Not only does the Ostrich Position provide an affirmative answer to the question which has troubled philosophers for centuries – “does my bum look big in this?”, it also provides the Courts with a juicy target when looking to apportion blame for company failures.
A recent case: Secretary of State for Business, Energy and Industrial Strategy v Selby  EWHC 3261 (Ch) demonstrates that directors cannot just stick their head in the sand or turn a blind eye to company problems, or even fail to interest themselves in the running of the Company, without risking disqualification as a director.
Directors’ duties apply not just to appointed Board members, they also apply to people who interest themselves in the running of the Company without actually being appointed to the Board (“Shadow Directors”). The key to whether or not a person is a Shadow Director is the degree of influence they exercise over the appointed Board, or the management of the Company. In many family companies, an older relative who is not a director can sometimes exercise a “guiding hand” which results in them becoming a de facto director, even if not appointed to the Board.
The case of Selby concerned a non-executive director who operated on a part-time basis as a director of a company (XE Solutions Limited “XES”) involved in the supply of equipment for water purification. The director in question only worked one day a month at the Company, was an experienced investment professional of 30 years’ experience and saw his role as being to introduce investment for the Company and prepare it for a listing on AIM. He did not see his role as being to interest himself in the day-to-day running of the Company. The Court did not agree that his role should be so limited.
In 2012, XES expanded into a new business line – that of supplying pumping equipment to the fracking industry. Within the space of 6 months, 28 deals were entered into relating to this new business line. Unfortunately, all 28 of those deals involved VAT fraud and HMRC disallowed VAT input tax of £1.1m, cancelled the Company’s VAT registration and raised penalties against the Company and the executive director most closely associated with the fraud. XES subsequently went bust owing £4.1m to creditors.
What did the non-executive director do wrong?
After all, he had not been directly involved in the VAT fraud and was seemingly unaware of it until HMRC came calling. The Court found that:
- he failed to inform himself about the Company’s affairs and was unaware of the 28 deals XES had done, even though he had signed the Company’s accounts for the period that covered 27 of them;
- he failed to investigate the reasons for the huge expansion in XES’s turnover (as a result of the VAT fraud) even though he was in receipt of management accounts for the relevant period; and
- he failed to engage with HMRC once it launched its investigation, leaving that to his fellow directors.
The judge also alluded to the non-executive director’s failure to make further enquiries when the business’s founders (and his fellow directors) informed him that they had served time in prison, save to rule out “something really grotesque”.
The Court was satisfied that the non-executive director’s honesty was not in question, simply his competence, but nonetheless disqualified him as a director for 4 years.
So, what is a director expected to do?
The Companies Act requires directors to exercise reasonable care, skill and diligence. This means the care, skill and diligence exercised by a reasonably diligent person with both:
- the general knowledge, skill and experience that may be reasonably be expected of a person fulfilling the role of a director in relation to the company (an objective test); and
- the general knowledge, skill and experience that a director actually has (a subjective test).
In the case of Selby, because the non-executive director was “an experienced City man”, the fact that he only worked one day a month did not absolve himself of the obligation to enquire into the running of the Company and the reasons for its sharp increase in turnover; his substantial experience as an investment professional actually increased the Court’s expectations of him as a director.
So, if you are a director, what should you do?
- attend Board meetings;
- ask questions of your fellow directors and have those questions and responses minuted or recorded in correspondence;
- if your business is regulated in any way, or has to comply with specific legislation (e.g. investment firms, waste transfer, chemicals production) make sure you know what the regulations require of your company, so that you can monitor compliance by the company (this is part of the first, objective test);
- if there are specific areas you don’t understand – ask again, using the Company’s professional advisors if necessary – make sure you are on good terms with the Company’s accountants;
- if any matters are delegated to other directors, or committees of directors, make sure those directors report back to the main Board and quiz them on their responses;
- if you suspect that documents are being withheld from you, or that the Company is engaged in unlawful activity – seek legal advice;
- if you are a part-time director, don’t assume that means your oversight duties are reduced.
The case of Selby reaffirms that a “See No Evil” attitude is not acceptable for a Company director. The Companies Act imposes real duties on each Board member (and shadow director) which they should be pro-active in discharging.
If you need any advice on your duties as a director, please do not hesitate to contact Iwan Emanuel on 01494 893 570 or email him at: firstname.lastname@example.org