Past Case, Present Lessons: Essential Insights for NEDs

Handling sensitive Directors & Officers (D&O) claims daily, we witness where things go wrong for Non-Executive Directors (NEDs). However, it is rare to find case law that is directly applicable to NEDs from which we can extract valuable learnings. This makes the Secretary of State for Business Energy and Industrial Strategy v Selby, Al Sayed, Awan and Bamford [2021] EWHC 3261 (Ch) decision noteworthy. It serves as a reminder of the standards to which NEDs are held, highlighting the importance of accountability and vigilance.

Case overview

The company’s three executive directors implicated it in a Missing Trader Intracommunity Fraud (MTIC), leading to over £4m in debts, and liquidation. Mr Bamford, the sole NED, was disqualified despite not being aware of or involved in the fraud.

The executives had previously served time in prison and although Mr Bamford knew this, he did not conduct further due diligence. Even when HMRC raised questions, he did not investigate the alleged fraudulent activities.

The court disqualified the executive directors for between 11 and 14 years. Mr Bamford was disqualified for four years due to his “abdication of responsibility” as he failed to conduct adequate due diligence and properly investigate significant changes in the company’s management accounts, which could have revealed the fraud. He appeared to be heavily reliant on the executives’ word that there was no fraud.

Key learnings for NEDs

This case offers a sharp lesson about the practical application of directors’ duties. While directors are entitled to delegate tasks, the court emphasised that “proper delegation does not involve abdication” and that “reliance must in the particular circumstances be consistent with the discharge of reasonable skill and care.” Although NEDs are not involved in the day-to-day operations, they are still subject to the same duties as executive directors.

The case also confirmed that, while the duties may be the same, their application can differ. The Judge referred to s.174 of the Companies Act 2006 which mandates that directors exercise reasonable care, skill and diligence. This duty is both objective and subjective, taking into account the director’s role within the company. The extent of this duty depends on the organisation of the company’s business and the director’s expected role within it.

What should NEDs do?

Clarify and document your role: To mitigate uncertainty regarding your role and the duties you are expected to perform, ensure that it is formalised in written terms of engagement, so you and the company are clear about your specific responsibilities. When in doubt, seek clarity on your duties and the company’s expectations of you.

Exercise diligence: Take actions and make decisions with appropriate care, skill and due diligence; Mr Bamford’s failure to investigate significant financial changes was a critical failing.

Engage actively: Regularly participate in board meetings and strategic discussions to keep informed about the company’s activities and financial health. Mr Bamford’s lack of engagement was a key factor in his disqualification.

Document decisions: Keep detailed records of your involvement in decision-making, demonstrating that you have met the standard of care required. This can protect you in case of legal scrutiny or investigation.

Where is the protection?

Mr Bamford found himself in a difficult position with the executives and the company, which is not uncommon for NEDs. Personal assets and professional reputation are at risk, making it crucial to understand how to engage with the company and D&O insurance for full protection. NEDs may encounter the following challenges:

• Conflicts of interest/refusal to indemnify: NEDs can face conflicts with executives implicated in wrongdoing, leading to a refusal to indemnify, especially if the company faces insolvency. Executives may also limit access to the D&O policy, prejudicing a NED’s rights.
• Coverage gaps: In large or protracted claims, policy limits might be exhausted by claims against the company or executives, leaving insufficient coverage for NEDs. Policy exclusions may also apply, leaving NEDs exposed.
• Policy management: If the policy lapses or is not renewed, NEDs may find themselves without coverage.

Mitigating these challenges

Indemnification Agreement: Obtain a robust agreement with the company to cover losses arising from the appointment, where legally permissible, clearly outlining terms and conditions.

Engage with D&O insurance: Review the policy annually with professional advice. Understand coverage details including limits, exclusions, and notification requirements. Know the contact point for seeking coverage.

Consider specialised insurance: Consider products like NED Protect by Rising Edge (https://www.risingedge.co/ned-protect), providing ring-fenced, standalone coverage for NEDs, covering multiple appointments, and situations where the company/D&O insurers refuse to pay.

Regular communication: Discuss the D&O policy and indemnification with appropriate company contacts to ensure alignment and understanding of coverage and policy activation.