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Commercial Question

Gee Up Neddy!

updated on 02 May 2006

Question

What are the duties and liabilities of a NED?

Answer

In April 2005 Equitable Life brought a multi-million pound negligence claim against Ernst & Young and 15 of its directors, including eight non-executive directors (NEDs). By December 2005 Equitable Life had dropped the claim, but the case highlighted the corporate role of NEDs and their potential personal accountability.

What is a NED?

A NED (or 'outside director') is a part-time director of a company. In some companies the role is limited to attending board meetings; in others it can include acting as a contact for shareholders or major suppliers, or sitting on independent committees. A NED is typically an independent, experienced voice providing the board with insight, guidance and supervision.

A glance at the senior appointment sections of the heavyweight newspapers shows an ever-increasing demand for NEDs.

Although the position may sound attractive for its limited decision-making responsibility, token working hours and healthy remuneration, in fact the standard of performance expected from NEDs is the same as that expected of executive directors.

What are his duties?

A NED's statutory obligations include duties to declare interests in company shareholdings or transactions, keep and file accounts and registers, and have regard to the interests of employees. The statutory duties also include a wide range of regulatory responsibilities covering consumer protection, environmental issues, health and safety legislation, insurance liabilities, copyright and trademark infringement and insolvency.

A director also owes common law fiduciary duties (proposed to be codified in the Company Law Reform Bill) to the company to act in good faith in the company's interests, to act with due care and skill, not to exceed/abuse his powers, not put himself in a conflict of interest, and not to make a secret profit.

NEDS have the same duties as executive directors. In fact, a NED may be held to a higher standard of care in respect of those duties, as his degree of responsibility is gauged in accordance to his particular knowledge and experience; for a semi-retired accountant or other professional with years of commercial experience, this may be a very high level of accountability indeed.

What risks does he face?

In addition to the obvious offences a NED could actively commit in the course of his duties (eg, theft or tax evasion), NEDs can be criminally liable for inactivity. Breach of many of the statutory duties cited above is a criminal offence and can lead to penalties and/or disqualification. NEDs can also be personally criminally liable for consent, connivance or neglect leading to corporate offences under health and safety, road traffic, environmental and employers' liability legislation.

NEDs of listed companies can also face regulatory penalties for being knowingly concerned in breaches of the Listing Rules.

Any director could be held personally liable to creditors on insolvency for allowing the company to continue trading where he/she knew or ought to have known that the company had no reasonable prospect of avoiding liquidation. The standards expected of a NED are somewhat lower than that of an executive director; after all, a NED is not expected to participate in the company's daily management. However, a NED claiming to have been unaware of obvious wrongful trading by the company may very well implicate himself.

Normally actions in tort are taken against the company rather than an individual director. However, where the director undertakes a personal duty of care, he may be personally liable for the harm caused.

How can he protect himself?

A NED can only protect himself against the risks if he knows what they are. He should satisfy himself that he has the knowledge, skills and experience to undertake the role. He should remain abreast of emerging legislation and case law. He must also remain an active board member by attending meetings, asking questions and requiring further information if necessary. Inactivity itself can be proof of negligence, unfitness, consent or neglect.

Being aware of the risks, a prudent NED will take professional advice. Sometimes taking advice and following it is enough to satisfy a director's duty of care. Every director should keep records of any advice given and of his own company activities both in and outside the board room.

The Companies Act 1985 was recently amended to relax the restrictions on companies indemnifying their directors for some liabilities arising in the course of their directorship. However, it is still not lawful to let a director off his liability to the company itself or to indemnify him against any claims made against him by the company or others in its group, or in respect of criminal penalties or those imposed by regulatory bodies such as the Financial Services Authority.

As any indemnity given is only as good as the company is solvent, it should be backed up by Directors and Officers Liability Insurance, covering civil liabilities and regulatory oversights (it is not possible to insure against criminal liability).

What's the catch?

In almost every area, NEDs are expected to perform to the same standard as executive directors, and are exposed to the same risks. In spite of his position as an 'outside director', his legal obligations actually require a NED to take an active role within the company.

Executive directors take an active role in managing a company, and their executive emoluments reflect the responsibility and risk involved. In contrast, in a corporate environment where NEDs are excluded from performance-related pay, how willing will NEDS be to take on a 'part-time' job which in effect offers a fraction of the remuneration but full exposure to liability? The answer: not very.

Heightened awareness of director liability following the Equitable Life saga has had two noticeable effects: a demand for increased NED salaries and lobbying for greater statutory protection from litigation. Not surprisingly, at the very next AGM following initiation of proceedings against its former non-directors, the incoming Equitable Life board proposed a remuneration package effectively doubling non-executive salaries. In 2005 the IDS Executive Compensation Review recorded that NED's salaries had continued to rise for the second year running.

The catch-22 of course is that the more significant a NED's salary is compared to his total income, the more his independence, and therefore his usefulness as an 'outsider', is called into question.

Dona Ardeman is a newly-qualified solicitor in Mills & Reeve's Corporate Department.