DIRECTORS’ DUTIES - 23.04.2009

Turning a blind eye will breach your duty

Clear lesson

Naturally, you’re a careful company director who knows everything about your business. But the recent decision in Lexi Holdings Plc v Luqman 2009, is a reminder to all directors about the dangers of accepting information from fellow directors at “face value”. So what happened in this case?

Facts of the case

The company was a family business run by two sisters (M and Z) and their brother (S). He was the managing director. In 2006 it was discovered that, over a number of years, S had fraudulently taken nearly £60 million from the company. This was mainly by way of fictitious director’s loans, false facility letters and the misapplication of company bank accounts.

Bullying tactics

Because of this the company became insolvent and the administrator sought to recover the lost money from the three siblings through the courts. In their defence M and Z claimed to have no knowledge of the fraud. They said that their brother, who was a “controlling bully”, ran the company on a day-to-day basis and kept important information from them.

Criminal convictions

But what the sisters did know was that S had previous criminal convictions for “dishonesty” and “obtaining property by deception”. Yet they failed to disclose this information to either the bank or to the other directors.At the first court hearing M and Z escaped liability and having to pay back any of the money. The judge remarked that even if they had tried to play a more active role in the company, they would have been “fobbed off” by S and he would have committed the fraud anyway.

Breach of duty

The administrator went to the Court of Appeal and argued that M and Z’s inactivity in itself was a breach of their duties. The court agreed and said, as fellow directors, M and Z had a duty to be “on their guard” and to “pursue adequate explanations in response to searching questions”. Had they acted properly and questioned S about his activities it felt the fraud would have been prevented.

Pass on information

It also said that if S couldn’t satisfy them that his actions were genuine, they should have informed the company’s auditors and other directors of the situation. By failing to do this S was able to secure increased banking facilities. This meant that they were both personally liable for the loss.

Conclusion

Although the facts of the case are unusual, this Court of Appeal decision makes it clear that all directors have “inescapable personal responsibilities” and that they should always exercise “independent business judgement”. The decision means that courts will no longer accept arguments that individual directors play no active role in the management of a company.

Tip. Don’t be afraid to challenge other directors. If there are any disagreements, make sure they’re recorded, either in writing or in the company minutes.