non-executive directors who were to be blamed for the losses suffered by
NIAL. It noted regarding the role of the Remuneration Committee (RC)
chairperson: “A major factor resulting in NIAL’s signing of the
contracts was the incompetence displayed in relation to the consideration of
their terms by the chairman of the RC, Rosemary Radcliffe CBE, although it must
also be said that she appears otherwise to enjoy universal plaudits for her
general ability. In this case, however, she deployed little of it and things
went badly wrong
.”
The litigation has so far chased
the law firm for damages: they spent a fortune to get GBP 2. However, it is
anyone’s guess as to what would have been the success had the company chased
the non-executive directors. The ruling makes it clear that in the new world of
corporate governance, independent directors are not mere embellishments on the
company’s boards. Not only would the law seek to punish them where there are
lapses or negligent omissions, even the companies/shareholders will not hesitate
to pursue them for damages.

 

Other rulings on liability of
independent directors
There have been several instances
in the past where claim for negligent conduct have been made against
independent directors. One of the most important of such cases is Equitable Life v Bowry [2003] EWHC 2263
where the company claimed compensation against the auditors, also filed a civil
case against its non-executive directors. Subsequently, litigation was dropped
against the directors, but continued against auditors. The case, estimated to
have cost some GBP 30 million in legal fees, dragged for years.
Before the Equitable Life ruling, in Dorchester
Finance Company Limited v Stebbing
 (1989) BCLC 498, stated the
general proposition of law that there is no distinction in law between
executive and non-executive directors in terms of their liability.  A detailed analysis of the case law in respect
of liability of non-executive directors can be found here.
Liabilities of independent
directors: Higgs Committee
The Jan 2003 report on The Review
of Role and Effectiveness of Non-executive Directors, popularly known as the
Higgs Report, has gone at length on the issue of liabilities of independent
directors. The ruling in the case of Equitable
Life
was particularly cited as being of concern. Arguments for exempting
independent directors were put forth; at the same time, the argument against
any special treatment, given the unitary board structures under the UK law were
also advanced. Higgs did not make any specific recommendation for generic
exemption of independent directors, and only recommended good use of the
equitable right to seek exemption under sec. 
727 of the UK Act of 1985, and generally a more expeditious disposal of
cases by courts.
Liability of independent directors:
Indian Companies Act 2013
The Indian Companies Act 2013 [sec
149 (12)] contains what may seem like a general immunity for independent
directors and non-executive directors. The section states:
(12) Notwithstanding anything contained in this Act,—
(i)        an independent director;
(ii)       a non-executive
director not being promoter or key managerial personnel, shall be held liable,
only in respect of such acts of omission or commission by a company which had
occurred with his knowledge, attributable through Board processes, and with his
consent or connivance or where he had not acted diligently.
This provision is not new – there
was a circular from the MCA to a similar intent in 2011. However, now that this
intent is coded in the law, it is important to understand a few points
regarding the provision:



1. The
provision is applicable not just to independent directors, but other
non-executive, non-promoter directors as well. Nominees of strategic investors,
who are not independent directors under the new law, will also be covered by
this immunity.
2. One may
casually call this section a general immunity provision, but it is not
immunity, truly speaking. All this provision says is – a director shall be
liable only such acts of omission or commission by a company (a) which occurred
(i) with his knowledge being a part of the board; and (ii) with his consent or
connivance; or (b) where he did not act diligently. Where the act/omission had
occurred with his consent or connivance, it is not necessary to prove knowledge
– so the essential element in (a) is, in fact, consent or connivance. As there
is an “or” between (a) and (b), it may be argued whether diligence will be a
defence even where an act occurred with the consent or connivance of the
director? Of course, if the director in question was present and voting at a
board resolution, his consent is explicit. If he disclaims, or votes against a
matter, he surely has a defence. But with diligence, where he could not detect
that there was an offence taking place, can he argue that mere knowledge or
consent cannot have an element of criminality where, with due diligence, the
director could not detect the offence? Of course, he does not have operational
level data or details. He knows only so much as comes out during the board
process. In the case of Newcastle
above, the maxim that absent dishonesty or exceptional circumstances one is
entitled to believe in what one is told. The immunity provisions of sec. 463,
which have been there in the statute over decades, also talk about the director
acting honestly and reasonably. Thus, the presumption must be that if the
director has acted honestly, diligently, and reasonably, he cannot sleep-walk
into legal liabilities merely because he puts the cap of a director in a company.
3. Sub-section (12) of sec 149
clearly shifts the onus on the prosecution to make a case that the director had
not acted diligently, or that he had consent or connivance. If the prosecution
continues to implicate independent directors, and they burden of proving that
the defence of sub-section (12) applies in their case, the very purpose of
sub-section (12) will be frustrated.
There is also a provision in sec
463 for exoneration by a court if the director in question acted honestly and
reasonably. This provision is not new and corresponds to sec. 633 of the 1956
Act and sec. 727 of the UK Companies Act 1985.
If the Companies Act is the only
statute that made a director liable for the offences of the company, perhaps
something like the general immunity contained in sec. 149 (12) of the Companies
Act would have helped. However, there are hundreds of other laws that charge
directors. In fact, the general legal principle is – wherever a company is
liable for a criminal proceeding, the directors, being the “controlling brain”
of the company, are liable. A UK publication says there are over 250 statutes
under which directors may be held liable[1].
The India, the number may be running in near a thousand laws.

Conclusion

Clearly, the sole purpose of
modern corporate governance codes requiring the presence of independent
directors on corporate boards is to impart balance to decision-making.
Independent directors cannot plead that they were looking elsewhere while
executive directors pursue self interest. At the same time, the unitary board
structure cannot be a reason to paint all directors with the same brush. One
needs to realise that independent directors are outsiders to the companies they
serve – the precise reason why they are regarded as independent. One cannot, thus,
be independent while at the same time carry the luggage of operational
liabilities pertaining to a company. Particularly so when the regulations now
require mandatory retirement of independent directors.

– Vinod
Kothari

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

Add comment

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Recent Posts

Topics

Recent Comments

Archives

web analytics