Directors are coming under fire as never before and need to have followed good process when making decisions involving business judgment.
In 2017, a Guernsey court case where claims were brought by the liquidators of Carlyle Capital Corporation Limited (in Liquidation) was successfully defended by various of its ex-directors.
It was alleged that they neglected their duties in the lead-up to the company going into liquidation as a result of the financial crisis in 2008: it was claimed that the company’s best interests required an immediate sell off of mortgage-based securities in order to reduce leverage and enhance liquidity and that this was not done.
The claims were dismissed, and the subsequent appeal has also been dismissed. The court’s 524-page decision provides a masterclass in directors’ defences, summarised in general terms below.
Conscientious key director
The core of the defence was that there was one key director who had greater expertise than the others in analysing the mortgage-based securities and was analysing the day-to-day position taking into account past experience and analysis. The court found that the key director conscientiously strove to maintain a soundly based balance of reason in the judgments he made.
- The other directors, while considering his views critically, could properly rely on those views.
- The key director should be keeping the others up to date.
- Directors can take information provided by management as accurate provided they examine the position rigorously and critically so as to satisfy themselves that there are no matters giving cause for caution or suspicion.
- A consensus as to the course of action is needed but not as to reasoning nor as to the reasons. There is no need for unanimity as to reasoning.
- Each defendant director must be considered individually and not as a collective, so each individual’s alleged failings had to be identified and pleaded.
- The defendants’ case was supported by emails and documentation as well as detailed witness statements and cross-examination. They had maintained a good email and document record trail. They did not shy away from defending their decisions and actions.
Directors make decisions in the context of the facts as they appear at the time:
- A director will only be in breach if the court is satisfied that no reasonably diligent director could have acted in the way in which the particular defendant did act. The decision complained of must go beyond making a mere error of commercial judgment.
- Mere risk taking is not negligence because risk taking is part of business activity.
- They should not be judged on the basis of hindsight.
Having a strategy
It helps to set a strategy and seek to follow it instead of reacting day by day.
- Once a strategy is set, the directors are not expected to change it daily or at short notice unless there is an obvious need for an emergency response.
- There is no need to carry out daily analyses and meetings in response to every event, provided the substance of the issues has at some point been considered and addressed by an in-depth, robust, thorough and searching discussion such as is to be expected at a board meeting, ending with adopting a medium-term strategy.
- It is then a question of looking at trends and whether they show significant changes requiring immediate action. If not and the situation is just unclear, it can be reasonable to expect a continuation of events rather than some sudden failure which requires emergency action.
Was loss was caused by any breach?
The fact a loss had been suffered is not of itself evidence of negligence. The court queried whether there was anything that could have been done to sell at the last minute and concluded that the cause of the company’s collapse was the unforeseen systemic liquidity crisis among the banks; so the plaintiffs had not proved that the decisions taken in fact caused any financial loss to the company.
Smoking guns sometimes fire duds
- Unhelpful comments in emails such as “ignored the canaries in the coal mine for too long, we should have done a more substantial fix last fall” were explained as being extravagant comments made to connected parties for PR purposes or as unconsidered comments.
- Alleged misleading statements in the company’s reporting documents could be disregarded for these purposes as they had no causative effect on the losses.
- Criticism of some of the detail of the information provided to the board being inaccurate in places did not go anywhere because it could not be shown that, if accurate, it would have affected the ultimate decision being taken, which was between the hold or the sell course. Suggesting it would was mere speculation.
Directors with skin in the game
Directors investing their own monies in the company supported the case that they believed it would survive and not become insolvent.
The defence did derive some small support from the attitude of a top-4 audit firm at and before the board meetings and the signing off on the annual report, in all of which they had expressed no qualms about the company’s position as a going concern or the good sense of continuing the hold strategy.
A lack of meetings may be evidence from which it can be inferred that directors did not give sufficient regard to the affairs of the company, but the court held there was no rule requiring directors to hold more than quarterly meetings: there could be emails and phone calls instead. Meetings are a tool to be deployed appropriately but were not the only way to manage the process
It was noted that, in times of crisis, holding meetings can be a diversion and more in the personal interests of directors to protect themselves than in the best interests of the company.
Concise board minutes
In relation to board minutes, the court held that the only legal requirement was for “the proceedings” to be recorded. The court concluded: “When the possibility of later recriminations or investigations by outsiders is considered, the laconic style of minute taking, leaving no hostage to fortune, may reasonably appear to be preferable.”
In making multiple amendments to the board minutes, the court commented that the directors could accept the guidance of their lawyers as to what is necessary, correct or appropriate to include when amending minutes.
Investment guidelines are not absolute
Allegations that investment guidelines were not being reinstated or board meetings being held were viewed by the court as absurdly unreal because the guidelines had been overtaken by events and were no longer necessary or appropriate. The only decision was whether to hold or sell.
The court felt the claimants should limit their claims to the core ones. Pleading additional claims and allegations did not help if:
- they were repetitive and/or used exaggerated language
- they were allegations which had no effect on the key matters alleged to have caused the loss
- they confused concepts of honesty and competence: this could lead to unduly restricted and flawed analysis. Fiduciary duties are concerned with concepts of honesty and loyalty not with competence; duty of care is concerned with competence. There is a bright line between competence and honesty/loyalty.
There is everything to be gained by ensuring an effective email record of decision making is kept and maintained, and that clearly helped in establishing honesty and the success of the defences.