Non executive directors liability issues

At our recent “Chatham House” meeting (graduates of the AICD course in Perth) we discussed the issues of:
1. Some of the great practical advice that graduates of the AICD Company Directors course had been able to apply; and
2. The legal issues and risks of being a director, particularly non-executive

The course is very good at outlining responsibilities and legal issues for directors – highly recommended if you are considering or are a director. Interesting, a number of participants indicated it is significant enough for them to never consider being a director. I have asked many people including various directors as well as Professor Bob Garrett who wrote The Fish Rots from the Head, amongst other books (signed copies proudly on my bookshelf) whether they shared the view that the legal position against directors is too onerous. No one seems to share the view.

In some respects, the purpose of a limited liability company is to encourage considered risk taking. However in recent times a great deal of that risk has been transferred to the board.

I was very pleased to see a great article by John M Green in this month’s Company Director magazine that succinctly gets to the heart of the issue. He also proposes a better way.

As John describes it, the key issue is that non-exec directors fees may be (depending upon the size of the company) from $30k to $200k per year. If the company faces a significant claim, directors can face unlimited liability, a weak business judgement rule and a newly burgeoning litigation industry? So, small amount of fees against potentially catastrophic risk. He makes a very good point.

Non executive directors are always going to be disadvantaged in business knowledge as compared to company management. Those people who have the talent to be non-executives also potentially can add value to companies by consulting – without the legal liability, and with the ability to involve their own consulting firm to deliver on other projects to the company without conflict of interest becoming an issue.

Non execs play an important role however in the governance of companies – and the role is required as more companies take the path of listing to expand their capital base.

John M Green’s suggestions (to apply only if fraud hasn’t occured):
1. Cap NED’s liability in proportion to their fees
2. Consider Charity NED’s and cap a fixed flat amount
3. Consider NED’s shares as part of settlement.

In summary, the reason why many people I have asked indicate that nothing is wrong with the current system is that the penalties are necessary to have big deterrents to avoid situations like HIH. I agree wholeheartedly. The area of reasonable concern is where directors act in good faith, being diligent and genuinely acting in the company’s best interests. Potential consequences are catastrophic but the rate of prosecution is low. John’s suggestions leave the big stick against fraud, but provide a more sensible position for NEDs. I look forward to the outcome of the government review in this area.

What do you think? Please leave your comments on your experience and views.

10 thoughts on “Non executive directors liability issues”

  1. There’s a lot of good points in this. AICD will be pushing this agenda hard to reduce the burden on Directors. There can be benefits in this, particulary with companies which don’t pay appropriate director remuneration.

    Having said that, it’s interesting to see some of the effects that Director liability are having. OH&S and Environmental legislation are possibly the most onerous on Directors (Graham Samuel is pushing for equally onerous penalties for cartel behaviour). The result of this onus on Directors is that OH&S and Environmental polution are now taken very seriously by boards, which is having great impacts particularly in the area of employee safety.

    I’ve never heard of a public company director going to jail for being negligent in their OH&S resposibilities, but I am seeing a great improvement in OH&S practices, particularly in pro-active risk assessment. Less injuries on work sites, less deaths on work sites, CEO and management held to account and grilled monthly about this area – this is a very good thing.

    If liability brings key areas into sharp focus, then it’s okay if those accountable squirm a bit. It means they’re focused, and doing the job.

    As it is, Directors seem to be a pretty unaccountable lot. The key thing that seems to drive resposibility is not legislation but reputation. If you look at any of the corporate disasters in the past 10 years (and there’s been plenty of them), the Directors usually got off the hook, with the CEO being the scapegoat, and maybe the loss of the Chairman. (Maybe).

    Directors have been moaning about compliance fatigue and liability for some time, and warning of people no longer wanting to be professional Directors. As a result of this lobbying there has been a doubling in Directors fees for large companies, while earnings stagnate and employees get their 3% increase. I don’t see a lot of them withdrawing, in fact I see the contrary.

    I agree, it’ll be interesting to see how the government responds on this one. It’s not a clear cut solution.

  2. Many are the companies that have non-executive directors appointed to their boards for reasons of their own, yet fully knowing this type of director is far less liable for his or her degree of responsibility for any resultant failures in their role as an non-executive directors, yet while having a high degree of input into the various of their board’s directions undertakings and operations.
    In my view a specific intent to evade the applicable letters of business law.
    A type of scam sham method of gorging upon company executive boards!

  3. Thanks for the comment William. My view is that if courses like the AICD Company Directors course ( my review here were mandatory, we would see better understanding of the roles and responsibilities of directorship, and a better quality of governance in our companies.

    For a counterpoint on the legal ramifications, please see

    Thanks again for your comment

    Justin

  4. Interesting article. I do agree with William, that boards appoint NEDs for their own reason…more than often to improve business performance. However with liability issues, NEDs can sit on more than one board? Does the differ the advantage of performance related contribution per board role, thus increasing liability for firms?

  5. Hi, and thanks for the question. I can talk about the Australian experience predominantly. Best practice is considered to have a good proportion of the board to be independent. Many non-executive directors serve on multiple boards, as many as 4 or 5 and typically including a not for profit board in the mix. Beyond this the workload becomes more difficult to manage.

    Please note this example is for a professional director, that is, not working full time in a role.

    Thanks for your comment!

  6. Hey, thanks Justin for replying. Much appreciated. NEDs, should definitely incorporate themselves with a not for profit organisation as a mix of boards they sit on. Hiring NED’s for commercial expertise is a great role for both the NED and not for profit organisation.

  7. Certainly is! And often a interesting challenge in getting best practice in place – some boards are outstanding and some struggle a little getting the balance between operations and governance…

  8. A very interesting post and I agree that there is significant importance in the selection of the NED. They are supposed to bring real value to a business through their experience and knowledge. What about smaller businesses? They may not know how to work alongside a NED. Similarly a NED may not really know the ‘director’ part of the role.

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