Directors' Fiduciary Duties: Inactivity May Be A Breach Of Duty
In a recent case the Court of Appeal has ruled that, where a
director commits fraud, his or her fellow directors are in breach
of their own duties to the company in allowing the fraud to happen,
and cannot defend themselves on the grounds that the fraudster
would have deceived them if they had tried to prevent the fraud.
The case reiterates an earlier judgement where it was said that it
is in itself a breach of duty by the remaining directors to allow
themselves to be dominated or bamboozled by one of their
number.
Lexi appealed against a decision that two of its directors (M
& Z) were not responsible for the misappropriation of funds by
the managing director (S), their brother. Over a number of years
the managing director had taken almost £60 million from the
company through fictitious director's loans, false facility
letters and misapplication of three of Lexi's bank accounts.
The three siblings were part of a close-knit family and M and Z
were aware that S had previous convictions for dishonesty and
obtaining property by deception. This information was not initially
disclosed to the bank or the other directors. Z also failed to
monitor the misappropriated director's loan account, on which
she was a named person.
At the original hearing M and Z were acquitted on the basis that
they were liable only for monies paid to them and that their
inactivity as directors had not caused Lexi's loss. At this
hearing the judge suggested that had M and Z attempted to play a
more active role in the company they would have been fobbed off by
the trickery of S. The judge had used the ability of S to trick
other, non-family, members of the board as a factor in the
exculpation of M and Z.
On appeal Lexi submitted that the inactivity of M and Z was a
further breach of fiduciary duty. The appeal was allowed comma not
semi-colon on the evidence provided the Court of Appeal finding
that the conclusion reached by the initial judge was incorrect. M
and Z knew of S's convictions and should have asked the
appropriate questions to satisfy their fiduciary duties. Had they
done so they would soon have realised the extent of the fraud being
perpetrated at the company. If M and Z had acted properly the
auditors and other directors would have been made aware of the
situation, the auditors would have been unable to provide
unqualified accounts and the increased banking facilities would not
have been available.
The key point was "that any individual who undertakes the
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