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"It Wasn't Me!" – The Expanding Duties of Non Executive / Independent Directors

Sep.21.2009

The Court of Appeal decision of Lexi Holdings Plc v Luqman & Ors [2009] EWCA Civ 117("Lexi") has forced non executive directors ("NEDs") across the country to sit up straight at board room tables. The judgment has endorsed the increasingly held view that a failure to act on the part of NEDs, particularly in the day to day management, may be a breach of their fiduciary and common law duties. In the past, courts were reluctant to hold directors liable for breach of their duty of care when the matter related to the wrongdoing of other directors because it was difficult to prove that their omissions resulted in losses to the company. However, following the Court of Appeal decision in Lexi, NEDs will be unable to excuse themselves of such inactivity by the time old saying of "It wasn't me" also known in the legal world as the "Shaggy defence 1".

Summary of the facts of the case
The case involved the misappropriation of £59,607,498 by the managing director Shaid Luqman ("Shaid") of Lexi Holdings Plc ("the Company") between 7 October 2002 and 15 November 2006 with the Company filing for administration in late 2006. The administrators issued proceedings to recover the money against Shaid, as well as a number of other directors, including his sisters Monuza Luqman ("M") and Zaurian Luqman ("Z") who had received payments from the misappropriated funds. Shaid was debarred from defending the action for serious breaches of a number of court orders including an asset disclosure order, freezing order and a failure to deliver up his Pakistani passport to the Company's lawyers. As a result, the Company was able to obtain judgment against Shaid for the full misappropriated amount plus interest. As against the NEDs, M and Z, the court at first instance concluded that they were only liable for some of the money. The court held that their inactivity did not directly cause any loss to the Company on the grounds that had they scrutinised and questioned certain accounting entries they would "have been fobbed off by lies" from Shaid. Accordingly, they were only liable for that part of the misappropriated funds that had been paid directly to them.

The Court of Appeal, however, saw things very differently, holding that M and Z failed to make appropriate enquiries, and had not succeeded in discharging their duties as directors. Shaid's ability to deceive his fellow directors did not excuse this conduct. M and Z had also failed to inform the other directors, and the banks lending money to the Company that Shaid had been previously convicted of dishonesty offences including five counts of obtaining or attempting to obtain money by deception. Further, M and Z had a duty to inform the Company's auditors and their fellow directors. If they had done so, the auditors were unlikely to have produced unqualified accounts which were relied upon by the banks that increased the Company's borrowing facilities. As a consequence, M and Z were held to have breached their duties as directors, and were ordered to repay approximately £42 million and £37 million respectively.

The decision is an excellent example of how NEDs can breach their fiduciary duties:

  • Failure to ensure that they have appropriately supervised the day to day affairs of the Company. This will include supervision of the actions of other directors. Tasks may be delegated but it still remains the business of all directors.
  • Failure to exercise judgment. NEDs should not be manipulated by actions of one individual. Even partial delegation of responsibility can be extremely detrimental and costly. In Lexi, the two NEDs should have requested explanations for a number of suspicious accounting entries and for details in relation to a fictitious director loan account in the names of the executive director, Shaid, and one other NED. The Court of Appeal held that had they properly carried out their duties as directors and questioned the actions of Shaid, the losses to the Company would not have been as extensive.
  • Failure to inform auditors, banks and other directors of special knowledge they possess for example: prior dishonesty offences. In Lexi, the two NEDs were held to have prior knowledge of Shaid's convictions and should have informed auditors that he had previously been imprisoned for offences which included obtaining or attempting to obtain money by deception.
  • Failure to seek appropriate advice from external professional advisors.

Conclusion
Regulatory authorities, particularly in the UK/Europe and the US are increasingly focused on holding an individual as opposed to a company accountable for losses and failures. While NEDs/independent directors could have been forgiven a few years ago for acting and behaving with limited knowledge, that is insufficient these days - in fact the holding in this case arguably extends their duty of care to that of a full time director. Most D&O policies exclude cover for an NED unless specific allegations are made against them and while the "Higgs" report in the UK mandated D&O cover for NEDs, the availability in the market has been subject to a number of caveats. This case can only be good for D&O Insurers, but may result in a lower number of NEDs taking up a position particularly with the FSA reviewing and approving executive positions going forward.

To read the full judgments links to the High Court and Court of Appeal judgments may be found below:

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