Director liability – mistakes are not easily swept under the carpet

A number of large companies have failed in a very high profile way in recent years, and in the wake of their failure there has been much talk about the role of Directors and, more specifically, Director liability.

Right at the forefront of that discussion was the criminal prosecution of five former directors, including the former-Chair, of Feltex.   The criminal charges arose from various acts which appear to have led to the demise of Feltex Carpets late in 2006.

Why would a Director be facing a criminal charge?

It is not just following a blatant case of fraud that a Director can find himself in court.   Board members have legal responsibilities and failure to discharge those responsibilities can land a Director in very hot water.    Directors can’t just turn up to meetings and hope for the best!

There are compliance matters.   Companies, through their Directors, must ensure they comply with applicable laws.   If they do not, Directors can be personally liable for financial or legal decisions made by their Boards where the Board has not followed correct procedures in reaching those decisions.    For example, as in the Feltex case, failing to comply with aspects of the Financial Reporting Act can result in criminal charges.   It was alleged that the Feltex Directors did not disclose certain banking covenants and that some debt was not properly classified.  They believed that they acted appropriately and on professional advice.   Which raises the next, all-important, point …

Show you have done the right thing

In most cases, a Director’s liability will be mitigated by evidence of good practice being followed.   Also, because Board members are not expected to “know it all,” professional advice, if obtained to aid decision-making, will provide useful evidence of discharging the responsibility as Director to take all steps to ensure they are adequately informed.

Directors are not expected to make the right decisions every time.   It is hoped that they do, but at the end of the day, they are human and will not always get it right.   What they should get right without fail, however, is process.   They should also always obtain professional advice where they are not sure about a topic or aspects of a topic they are addressing.

Potential Outcome

If convicted, each former Feltex director would have been liable for a fine of up to $100,000.

Further, it is possible that the Court will hold the Chair to a higher level of accountability than the other Directors.   Why might that be?   The Chair is charged with a higher level of responsibility, which is to ensure that the Board functions successfully.   The Chair is expected to steer the Board through the rules and procedures so that where decisions are reached they are arrived at correctly.   If this was not the case, the former Feltex Chair could have been left more exposed than the others.

As a Director, what can you learn from the mistakes of others?

While in the Feltex case the Directors were found not guilty, the seriousness of the action they faced serves as a timely reminder to all directors not to cut corners. Document and follow procedure for decision-making in all circumstances.   Also, always obtain professional advice where necessary.

Be vigilant, and take the role of Director seriously.   The risk of litigation or criminal charges, not to mention the potential for damage to reputation, should be enough for every Board member and/or Director to ensure that all decisions rely on good judgment and expertise.   Paid or unpaid, Board members are accountable for the decisions that they make.   Mistakes are not easily swept under the carpet.