A recent Court of Appeal Judgment has served to highlight the obligations upon ‘innocent’ directors when fraud or wrongdoing is suspected by another director.

The law says that a director who has knowledge of his fellow director’s misapplication of company property and stands idly by, taking no steps to prevent it, will not only breach the duty of reasonable care and skill he owes the company but will himself be treated as party to the breach of fiduciary duty by his fellow director in respect of that misapplication by having authorised or permitted it.

In this case, the judgment being appealed had made the both the innocent and guilty directors liable for 50% of the losses suffered by the company after the wrongdoing was discovered.

Not surprisingly the innocent director objected, making the point that as one of only two directors in a 50/50 company there were limited options available to him and he had not benefited from the wrongdoing.

It was emphasised that this was not a case in which a director knew that his fellow director was misappropriating assets, and could by reporting the matter to the board or taking other steps falling short of litigation, insure that the misappropriation was brought to an end.

These submissions were accepted by the Court of Appeal, the Judge pointing to the evidence that “Far from encouraging or consenting to [the] misconduct, [the director] protested it, was told to mind his own business, and was thereafter ignored”. It was also clear that no benefit had accrued to the innocent director.

The burden of any joint liability should therefore fall entirely on the ‘guilty’ director.

However, the wider message is that directors who discover wrongdoing by co-directors should understand their obligation to take appropriate steps to preserve and protect the company’s interests and assets. What those steps are will depend on the circumstances but simply objecting to the conduct may not be enough in itself.

That said, those directors who do nothing when on notice of wrongdoing by a fellow board member run the risk of personal liability for the losses suffered by the company even if they derive no benefit themselves from the misconduct.

Clegg v Pache (Deceased) [2017] EWCA Civ 256

For further information relating to the points raised in this article, please contact Simon Lockley, Director of the Dispute Management Team.

Please note this information is provided by way of example and may not be complete and is certainly not intended to constitute legal advice. You should take bespoke advice for your circumstances.

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