In a decision which is likely to be persuasive in Australia, the English High Court has cleared the way for a life insurance company to sue some of its former non executive directors for up to £3.3 billion over a strategy they implemented between 1993 and 2000 to contain losses.
Although important in its own right, the decision also provides further food for thought about the substantial exposures that directors now face, including those non executive directors who may consider they play only minor roles in some decision making.
In Equitable Life Assurance Society v Bowley & Ors, the English High Court emphasised the importance of non executive directors seeking advice before making decisions that may affect policyholder/investor rights. It also ruled that directors who delegate authority are not absolved from supervisory responsibility and the need to exercise independent judgment.
When Equitable brought its action for negligence and breach of fiduciary duty, the non executive directors sought to have the case struck out. A matter may be struck out if the court considers that there are "no reasonable grounds for bringing the claim" or that the claimant "has no real prospect of succeeding on the claim" and "there is no other compelling reason why the case or issue should be disposed of at a trial".
In this case, the non executive directors also requested summary judgment which would have excused them from all liability and given them a company-provided indemnity against the cost of the proceedings. This application failed.
Equitable’s problems stemmed from many of its policyholders holding guaranteed annuity options which permitted them, on retirement, to choose to receive annuities at a guaranteed rate rather than the annuity rate prevailing at their date of retirement.
However, Equitable's guaranteed annuity rates were substantially higher than its returns. Hence, it was paying out significantly more than it was earning. The Board, which was well aware of this problem, resolved to stem the losses by adopting a differential terminal bonus policy. In 2002, the House of Lords ruled that this strategy was illegal, and the judgment exposed Equitable to additional liabilities of some £1.5bn. The claim now ranges between £0.8 billion to a maximum exposure of £3.3 billion.
Equitable is now suing the directors in negligence and breach of fiduciary duty for:
- initially having failed to take legal advice as to the validity of the differential terminal bonus policy, and
- after the problem was known and legal advice had been obtained, having failed to reduce bonuses or ensure that existing and prospective policyholders were fully aware of the potential costs.
Duties of non executive directors
There is a significant amount of case law concerning the duties that non executive directors have to their company. In Equitable Life, Justice Langley summarised that case law by quoting Lord Justice Hoffmann in Re D' Jan of London Limited when he said that the duty of care owed by a director at common law is the conduct of "a reasonably diligent person having both-
- the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and
- the general knowledge, skill and experience that that director has."
- "Directors have, both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company's business to enable them properly to discharge their duties as directors.
- Whilst directors are entitled (subject to the articles of association of the company) to delegate particular functions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent, the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions.
- No rule of universal application can be formulated as to the duty referred to in (ii) above. The extent of the duty, and the question whether it has been discharged, must depend on the facts of each particular case, including the director's role in the management of the company."
The first requirement is an objective test. The second is a subjective test that looks to the actual knowledge, skill and experience of the director in question.
Other case law describes what may be expected of a "reasonably diligent" director and acknowledges the obvious qualification that what the test requires must depend on the particular circumstances before the court.
In Re Barings Plc (No 5), the UK Court of Appeal approved the summary given by Justice Parker at first instance in these terms:
This argument contrasts with what Justice Romer said almost 80 years ago in In Re City Equitable Fire Insurance Company Limited:
"In respect of all duties that, having regard to the exigencies of business, and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly."
Justice Langley did not feel that this statement represented the modern law because it means unquestioning reliance upon others to do their job. He held that "It is plainly arguable, I think, that a company may reasonably at least look to non-executive directors for independence of judgment and supervision of the executive management."
His Honour also considered section 727 of the UK Companies Act in that, if in any proceedings for negligence, default, breach of duty or breach of trust against an [director], it appears to the court hearing the case that that [director] is or may be liable in respect of the negligence, default, breach of duty or breach of trust, but that he has acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused for the negligence, default, breach of duty or breach of trust, that court may relieve him, either wholly or partly, from his liability on such terms as it thinks fit.
This is not dissimilar to the Australian business judgment rule which provides that a director who makes a business judgment will satisfy the duty of care and diligence in they make the judgment, among other things, in good faith, for a proper purpose, having informed themselves of the relevant subject matter and rationally believing the judgment to be in the best interests of the company.
Applying the above principles, Justice Langley then examined the conduct of Equitable's non-executive directors.
The court's attention was drawn to a note between directors referring to a possible approach which would draw "less attention" to the existence of the decreased annuity bonus plan with the disadvantage that "clients might feel that we had been a bit underhand in 'sneaking in' this change". These conclusions were withheld in formal papers presented to the company and there was no record of these concerns in minutes of the board meetings.
Furthermore, in none of the meetings was the plan discussed or raised for discussion. The board minutes were not a full record of everything that occurred which was of potential importance to the relevant issues. Although the Appointed Actuary prepared various papers addressing the overall approach to Equitable's new procedure for handling policyholder claims, these papers made no reference to the plan.
Justice Langley held that from the information provided, he could not dismiss the concerns raised by Equitable on a summary basis. In line with his conclusion that non-executive directors retained an obligation to exercise independent judgment and to supervise executive management, he considered that it remained arguable that the non executive directors should have done more to ensure that the plan was legal and would not cause policyholder concerns. He emphasised the need for advice to have been obtained prior to such an important decision being made.
He also refused to summarily dismiss the claim against those non executive directors who had not been present at the relevant meetings where the plan was discussed. It was at least arguable, he said, that these directors should have informed themselves of the matters discussed at meetings at which they were not present and to have raised concerns if it appeared that anything untoward had happened. He held that he could not conclude on a summary basis that the non-executive directors had acted reasonably in all the circumstances.
Although much will depend on the result of the final judgment taking into account all the evidence, the decision suggests that non executive directors cannot simply rely on delegates to perform their functions competently. They must maintain a supervisory role and exercise their own independent judgment regarding the reasonableness of the company's activities. A failure to obtain legal or other expert advice when issues arise may also be called into question.
The case sends a clear message that non executive directors must proactively ensure that the company is fully advised of issues that may impact on policyholder or investor rights and therefore could lead to actions against the company. All relevant considerations should be canvassed at board meetings and recorded in the minutes.
Clearly, merely relying on unsupported assertions from other directors in response to concerns over policyholder/customer issues may leave directors exposed to subsequent action against them by the company. At a time when many directors are having difficulty obtaining Directors’ and Officers’ insurance, this judgment raises particular concerns and exposes directors to personal liabilities which they may not be able to shoulder.
Ray Giblett is a senior associate (Litigation & Dispute Resolution) in the Sydney office of national law firm Clayton Utz.
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