Non-executive directors could face the same obligations as their full-time colleagues. Edward Smerdon and Bonita Hill look at boardroom responsibilities

In the wake of the Enron collapse, Lord Young, ex-Conservative cabinet minister and a former chairman of Cable & Wireless put the cat among the pigeons by suggesting that non-executive directors should be abolished. The reason, he said, was that part-time non-executive directors, attending one or two days a month, could not know enough about a company to properly undertake corporate governance. In his view, all directors should be full time.

The reason Lord Young's recent comments are so controversial is because they are at odds with the various City reports of Cadbury and Hampel, which have continued to emphasise the importance of the non-executive director in ensuring corporate governance. In theory, the role of the non-executive director is to provide a vital check on audit and remuneration committees, to question decisions of the board and to provide a more strategic and long term view of the company.

It is considered that because the non-executive directors are not involved in the everyday running of the company, they are best placed to carry out these duties. However, questions have been raised about the apparent disparity between the theory and the reality.

Accounting procedures
On 15 April the Department of Trade and Industry announced it was to conduct an independent review into the role and effectiveness of non-executive directors. This coincides with a government review of accounting procedures and a tightening of the regulatory framework.

In recent months, high profile non-executive directors of companies such as Enron and Marconi have seen their entire careers threatened through their involvement with companies that have run into trouble.

An increasingly litigious climate means that it is not only the auditors and professional advisers, but also the directors, who face the prospect of being sued by shareholders and creditors when companies fail. The Equitable crisis is a prime example, where the board is being sued for £3bn. Who could have envisaged that a non-executive directorship with an erstwhile reputable insurance company would carry such a high price?

The law in this area is reasonably established and, as a consequence, there is very little case law. One theme that remains constant is that courts will approach each case on its own facts. Therefore the case law, while a guide, will not give the complete answer to the question of directors' personal liability.

It is well established that directors owe a fiduciary duty and a duty of care and skill to the company and may be liable for breaches of that duty. It is also settled law that the standard of duty owed by a non-executive director is the same as that owed by an executive director.

It will, therefore, be no defence for non-executive directors that they would not have had significant involvement in the day-to-day affairs of the company and so owed a lower duty of care to the company. This is, of course, of considerable concern to those non-executive directors who do not fulfil their role as laid down under Cadbury and Hampel.

Minimum standard
The standard of care expected of any director has until recently been relatively undemanding. It was thought that directors must act with the care that a reasonably competent person in a similar position with similar skills and experience would exercise under similar circumstances, performing their duties in good faith in a manner they reasonably believed to be in the best interests of the company.

This suggested that errors of an inexperienced director would not be judged by the same standard as one who was more experienced. Now, however, the standard has probably changed, so that there is now a minimum standard of care below which a director's conduct may not fall.

In assessing the required objective standard, in the case of directors of public companies, a court is likely to take into account the company's compliance with the Turnbull guidance, by particular reference to the directors' attitudes to the relevant corporate risk which caused loss to the company. This will apply to non-executive directors to the same extent as to executive directors. Indeed, it could be argued that the role of the non-executive director is almost entirely risk focused.

Directors of public companies, specifically, due to the expertise considered necessary to protect and heighten shareholder value, may find themselves vulnerable to the charge that they are effectively professional directors.

Another recent development is the introduction of the Financial Services and Markets Act [2000]. This Act brought with it more civil liabilities and criminal offences for directors and gave regulators - the Financial Services Authority - wide ranging powers of enforcement, including the levying of large fines and `name and shame' provisions.

In light of the potential for liability attaching to all directors, non-executive directors in particular should be asking serious questions about the extent of their involvement within a company and the extent of their directors' & officers' (D&O) cover.

Non-executive directors are usually covered under a company's D&O policy, along with the executive directors.

Notwithstanding this, non-executive directors who sit on more than one board may feel that they would have added security with a personal D&O policy. The difficulty is that it is inherent in the role of a non-executive director, who sits on several boards, that the risks will be hard to evaluate, making such a policy difficult to underwrite. For this reason, such a policy is not widely available.

Another possibility of cover lies with the outside board extension, which frequently appears on D&O policies of public companies. Under such an extension, the director may be covered for exposures faced while sitting as a non-executive director on another public company board.

What is clear is that there is a marked difference between US directors, who will invariably have a D&O policy and UK directors, many of whom remain unaware of the risks they are exposed to. There is undoubtedly greater exposure to shareholder claims for US directors.

However, the expanding liabilities and increasingly complicated regulatory framework means that all directors, executive and non-executive should be ensuring that they have the appropriate cover.

In particular, non-executive directors should be aware that, notwithstanding uncertainty about their public persona, they are for all intents and purposes, potentially just as exposed as their executive counterparts.

  • Edward Smerdon is a partner and Bonita Hill is a solicitor in Reynolds Porter Chamberlain's D&O unit