The recent English Court of Appeal decision in Lexi Holdings PLC v Luqman & Ors  EWCA Civ 117 is a timely reminder of the duties which non-executive directors (“NEDs”) owe to the companies on whose boards they sit.
In particular, the case highlights the difficulties that NEDs have in arguing what has become known in legal circles as the “Shaggy Defence1” when a company fails. In this case, arguing “it wasn’t me” or “it wasn’t my fault”, because the NEDs were manipulated by the executive director (who proceeded to misappropriate large amounts of the company’s money), did not find favour with the English Court of Appeal. Nor do we expect that such arguments would find favour in a Guernsey court in similar cases either.
The facts of the case are unusual. To cut a long (and complicated) story short, the material facts are as follows:
- Lexi Holdings PLC (the “Company”) was incorporated in September 2000. The Company was in the business of providing bridging finance to people looking to buy property.
- From June 2001, Shaid Luqman (“S”) was the managing director. His sister, Zaurian Luqman (“Z”), was the controlling shareholder and was also a director. If the case were a pantomime, S would be the villain of the piece– he was described in the High Court as being “a persuasive, sophisticated, charming and highly intelligent liar”. In October 2003, S and Z were joined as directors by another of S’s sisters, Monuza Luqman (“M”). Both Z and M were non-executive directors. Two other non-family member directors were also appointed and resigned as directors at various times.
- The Company was provided with finance by Barclays, on behalf of a syndicate of banks. The syndicate provided revolving credit facilities of various amounts. The facilities increased from £2.5m in November 2001, up to £120m in July 2005.
- Between 7 October 2002 and 15 November 2006, approximately £59.6m of the Company’s money was misappropriated by S. The Company went into administration in October 2006.
- S was sent to jail for contempt. However, it was not S’s first brush with the law. In 1993, he had been convicted on five counts of obtaining or attempting to obtain property by deception, and was sentenced to 21 months’ imprisonment. In 1997, S was again convicted of attempting to obtain property by deception and sentenced to two years’ imprisonment.
- In November 2006 the Company (acting through its administrators) sought to recover the money which S had misappropriated from various people, including from M and Z in their capacity of directors of the Company. The claim against M and Z rested on various arguments, the pivotal one being the claim that the losses were caused by M and Z’s failings as directors. In particular, it was claimed that they had been completely inactive in the management of the Company and that this inactivity represented a breach of the duties which they owed the Company as directors, meaning they should be held liable for all the funds misappropriated by S.
Decisions of the High Court and Court of Appeal
In the High Court, Mr Justice Briggs concluded that M and Z were only liable for some of the money which S had misappropriated, but not all of it. He found them liable for the money which S had paid directly to them, but went on to hold that M and Z were not liable for the remainder of the sums misappropriated by S. Mr Justice Briggs concluded that it was not M and Z’s inactivity as directors which had permitted these funds to have been misappropriated by S and therefore caused loss to the Company. He decided that, even if they had taken steps to discharge their duties as directors by, for example, asking questions about accounting entries which did not stand up to scrutiny or similar, they would “have been fobbed off by lies from S” and were not therefore in breach of duty and did not cause the loss.
The Company appealed.
The Court of Appeal approached the issues very differently. It took the view that S’s ability to deceive his fellow directors was not a factor which excused the conduct of those directors. The Court reviewed the facts and noted that M and Z had failed to make due enquiries into a number of matters, including the accounts. Had they made enquiries, the results of these would have shown that there was simply no plausible explanation for the accounts other than fraud. The Court of Appeal also noted that M and Z had failed to communicate the fact that their brother had previous convictions to the non-family directors of the Company, despite M and Z being aware of these convictions. They also failed to disclose these to the banks lending money to the Company and failed to supervise S despite this knowledge of his criminal record for fraud-type offences. Drawing all these facts together, the Court held that M and Z were in breach of their duties and that they should be found liable for the consequences. Orders were made against M and Z for payment of approximately £42m and £37m respectively.
What are the lessons for NEDs?
While this case might be viewed as involving extreme facts, some principles arise from it which are of general application – particularly in relation to NEDs (which M and Z were).
- The position of an NED is certainly not a “risk free” proposition. There are a number of duties pertaining to an NED. The consequences of failing to discharge those duties can be very serious.
- A proper degree of delegation and division of responsibility between members of a board of directors is allowed (and is often necessary). However, total abrogation of responsibility (as occurred in this case) is not – and the potential liability for abrogating one’s responsibility can be extremely costly.
- A board of directors should not allow any one individual to dominate nor should the directors allow themselves to be used by one individual. The message is clear: don’t be swayed by someone’s charisma. Exercise judgment and don’t just take everything on trust. It is no defence to play the “it wasn’t me!” card.
- NEDs are not employed or directly involved in the day-today operations of the business. This means that they are likely to have less access to information than executive directors and may as a result be less able to exert influence. However, lack of information is not a defence for failing to monitor the actions of other directors or scrutinising the accounts of the business and asking appropriate questions. It is worth noting that the Companies (Guernsey) Law, 2008 draws no distinction between executive and non-executive directors.
- NEDs’ obligations are particularly clear where they have special knowledge which should put them “on notice” of concerns regarding their fellow director(s). In this case, both M and Z were aware of S’s previous convictions but took no steps to ensure these were disclosed to the relevant persons. Similarly, they could reasonably have been expected to monitor S’s activities closely to ensure that fraud would not occur, knowing that he had prior convictions of this type.