The Essentials of being an Effective Director – Lessons from the High Court

Posted by Jesvin Boparoy on October 14 2019 in News

In the wake of numerous director reckless trading decisions before the High Court, it is timely to remind all those who hold directorships of their legal roles and responsibilities under the Companies Act 1993 (the Act).

Earlier this year, the liquidators of Mainzeal Property and Construction Ltd (Mainzeal) scored a significant win when the High Court released a high-profile decision finding the directors of Mainzeal, including Dame Jenny Shipley and Richard Yan, liable for reckless trading. The Court made a finding that the directors breached their duty under s 135 of the Act (reckless trading) because they had caused or allowed Mainzeal to trade for years with a negative balance sheet and placed the creditors at a substantial risk of serious loss. The case is currently under Appeal in relation to the quantum of the losses suffered.

What is often overlooked in the industry is that being a director is more than just a title. Directors have a legal responsibility to actively monitor the management of the company. If they do not, they may face serious penalties if things go wrong.

Some of the key obligations imposed under the Act include:

1. Duty to act in good faith and in the best interest of the company (s 131)
2. To exercise powers for proper purpose (s 133)
3. To comply with the company constitution (s 134)
4. To not trade the company recklessly (s 135)
5. To exercise care, diligence and skill (s 137)
6. Ensure that the company keeps compliant accounting records (s 194)

We have made a list of short tips to remind you of your continuing obligations and what to do when things go wrong.

Tips before you take on a directorship

Do your homework: Like any investment or business opportunity, before you become a director, you should get to know the company and its markets. How much money does the company make? How are the risks currently being managed? Does the company have insurance for directors and any prior or existing claims? Have you reviewed the financial accounts/forecast and constitutional documents? Have you taken independent legal or financial advice about the financial reporting requirements you need to undertake? Remember, you may be personally responsible and liable for any decision the company makes.

Allow time to deal with issues: While you can delegate work to employees and managers to prepare books/accounts or carry out the day to day affairs, you are ultimately responsible for the governance of the company. Value can only be added if you actually have the time to carry out those duties.

Tips while you are a director

Big picture strategy: Directors who look at the bigger picture and think about a long-term strategy for their business will have the foresight to understand what is happening both internally and externally with the company. One example is to learn from the annual review performance each year. There are now many online appraisal tools that can help with ascertaining the big picture.

Keep records: These are treated as the official record of the company and are discoverable documents in legal proceedings. Minutes of board meetings should accurately reflect what was said at that meeting. If a company goes into liquidation, one of the first steps a liquidator will do is to ask for books and records. Be proactive now, and ensure all records are kept. It will save the hassle of having to prove that you did not consider an issue facing the company and/or act in its best interest.

Meet the solvency test: Before you pay dividends to your company’s shareholders, you must be aware of the solvency test. For certain transactions, you will be required to sign a solvency certificate and provide reasons in your opinion why the company will meet the solvency test. If you do not know, seek advice.

Seek expert advice: Directors can rely on information from professionals outside their realm of expertise to help them make certain decisions. However, they can only rely on this advice if they 1) act in good faith 2) make a proper inquiry where the need of that inquiry is indicated by the circumstances and 3) have no knowledge that such reliance is unwarranted (section 138 of the Act). Remember, the quality of the advice is only as good as the information provided to the professional.

Signing of Financial Statements

Educate yourself: As a director, you must understand the fundamentals of the business, monitor the performance and review financial statements as required. The courts have often noted that a degree of financial literacy is required. Make sure you are familiar with, and learn to read, the balance sheets, and the profit and loss statements of the company.

Don’t sign off financials you are not comfortable with: If you are not clear on the financial accounts, do not sign off on it. Ask your auditors to clarify what it means or seek independent advice. Under the Act, you are responsible for signing the accounts as accurate. Make sure that they are.

Tips when things go wrong

Early warning signs and refinancing: Be aware of early warning signs and monitor the financial forecasts of the company. Think about refinancing to ensure that the company remains afloat. Your lawyers can give advice about proper restructuring of your affairs.

Stop trading if insolvent: Directors have a duty not to cause or allow the business of the company to be carried out in a manner likely to cause substantial risk of serious loss to its creditors. If the company cannot pay its debts as they fall due - stop trading.

Appoint administrator/liquidator: If all else fails, you have the option of appointing a voluntary administrator/liquidator to take over the company (if the board agrees). Remember, you will lose control of the company if you take this step. However, your role does not end there—you will still need to assist the liquidator or administrator to carry out their role, including providing books and other records (s 261 of the Act).

Directors need to be both risk managers and responsible risk takers to enable the company to grow and survive. If you would like to learn more about your role and responsibilities as a director and the legislative requirements, please contact our litigation and commercial team.

Author: Jesvin Boparoy