Role of Non-Executive Directors- An Analysis

There is a vibrant body of non-executive directors in the majority of the leading Australian companies. However, these directors did not take their roles as seriously and they are just dancing the tune of the chairman cum managing director or powerful group of directors of the company. A non-executive director is not involved in the day-to-day management of the company. The best example is the disintegration of the State Bank of South Australia which offers a recent illustration of a mainly non-executive board that failed to make management more accountable.

The first factor is that whether a non-executive director if he is a shareholder or erstwhile employee or creditor of the company, he may not act in an independent manner. The National Safety Council of Australia Victoria Division has filed for bankruptcy due to large-scale fraud committed by its chief executive officer. A creditor filed a case against the directors and one non-executive director was ordered to pay about $ 97 million and this decision was considered to be a pivotal judicial verdict on the responsibilities of care owned by non-executive directors.

In AWA Ltd v Daniels, the company incurred financial losses of $ 49 millions from some foreign exchange transactions. The reason for loss was due failure to establish of some adequate internal controls and accounting systems, especially for forex transactions. The company initiated legal proceedings against the auditor for negligence and breach of duty. The auditor contended that three non-executive directors and CEO had been contributorily negligent. In this case, the court made the following observations:

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• Non-executive directors are expected to show a degree of care and cannot demonstrate “lack of knowledge” as a defense as laid down in Francis v United Jersey Bank.
• If the director does not have any required business knowledge, he should try to acquire the same else he should refuse to act as a director.
• It is the duty of care imposed on a director to know about the activities of the company and after observing its performance, they should be in a position to monitor the management of the company.
• The duty of care also includes the knowledge about the activity of the business, how it is being administered, and making sure that the board has available means to audit the management of the company.
• Such review will help to find out any illegal course of activity in the company and in such case, he has an obligation to object and if the corporation does not mend its ways, he should resign.
• Director position is a special position and it requires a reasonable standard of care.

Due to the multiplicity of insolvency cases, the decision held in AWA Ltd v Daniels suggested that directors must have proficiency that permit them to understand not only company accounts but also to assess them. Rogers CJ, in this case, viewed that non-executive directors' duty was subjective in nature and permitted them to entrust their obligations to management. However, in a subsequent appeal, in Daniels v Anderson, it was held that an objective standard of care was applicable to both executive and non-executive directors.

The views observed in Daniels v Anderson that the duty of care obliges an objective standard of care by non-executive directors were later approved in South Australia v Marcus Clark and also in ASIC v Adler. In this case, Adler was a non-executive director of HIH Insurance Ltd. On the request of Adler, $10 million was transferred by HIHC a subsidiary of HIH to PEE which was controlled by Adler. Adler used these funds to purchase the shares of HIH mainly to support the share price of HIH’s share for the benefit of his major personal shareholding in the company.

Later, Adler sold HIH shares and incurred about $ 2. 1 million loss. ASIC initiated legal proceedings against Adler and other directors of the company for breaches under s. 260A. Adler claimed that financial assistance did not harm the interest of the shareholders, company or its ability to settle its creditors within. It was held in the lower court and confirmed in appeal that s. 260 A had been infringed and Adler and others were involved in such infringement.

In Duke Group Ltd ( in liquidation) v. Pilmer & Ors (1998), Mullighan J viewed that non-executive director involved in breach of duty by not familiarizing themselves with the business of the company and in relying upon the executive director that company was earning profits when it running in a loss in reality. The failure on the part of non-executive directors to owe a duty of care was an infringement of their director’s duties. (Baxt & Lacy, 2005, p. 96).

In Australia, the insolvent trading provision has attracted wide attention due to the flooding of cases in which non-executive directors were held accountable despite of the fact that never actively engaged in the management of the company. In Morley v Statewide Tobacco Services Ltd (1992), the court held that a non-executive director (managing director’s mother) ought to pay $ 165, 500 against the corporate debt owed by her son, the managing director of the company.

In this case, Go-Carts was explained as a newly registered company, and Earl became its managing director in April 2006. In December 2007, the liquidator was appointed on the assumption that the company filed a bankruptcy petition. The liquidator reported a probable shortage of funds of over $ 3 million. The liquidator in his report alleged the following: A loss of $ 1 million due to investment in an estate in France.

A loss of $ 800,000 due to improper purchases. There is a loss of $ 130,000 due to the diversion of funds to Earl’s company Shrewd Advisors Ltd.

Misappropriation of funds of $ 1 million by Earl to finance his extravagant lifestyle. The problem also states that Elisabeth Deal, Eleanor Arnold and Enid Patton were the directors of the company during the period 2003-2004. There is a contradiction that how these persons can be acting as directors of the company in 2004 while the Go-Carts was explained as a newly registered company and Earl became its managing director during April 2006.

Findings and Conclusions

However assuming that the above were acted directors in 2006 also, the following conclusions can arrive.

Though Elisabeth Deal, Enid Patton conceived that their role to be of non-executive directors concerning planning and policy-making and there is no evidence of default or willful neglect on the part of these non-executive directors, the liquidator under the insolvent trading provision can initiate legal proceedings against them though they never actively engaged in the management of the company as laid down in Morley v Statewide Tobacco Services Ltd (1992).

Both Elisabeth Deal and Enid Patton will be held responsible as per principles laid down in Daniels v Anderson, where it was held that an objective standard of care as applicable to both executive and non-executive directors. In Duke Group Ltd ( in liquidation) v. Pilmer & Ors (1998), Mullighan J viewed that non-executive director involved in breach of duty by not familiarizing themselves with the business of the company and in relying upon the executive director that company was earning profits when it actually running in a loss in reality.

Under this principle, both the non-executive directors namely Elisabeth Deal and Enid Patton will be held responsible.

Eleanor Arnold may be exonerated by the Court due to his indisposition and due to his absence. However, he should have submitted his resignation from the directorship. It is prudent to submit resignation from directorship in such scenarios else he may also hold responsible as non-executive directors are expected to show a degree of care and cannot demonstrate “lack of knowledge” as a defense as laid down in Francis v United Jersey Bank and in the case AWA Ltd v Daniels.

References

1. Adams Michael and Barker David. (2005).
2. Australian Essential Corporate Law 2/e. Australia: Routledge.
3. Baxt Robert & Lacy Anne De. (2005).
4. Duties and Responsibilities of Directors and Officers. Australia: AICD.
5. Bosch Henry. (1995). The director at risk: accountability in the boardroom. Allen & Unwin. Australia: AICD.
6. Cassidy Julie. (2006).
7. Concise Corporations Law. Australia

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