Simon Graham, a consultant in Wragge & Co's Corporate, Banking & Finance group, investigates two systems of corporate governance and what happens when the two come into contact. Solicitors Journal published a version of this article in June 2010.
Several company law cases and controversies illustrate that Anglo-American corporate governance is, if not a myth exactly ('Beyond the myth of Anglo-American corporate governance', ICAEW, 2005), then a fallacy. More than one US court has illuminated a series of stark differences between respective directors' duties of care. Simon Graham, a consultant in Wragge & Co's Corporate, Banking & Finance group, investigates two systems of corporate governance and what happens when the two come into contact. Solicitors Journal published a version of this article in June 2010.
Several company law cases and controversies illustrate that Anglo-American corporate governance is, if not a myth exactly ('Beyond the myth of Anglo-American corporate governance', ICAEW, 2005), then a fallacy. More than one US court has illuminated a series of stark differences between respective directors' duties of care.
Even the director's duty of loyalty is delineated so differently as to render perfectly loyal behaviour over there disloyal here (compare O'Donnell v Shanahan and another [2009] EWCA Civ 751 with the still seminal Guth v. Loft, Inc., 23 Del. Ch. 255, 5 A.2d 503 (1939)).
Kraft's unsolicited tender offer (hostile bid) for Cadbury PLC exposed a large array of corporate Americana, from the spectre of poison pills and anti-takeover statutes to statutorily-permissible caps on the liability of directors and an alternative approach to shareholder rights. (Pre-emption rights anyone?)
Even in the context of Anglo-American extradition arrangements, where one might expect not so much convergence as reciprocity, one comes away disappointed.
This update addresses three topics of importance to company officers (as used in the UK so as to encompass directors and auditors): the director's duty of care; ex turpi causa; and extradition.
By way of prefatory note it is of course simplistic to refer to American law. Corporations in the US are governed first and foremost at the state level. Federal law (including SEC rules) and stock exchange requirements provide additional layers of protection.
This update focuses on the position in Delaware, the state which the majority of incorporators of would-be public corporations continue to find the most accommodating.
There nevertheless remain observable national variations. Practising corporate lawyers know this to be the case in contexts from board governance (our corporate governance code v. their Sarbanes-Oxley) to takeover regulation (observe how we deal with City Code violators).
From directors' duties (which in Delaware at least are uncodified and are owed to a corporation and its stockholders) to immunity from liability (directors of Delaware corporations can expect to be immunised from liability even for gross negligence).
And this is not to mention long-standing cultural differences in the sphere of litigation, including US-style class actions, the use of obstructive lawsuits in US takeover practice and "the English rule" on cost-shifting in civil cases.
All references below to the Supreme Court are to America's highest judicial body, not that in the UK.
The director's duty of care, and in particular oversight English common law in this area, such as it is, now takes its lead from Re Barings No 5 [1999] 1 BCLC 433 (affirmed on appeal).
In this directors' disqualification case, Jonathan Parker J derived from a basket of ten cases, half of them American, the following propositions:
i.directors have a duty to maintain a sufficient knowledge of their company's business to enable them to discharge their duties; and ii.even where directors may delegate functions, they are not absolved thereby from a duty to supervise. Admittedly two of the US cases cited by Parker J - Martin v Webb, 110 U.S. 7, 15, 28 L. Ed. 49, 3 S. Ct. 428 and Briggs v. Spaulding, 141 U.S. 132, 35 L. Ed. 662, 11 S. Ct. 924 - were nineteenth century Supreme Court decisions which had effectively been overruled 60 years before. But the others were of more recent vintage (well, 1907, 1938 and 1993) from all over the map (well, Arkansas, Kentucky and Indiana).
It is the courts of Delaware in the last 15 years or so that have done most to articulate a directorial duty of oversight: e.g. In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del Ch. 1996).
In a conventional Caremark claim - Caremark, as the name suggests, was a healthcare company whereas the US cases referred to in the preceding paragraph all concerned banks - plaintiffs argue that directors are liable because they failed properly to monitor or oversee employee misconduct or violations of law.
To prevail plaintiffs must show not gross negligence on a director's part - the normal hurdle in that state - but scienter (bad faith). Suffice to say that the plaintiff in such a case typically does not prevail.
In the wake, if that is the correct expression, of the financial crisis plaintiffs sought to recover at least some of their losses by means of variations on the Caremark theme. An early and, significantly, unsuccessful example was a derivative action brought against directors and officers of Citigroup Inc.
The board had failed, it was alleged, to monitor Citigroup's increasing exposure to the subprime mortgage market. The claim was dismissed on the basis it amounted to an attempt to hold Citigroup's directors liable for making (or allowing to be made) business decisions that turned out poorly.
This type of lawsuit represents the very mischief at which Delaware's business judgment rule is aimed: In re Citigroup Inc. S'holder Deriv. Litig., 964 A.2d 106, 125 (Del. Ch. 2009).
Two claims subsequently brought in New York similarly failed, as did derivative actions brought in that state against directors and officers of Goldman Sachs (alleged failure to monitor business risk associated with auction-rate securities) and AIG (alleged failure to oversee the company's credit default swaps).
Were a Caremark claim to come before a court here, the starting point, as of 1 October 2007, would be whether the directors in question discharged their statutory duty to exercise reasonable care, skill and diligence.
Attribution and ex turpi causa There are several reasons why the split decision of the House of Lords in Stone & Rolls Ltd (in liq) v Moore Stephens [2009] UKHL 39 remains noteworthy (see Vol 154 no 5 09-02-2010). One is that, in considering whether to attribute a director's criminal acts and intentions to his company, Lord Walker and to a lesser extent Lord Brown chose to follow what is in some US states called the "sole actor exception".
Say that the rule in a given state, by way of exception to the normal rule on attribution, is that X's conduct will not be imputed to the corporation if the interests of X are adverse to those of the corporation and not for its benefit. The effect of the sole actor exception is to revert to the norm where X is the corporation's only representative.
Thus was Zvonko Stojevic's fraudulent conduct attributed to Stone & Rolls, leading to the conclusion that the company's claim against its auditors was founded on the company's own fraud and so defeated by ex turpi causa (the public policy defence to the effect that one cannot recover compensation for losses suffered in consequence of one's own criminal act).
But if a company can be so associated with its fraudulent CEO as to be precluded from suing its auditors, what is to stop the company (or its liquidator) being likewise precluded from suing the CEO? Surely ex turpi causa will not avail the fraudster?
American attorneys can point to decisions of Delaware's Court of Chancery in cases concerning AIG and, a few scandals back, HealthSouth in support of the argument that its preferred formulation of ex turpi causa - in pari delicto - will not allow insiders, vis-à-vis their corporations, to avoid the consequences of their own handiwork.
At least part of the rationale on this side of the pond appears to be that ex turpi causa does not apply where a company's liability is vicarious or arises under normal agency principles: Safeway Stores Ltd & Ors v Twigger & Ors [2010] EWHC 11 (Comm); Soods v Dormer and another [2010] EWHC 502 (QB). Contrast the responsibility of Stone & Rolls for Stojevic's wrongdoing, which was primary or direct.
Two jurisdictions face-to-face American courts have dismissed derivative lawsuits brought against directors of English public companies in three recent cases.
On the first two occasions the courts in question, applying the laws of New York and the District of Columbia respectively, held that:
i.the (pre-Companies Act 2006) laws of England and Wales applied to the substantive claims; and ii.on the facts derivative actions were prohibited: see In re BP, PLC Derivative Litig., 507 F. Supp. 2d 302, 308-09 & n.19 (S.D.N.Y. 2007) and City of Harper Woods Employees' Retirement Sys. v. Olver, 577 F. Supp. 2d 124, 128 (D.D.C. 2008), affirmed on appeal (concerning BAE Systems PLC). The third concerned Cadbury PLC. During the Kraft saga, a derivative suit was levelled at the target's directors alleging breach of various duties arising from their "refusal to negotiate" with Kraft and the publication of an "inadequate stockholder circular": Steward Int'l Enhanced Index Fund v. Carr, No. 09 Civ. 5006, 2010 WL 336276 (D.N.J. Jan. 22, 2010). Citing among other things differences between our nations' corporate laws, Judge Cavanaugh granted a motion to dismiss on grounds of forum non conveniens.
It is in part a function of the special relationship between England and America that the extradition process has worked so distressingly in the case of Ian Norris, former CEO of Morgan Crucible PLC. After years spent fighting attempts to extradite him, on the grounds initially of price-fixing and then of criminal cover-up, Mr Norris was reported to have been handed over to US Marshals on 23 March 2010 at Heathrow Airport.
On the morning of March 24 he entered the James A Byrne US District Courthouse in Philadelphia. At my request a clerk dug out the criminal docket for Case # 2:03-cr-00632-ER-1: the 03 stands for 2003. "He's been on the run that long?" the clerk asked, rhetorically, while scanning the pending counts: conspiracy to defraud the US, antitrust violations, intimidation or force against a witness (under specialty, or speciality, principles Mr Norris will not face trial on the antitrust violations).
To US eyes, then, Norris was just another fugitive from justice. To many in the UK he is the presumably innocent victim of an extradition system that was for a long time and they argue still is lop-sided at the national level and unfair to the individual.
Prior to his extradition no prima facie case had been, or needed to be, established against Norris. On agreeing to travel restrictions and - in a distinctly American touch - to refrain from obtaining firearms, Norris was released on $1 million bail, secured by posting $200,000 cash.
Interestingly, the new UK coalition government proposes to review the current US/UK extradition treaty to ensure it is "even-handed". In the meantime Ian Norris remains under house arrest in Washington DC, awaiting trial. Even the director's duty of loyalty is delineated so differently as to render perfectly loyal behaviour over there disloyal here (compare O'Donnell v Shanahan and another [2009] EWCA Civ 751 with the still seminal Guth v. Loft, Inc., 23 Del. Ch. 255, 5 A.2d 503 (1939)).
Kraft's unsolicited tender offer (hostile bid) for Cadbury PLC exposed a large array of corporate Americana, from the spectre of poison pills and anti-takeover statutes to statutorily-permissible caps on the liability of directors and an alternative approach to shareholder rights. (Pre-emption rights anyone?)
Even in the context of Anglo-American extradition arrangements, where one might expect not so much convergence as reciprocity, one comes away disappointed.
This update addresses three topics of importance to company officers (as used in the UK so as to encompass directors and auditors): the director's duty of care; ex turpi causa; and extradition.
By way of prefatory note it is of course simplistic to refer to American law. Corporations in the US are governed first and foremost at the state level. Federal law (including SEC rules) and stock exchange requirements provide additional layers of protection.
This update focuses on the position in Delaware, the state which the majority of incorporators of would-be public corporations continue to find the most accommodating.
There nevertheless remain observable national variations. Practising corporate lawyers know this to be the case in contexts from board governance (our corporate governance code v. their Sarbanes-Oxley) to takeover regulation (observe how we deal with City Code violators).
From directors' duties (which in Delaware at least are uncodified and are owed to a corporation and its stockholders) to immunity from liability (directors of Delaware corporations can expect to be immunised from liability even for gross negligence).
And this is not to mention long-standing cultural differences in the sphere of litigation, including US-style class actions, the use of obstructive lawsuits in US takeover practice and "the English rule" on cost-shifting in civil cases.
All references below to the Supreme Court are to America's highest judicial body, not that in the UK.
The director's duty of care, and in particular oversight
English common law in this area, such as it is, now takes its lead from Re Barings No 5 [1999] 1 BCLC 433 (affirmed on appeal).
In this directors' disqualification case, Jonathan Parker J derived from a basket of ten cases, half of them American, the following propositions:
- directors have a duty to maintain a sufficient knowledge of their company's business to enable them to discharge their duties; and
- even where directors may delegate functions, they are not absolved thereby from a duty to supervise. Admittedly two of the US cases cited by Parker J - Martin v Webb, 110 U.S. 7, 15, 28 L. Ed. 49, 3 S. Ct. 428 and Briggs v. Spaulding, 141 U.S. 132, 35 L. Ed. 662, 11 S. Ct. 924 - were nineteenth century Supreme Court decisions which had effectively been overruled 60 years before. But the others were of more recent vintage (well, 1907, 1938 and 1993) from all over the map (well, Arkansas, Kentucky and Indiana).
It is the courts of Delaware in the last 15 years or so that have done most to articulate a directorial duty of oversight: e.g. In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del Ch. 1996).
In a conventional Caremark claim - Caremark, as the name suggests, was a healthcare company whereas the US cases referred to in the preceding paragraph all concerned banks - plaintiffs argue that directors are liable because they failed properly to monitor or oversee employee misconduct or violations of law.
To prevail plaintiffs must show not gross negligence on a director's part - the normal hurdle in that state - but scienter (bad faith). Suffice to say that the plaintiff in such a case typically does not prevail.
In the wake, if that is the correct expression, of the financial crisis plaintiffs sought to recover at least some of their losses by means of variations on the Caremark theme. An early and, significantly, unsuccessful example was a derivative action brought against directors and officers of Citigroup Inc.
The board had failed, it was alleged, to monitor Citigroup's increasing exposure to the subprime mortgage market. The claim was dismissed on the basis it amounted to an attempt to hold Citigroup's directors liable for making (or allowing to be made) business decisions that turned out poorly.
This type of lawsuit represents the very mischief at which Delaware's business judgment rule is aimed: In re Citigroup Inc. S'holder Deriv. Litig., 964 A.2d 106, 125 (Del. Ch. 2009).
Two claims subsequently brought in New York similarly failed, as did derivative actions brought in that state against directors and officers of Goldman Sachs (alleged failure to monitor business risk associated with auction-rate securities) and AIG (alleged failure to oversee the company's credit default swaps).
Were a Caremark claim to come before a court here, the starting point, as of 1 October 2007, would be whether the directors in question discharged their statutory duty to exercise reasonable care, skill and diligence.
Attribution and ex turpi causa
There are several reasons why the split decision of the House of Lords in Stone & Rolls Ltd (in liq) v Moore Stephens [2009] UKHL 39 remains noteworthy (see Vol 154 no 5 09-02-2010). One is that, in considering whether to attribute a director's criminal acts and intentions to his company, Lord Walker and to a lesser extent Lord Brown chose to follow what is in some US states called the "sole actor exception".
Say that the rule in a given state, by way of exception to the normal rule on attribution, is that X's conduct will not be imputed to the corporation if the interests of X are adverse to those of the corporation and not for its benefit. The effect of the sole actor exception is to revert to the norm where X is the corporation's only representative.
Thus was Zvonko Stojevic's fraudulent conduct attributed to Stone & Rolls, leading to the conclusion that the company's claim against its auditors was founded on the company's own fraud and so defeated by ex turpi causa (the public policy defence to the effect that one cannot recover compensation for losses suffered in consequence of one's own criminal act).
But if a company can be so associated with its fraudulent CEO as to be precluded from suing its auditors, what is to stop the company (or its liquidator) being likewise precluded from suing the CEO? Surely ex turpi causa will not avail the fraudster?
American attorneys can point to decisions of Delaware's Court of Chancery in cases concerning AIG and, a few scandals back, HealthSouth in support of the argument that its preferred formulation of ex turpi causa - in pari delicto - will not allow insiders, vis-à-vis their corporations, to avoid the consequences of their own handiwork.
At least part of the rationale on this side of the pond appears to be that ex turpi causa does not apply where a company's liability is vicarious or arises under normal agency principles: Safeway Stores Ltd & Ors v Twigger & Ors [2010] EWHC 11 (Comm); Soods v Dormer and another [2010] EWHC 502 (QB). Contrast the responsibility of Stone & Rolls for Stojevic's wrongdoing, which was primary or direct.
Two jurisdictions face-to-face
American courts have dismissed derivative lawsuits brought against directors of English public companies in three recent cases.
On the first two occasions the courts in question, applying the laws of New York and the District of Columbia respectively, held that:
- the (pre-Companies Act 2006) laws of England and Wales applied to the substantive claims; and
- on the facts derivative actions were prohibited: see In re BP, PLC Derivative Litig., 507 F. Supp. 2d 302, 308-09 & n.19 (S.D.N.Y. 2007) and City of Harper Woods Employees' Retirement Sys. v. Olver, 577 F. Supp. 2d 124, 128 (D.D.C. 2008), affirmed on appeal (concerning BAE Systems PLC).
The third concerned Cadbury PLC. During the Kraft saga, a derivative suit was levelled at the target's directors alleging breach of various duties arising from their "refusal to negotiate" with Kraft and the publication of an "inadequate stockholder circular": Steward Int'l Enhanced Index Fund v. Carr, No. 09 Civ. 5006, 2010 WL 336276 (D.N.J. Jan. 22, 2010). Citing among other things differences between our nations' corporate laws, Judge Cavanaugh granted a motion to dismiss on grounds of forum non conveniens.
It is in part a function of the special relationship between England and America that the extradition process has worked so distressingly in the case of Ian Norris, former CEO of Morgan Crucible PLC. After years spent fighting attempts to extradite him, on the grounds initially of price-fixing and then of criminal cover-up, Mr Norris was reported to have been handed over to US Marshals on 23 March 2010 at Heathrow Airport.
On the morning of March 24 he entered the James A Byrne US District Courthouse in Philadelphia. At my request a clerk dug out the criminal docket for Case # 2:03-cr-00632-ER-1: the 03 stands for 2003. "He's been on the run that long?" the clerk asked, rhetorically, while scanning the pending counts: conspiracy to defraud the US, antitrust violations, intimidation or force against a witness (under specialty, or speciality, principles Mr Norris will not face trial on the antitrust violations).
To US eyes, then, Norris was just another fugitive from justice. To many in the UK he is the presumably innocent victim of an extradition system that was for a long time and they argue still is lop-sided at the national level and unfair to the individual.
Prior to his extradition no prima facie case had been, or needed to be, established against Norris. On agreeing to travel restrictions and - in a distinctly American touch - to refrain from obtaining firearms, Norris was released on $1 million bail, secured by posting $200,000 cash.
Interestingly, the new UK coalition government proposes to review the current US/UK extradition treaty to ensure it is "even-handed". In the meantime Ian Norris remains under house arrest in Washington DC, awaiting trial.
