Directors reminded of their duties in multi-million pound fraud case

Directors reminded of their duties in multi-million pound fraud case

Published:

Author: Emma Gibson

A recent case has highlighted a number of points relevant to directors and their duties to the company.

The background

The initial claimant Group Seven Limited brought a claim in relation to a fraudulent investment of #100 million, Group Seven Limited, Rheingold Management Inc v Allied Investments Corporation Limited, Marek Rejniak, Paul Sultana, Larn Limited, Luis Nobre [2014] EWHC 2046 (Ch).

It was persuaded to make the investment by several plausible fraudsters with the agreement and even co-operation of two of its own directors, one of whom was the company's in-house legal counsel.

Although this case was decided under Maltese law, it is relevant to how directors must approach their statutory duties in England and Wales.

Liability of the directors

The defendants claimed an indemnity from two of the directors for being negligent and in breach of the duties they owed to the company. Although the judge found this was a fraudulent investment scheme, he made a number of scathing comments about the negligence of the directors including that they 'failed to stop the obvious'.

The directors had been negligent because they should have been sceptical about the various methods used to make the investment. A simple element of cross-checking those who were involved would have revealed the fraudulent nature of the scheme. The directors were forcefully reminded that they are in a position of responsibility. As experienced businessmen, they were expected to be sceptical about the proposed scheme not least because of the ambitious projected return on the investment.

However, the judge concluded the directors had been 'fools not knaves', having been misled rather than being actively complicit in the fraud.

Duty of care, skill and diligence

Directors have a duty under section 174 Companies Act 2006 to exercise reasonable care, skill and diligence. It is a two-part test. Directors must carry out their functions sufficiently carefully and competently which means with the care, skill and diligence that would be exercised by a reasonably diligent person with:

  1. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and
  2. the general knowledge, skill and experience that the director has.

The duty is based on the common law duty of care and skill and if breached may give rise to a claim of compensation or damages by the company to whom the duties are owed.

It's possible that were proceedings for negligence or breach of duty brought against the two such directors, the court might relieve them from liability if it considered both that they acted honestly and reasonably and, considering all the circumstances of the case, they ought fairly to be excused.These directors fell short of exercising their curiosity, judgment and, in the case of the in-house counsel, their own legal training.

The moral for directors is not to rely on the court's discretion but to make sure they use their knowledge, skill and experience when making decisions.

Disclaimer

This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.