Friday, October 9, 2009

Fiduciary Duties and Non-Executive Directors

An earlier post had discussed a recent Australian judgment on the role and duties of a non-executive director, Australian Securities and Investment Commission v. MacDonald. More recently, according to a report on the Corporate Law and Governance blog, the Inner House of the Court of Session of Scotland has again commented on the role of non-executive directors. (The Court of Session is Scotland’s highest civil Court; an appeal lies directly to the Supreme Court of the United Kingdom [previously the House of Lords]). The case, Commonwealth Oil and Gas Co. Ltd. v. Baxter and Eurasia is available here.

In commenting on the Australian decision, I had noted in the previous post that “the Court seems to have imposed a duty of care on non-executive directors which cannot be satisfied simply by relying on information provided to them by others. What exactly is the content of this duty is a question not conclusively answered.

Commonwealth Oil can be useful in clarifying the content of the duty – the Court held that the contents of duty were the same, whether the director was an executive director or not. Undoubtedly, the executive director may have specific executive functions in specific areas of business which have been delegated to him to perform. But this fact does not alter his status: “he is a director of the company as a whole, and his duties to the company are to manage the general affairs of the company and are not confined to the responsibilities arising from his executive function. A director's fiduciary duty of loyalty is owed to the company as a whole; and the duty to avoid a conflict of interest must be related to the interests of the company as a whole… the fact that he was a non-executive director does not mean that he did not owe to the company the same fiduciary duties as its executive directors owed to it.

This not an entirely novel proposition of law – for instance, a decision in Dorchester Finance v. Stebbing, [1989] BCLC 498, had also stated that there is no distinction in principle between executive and non-executive directors. The Scotland decision reaffirms this point. More importantly, perhaps, the Scotland decision contains an elaborate discussion of the important case-law on the fiduciary duties of directors more generally. On its facts, the case dealt with the no-conflict rule; a previous post which had discussed the strictness of the no-conflict rule and the corporate opportunity doctrine is available here.


Anonymous said...

Interesting decision. A question - why should courts decide on the basis of whether the director is an executive or non-executive one? Will it not be possible to fashion a standard somewhat based on or around professional negligence standards - such as, the duty of care and skill for both executives and non-executives would correspond to the professional qualifications of the directors?

Mihir Naniwadekar said...

Hello, thanks for the comment.

I believe that there can be a generaldistinction between fiduciary duties such as 'no conflict' type duties; and the duty of care and skill. Dorchester Finance v., Stebbing did away with the distinction between executive and non-executive in the latter case(the issue was negligence in issuing cheques); Commonwealth has done so in the broader arena of fiduciary duties also.

Insofar as care and skill is concerned, the logic you put forth would hold good. Indeed, there has been a consistent debate over whether the duty of care and skill should be an objective or subjective duty; to some extent, the argument you put forth has been considered in that context. But for the other fiduciary duties, I am not sure how far the logic would continue to hold. For the existence of the general fiduciary duties would depend on the fact that a person is a director;l not ton the fact of what that particular director's qualifications are. But insofar as the argument is restricted to care and skill, I would agree.

Vanessa Finch's article on the topic is an interesting piece on related areas of law; the citation is:
Finch, Company Directors: Who Cares About Skill and Care?, 55 MOD. L. REV. 179 (1992)

Anonymous said...


Umakanth V. said...

Thanks, Mihir and Anonymous, for the interesting discussion. If I were to summarise the position (at some risk of over-simplification), it would appear as follows:

In common law, directors can broadly be stated to have two types of duties:

(i) duty of care, skill and diligence, and

(ii) fiduciary duties (being (a) to act in the best interests of the company; (b) not to put himself/herself in position of conflict with the company (i.e. the no self-dealing rule) and (c) to act for proper purposes.

As far as (i) is concerned, all directors (whether executive or non-executive) will be subject to a common minimum standard of duty. Therefore, non-executive directors cannot get away from liability on that count alone. On the other hand, executive directors or even professionals (e.g. a finance professional on the audit committee) could be held to a higher standard than other directors. Hence, while the standard cannot be lowered below the common minimum, it can nevertheless be raised for executive and professional directors.

As regards (ii), there is unlikely to be any distinction between executive and non-executive directors and all of them may be held to the same standards, as these involve fiduciary duties and loyalty towards the company, which are not based on the executive status or expertise of the directors.

Since the Companies Act does not provide specific statutory guidance on directors' duties, courts are willy-nilly required to follow common law principles. This is not a phenomenon restricted to India, but holds true in other Commonwealth jurisdictions as well. Hence, this is an area that involves heavy borrowing of case law across jurisdictions (which may not necessarily be an unhealthy trend).

Anonymous said...

Are you suggesting that in the event of a financial fraud in a company, it would be possible to proceed against a non-executive director, with financial expertise, on the audit committee and not against other non executive directors?

Umakanth V. said...

@Anonymous. Thanks for the comment. That would depend on the specific facts of a given case, but it is not as if independent directors cannot be proceeded against at all. For instance, an oft-quoted statement of the New Jersey Supreme Court in Francis v. United Jersey Bank 432 A.2d 814 at 822 (N.J. 1981) goes as follows:

"Because directors are bound to exercise ordinary care, they cannot set up as a defense lack of the knowledge needed to exercise the requisite degree of care. If one “feels that he has not had the sufficient business experience to qualify him to perform the duties of a director, he should either acquire the knowledge by inquiry, or refuse to act”

This has been followed in Australia in Daniels v. Anderson, 37 NSWLR 438; 16 ACSR 607, a decision in which the court tries to clarify the position regarding a somewhat difficult area of the law:

"A person who accepts the office of directors of a particular company undertakes the responsibility of ensuring that the or she understands the nature of the duty a director is called upon to perform. That duty will vary according to the size and business of the particular company and the experience or skills that the director held himself or herself out to have in support of appointment to the office. ..."

The last sentence above provides emphasis on the "experience and skills" of the director. In that sense, a member of the audit committee with financial expertise could have a varied (read higher) standard of care to demonstrate, particularly because their duties are more specifically set out in Clause 49 (as compared to the board in general).

Having said that, the available empirical evidence suggests that non-executive directors (particularly those that are outside or independent directors) have rarely been successfully sued where they have had to make pay-outs to successful plaintiffs for breach of duties. It is only in a few exceptional situations (or "perfect storm" scenarios as the authors of these studies note) that outside non-executive directors have been held liable.