By: Jared Ormsby
Published: 28/01/2013
Recent litigation surrounding collapsed finance companies has brought into question the legal standard of the care, diligence, and skill expected of company directors.  In particular the cases have grappled is the extent to which specialisation within a board of directors is permitted. 

There has been a trilogy of recent cases in which the Financial Markets Authority has brought criminal proceedings against the directors of failed finance companies under section 58 of the Securities Act 1978.1
  The cases involved instances where the company has published a prospectus or advertisement which was found to be untrue.  In each case, some of the defendants attempted to argue that they had a limited role on the boards of directors thus supporting a defence that it was reasonable to believe the statements were true.  Although these cases concern directors' duties as they exist in the context of a finance company, the principles arising from the judgments can be applied to all manner of companies.

Specialisation of directors

Section 128 of the Companies Act defines the role of the board of directors as having primary responsibility for the management of the company's business and affairs.  If a company's business and affairs are complex, it is desirable for the board to be staffed with personnel competent to manage the company.  Large companies, particularly finance companies, can employ many directors each with different skills and experience.  The tendency is then for different directors to exercise different responsibilities within the board.

The downside to specialisation is that, when the management of the company is challenged in legal proceedings, the cases do not appear to lend much support for the defence that "it was not my job to be involved in that side of the company's affairs".

Cases and principles

When examining the standard of care expected of company directors, recent cases take as their starting point the comments of Miller J in Davidson v Registrar of Companies2.  His Honour stated that the standard of care required of a director depends on his or her position and responsibilities, but the standard cannot be removed from the nature of the company and the particular decision being made.  Miller J cited section 137 of the Companies Act 1993, which provides:

A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation,—
(a)The nature of the company; and
(b)The nature of the decision; and
(c)The position of the director and the nature of the responsibilities undertaken by him or her.
 
His Honour expounded this provision as:

A director must understand the fundamentals of the business, monitor performance and review financial statements regularly.  It follows that a degree of financial literacy is required of any director of a finance company.  Without it, Mr Davidson could scarcely understand the business, let alone contribute to policy decisions affecting risk management and monitor the company’s performance, yet his presence and reputation might encourage investors to believe that the group was well managed.  Nor could he delegate performance monitoring to other directors, especially when he was one of only two who were independent.
 
Miller J's comments tend to the conclusion that specialisation within a board of directors is not permitted if, by so doing, a director fails to understand the fundamentals of the company's business to the point where he or she cannot contribute to important policy decisions. 
 
In R v Moses the defendant directors sought to argue that they had differing functions within the company, particularly in terms of executive and non-executive directors.  Heath J responded to this argument by saying:
 
As a matter of law, no distinction is drawn between the roles performed in the boardroom by directors, whether labelled executive or non-executive.  Every director is required to act in good faith, in what he or she believes to be the best interests of the company and to exercise the “care, diligence, and skill that a reasonable director would exercise in the same circumstances.”  Use of the term “reasonable director” does not suggest different types of directors but is consistent with each having particular responsibilities within the board structure.”
 
Heath J concluded that every director's duty is to ensure that he or she has enough information on which to make an informed decision regarding the company's affairs.  Once in receipt of that information, his Honour added that the director must have the ability to read and understand the financial information.

The decision in R v Petricevic may be seen as more supportive of the role of a specialised director.  Several of the directors advanced arguments that they were non-executive directors and therefore had reasonable grounds for a belief that the statements were true.  For Mr Petricevic it was argued that, as a non-executive director, he was not competent to construct financial statements.  Instead he had a practice of relying on the company’s other directors and accountants and asking them whether there were other matters he should have been aware of when signing off documents.

Venning J held that Mr Petricevic was entitled to look to the other directors (who were a finance director, a commercial lawyer and an independent chair) for expertise in certain areas.  That did not, however, absolve him from the obligation to make his own inquiries if he was put on notice.  Venning J held that the documents Mr Petricevic had viewed had put him on notice as it was plain from the documents that the company’s financial position was not sound.

Lessons to be learned

The cases reiterate the need for all directors of a company to be able to monitor the company's financial health.  It is not simply enough for a director to assert he or she was not an expert in a particular area of the company's business, or that he or she relied on fellow-directors when making decisions.  It is imperative that directors ensure they are supplied regularly and comprehensively with the necessary information on which to make informed decisions about the company's risks.  If the director cannot understand that information, or make informed decisions from it, he or she has no place on the board.

1 [2011] 1 NZLR 542 at [121].
2
R v Moses HC Auckland CRI-2009-004-1388, 8 July 2011.; R v Petricevic [2012] NZHC 665.; R v Graham [2012] NZHC 265.

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