3. To whom are duties owed

Duties owed primarily to the company itself – duties to third parties to act with reasonable care – duties under service contract to the employer – vicarious liability of employer if acts are within the scope of employer, but not otherwise – directors may put themselves in a position where special reliance is placed on them as individuals – legal consequences.

The conventional analysis of agent and principal points to a director owing his duties of skill, care and diligence primarily to ‘his’ company. Moreover, it is well established that fiduciary duties are owed only to the corporate ‘beneficiary’ since the office of director imposes a quasi-trust relationship requiring good faith. But not all duties are fiduciary, and directors may be liable to third parties if they act carelessly. In reality, a number of duties arise from different relationships, each with a different legal basis, and with separate rules as to the attribution of responsibility.

In Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187,[1990] BCLC 868, PC, the plaintiff trustee of certain company loan stock sought to make the employer of the two directors who negligently prepared financial certificates for the trustee relating to the stock (the employer being a bank who had made nominee appointments to the debtor company board) liable for their negligent acts. To succeed, the plaintiff needed to show that the employees were acting within the scope of the bank’s employment, as distinct from their agency authority from the company of which they were directors. In dismissing the claim, Lord Lowry, giving the judgment of the Privy Council, said:

‘[the two directors] owed three separate duties. They owed in the first place to [the company] the duty to perform their duties as directors without gross negligence ... they owed a duty to the plaintiff [the trustee] to use reasonable care to see that the certificates complied with the requirements of the trust deed. Finally, they owed a duty to their employer, the bank, to exercise reasonable diligence and skill in the performance of their duties as directors … but these duties were separate and distinct and different in scope and nature.’

The debtor company having got into financial difficulties (the usual case), the plaintiff wished to find the defender with the deepest pocket. It would not normally be worth suing directors personally for breach of any duty found to be owing other than directly to the company, and it was not worth suing the company even if it was bound by the directors’ act. Yet a claim based on vicarious liability against the directors’ actual employer, the bank, while accepted by the court as soundly based, failed because there was no finding that the bank influenced, controlled or even authorised the way the misleading certificates were prepared.

In the majority of cases where directors are found to owe negligence-based duties to third parties, i.e. arising under a different head from their agency-based duties to the company, the company will nevertheless be liable for their defaults in the same way that an employer is vicariously liable for the default of the employee. It follows that if a release is given to one party in respect of the wrongful act, it must be taken to be given to the other. In the recent Privy Council case of New Zealand Guardian Trust Co Ltd v Brookes [1995] 2 BCLC 242 a similar set of circumstances to Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187,[1990] BCLC 868 arose save that on this occasion the directors were pursued personally for negligence in relation to the preparation of the financial certificates. They, in turn, argued that even if an independent duty of care did exist, the formal release which the trustee had already given to the company covered them as well, because of the operation of vicarious liability. In an instructive passage Lord Keith said ([1995] 2 BCLC 242 at 245):

‘The directors of [the company] were its agents, and the question is whether or not they were acting in the course of their agency when they prepared the certificates. There can be no doubt they were acting in their capacity as directors when they did so, and indeed this was conceded by counsel for the appellant. Further, they were acting within the scope of their agency. They could not have prepared the certificates if they had not been authorised by [the company] to do so, and their doing so was for the benefit of [the company] because the rendering of the certificates was necessary to the maintenance of the loans to it. It is to be accepted that the directors assumed a personal responsibility towards [the trustee] to see that the certificates complied with the requirements of the trust deed and to exercise reasonable care in their preparation, but in most if not all cases where the acts of an employee or agent render the employer or principal vicariously liable it is because the employee or agent was in breach of the duty which he personally owed to the third party.

It is no doubt possible that the terms of the contract such as that which is here involved [the loan stock trust deed] may be such as to make it plain that any liability for the negligent preparation of certificates is to rest on the directors alone, to the exclusion of the company. Their Lordships can find nothing in the general structure of this trust deed … capable of evincing an intention that such should be the position in the present case. Their Lordships were not referred to any authority or statement of principle indicating a possible basis of distinction between cases where the negligence of directors acting within the scope of their authority might engage the liability of the company and cases where it does not.’

Thus, if directors are sued personally for a duty owed to a third party that arises out of something they did in the course of their directorship, the company is a jointly liable with them. Williams v Natural Life Health Foods [1997] 1 BCLC 131, CA. This is, of course, not the case where the directors’ duties are owed to the company itself. A director may also be able to claim the benefit of an indemnity he has from the company under the articles of association, or a payout under Directors and Officers insurance. The problem arises where the company has insufficient assets for a director to recoup his own losses, and in such a case he will be solely liable for the damages. It should be noted that this is not a true exception to the normal rule that an agent is not liable for contracts procured on behalf of his principal, since, as stated above, the relationship with the third party is not agency-based but founded on a common law duty of care which is inferred from the reliance which is placed on the director, on Hedley Byrne v Heller lines (Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465,[1963] 2 All ER 575, HL), and carries personal responsibility.

It follows from the analysis of these overlapping duties that: (i) where a claim is based on vicarious liability because a director or senior manager is also an employee of the company, responsibility will not be attributed if the employee can be shown to be acting outside the scope of his employment; (ii) where liability is attributed because the director was acting as an agent of the company, the company will likewise not be liable if the director was acting totally outside the scope of his actual, usual or ostensible authority or if it is clear from the facts that he intended to assume the liability of principal himself. However, the statutory ‘whitewash’ given to acts of directors by CA 1985, s 35 means it will be extremely difficult to show a lack of authority. On the other hand, as noted in the judgment of Lord Lowry above, it is possible for a director or indeed any other officer or employee to divorce himself from his office and assume a personal liability for which the company will not be a jointly liable.

In a number of corporate and commercial transactions directors will be put in a special position of reliance. We have already noted the case where financial certificates have to be provided under a loan stock instrument, but a more common example is where directors are asked to warrant or give undertakings in relation to information about a company when it is being bought or sold. Where directors are made separate parties to a sale and purchase agreement (which is unusual), they will clearly have a separate liability, whether or not there is a right of recourse or indemnity against the company. But if the agreement is simply between buying and selling shareholders, and warranties are given ‘to the best of the directors’ knowledge, information and belief’ or ‘after due and careful inquiry’, it seems likely that an independent duty arising in (delict )to the person relying on an appropriate degree of care being applied, will exist. Delictual remedies operating within the framework of a contract are more likely to be available as a result of recent cases such as Henderson v Merrett Syndicates Ltd [1995] 2 AC 145, HL and Holt v Payne Skillington [1996] 02 LS Gaz R 29, which, however, are outside the scope of the present discussion to consider in any detail.

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1. A SUMMARY OF DIRECTORS DUTIES | 2. STANDARDS OF SKILL AND CARE

Prepared by Peter Watson