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The Court disqualifies experienced non-executive director – important governance lesson

Posted on 7 February 2022

The High Court has disqualified a non-executive director described as 'a distinguished city man' for 4 years. The director will not be capable of acting as a company director for that period and will appear on the Companies House register of disqualified directors.

The case serves as a reminder to non-executives of their important role in holding the executives to account and a warning of the dangers in placing too much trust in those they deal with. The Judge disqualified the director, not for his own acts (indeed he found the director was 'blind as to what was actually happening' at the company), but for unfitness due to abrogation of responsibility.

Judgment

In the proceedings, the director sought to distinguish his role from that of the executives running the company on which he relied. In the Judgment, however, the Judge cited established law on directors' duties. While directors are entitled to delegate, 'proper delegation does not involve abdication'. 'Reliance must in the particular circumstances be consistent with the discharge of reasonable skill and care'. Although not employed by a company, or working in it, non-executives are subject to the same duties as executive directors.  

Case background

In the case, the director in question (Mr B) became involved with men who were establishing a business to exploit products relating to the purification of water. The plan was to establish and grow the company with a view to an eventual IPO on AIM. Mr B's role was to 'be a non-executive director and take no role in the running of the company'. 'He was only to assist with Investors' and be 'responsible for shareholders and the general raising of the profile of the company'.

In fact, the company - through its executives - became involved with a VAT fraud, a scheme known as MTIC (Missing Trader Intracommunity Fraud). This type of fraud involves the importing of goods from the EU into the UK at zero rate (i.e. no VAT is due). The importer then charges VAT on a resale in the UK. After further sales, there is an eventual export at zero rate to a buyer in the EU. The input VAT paid for the supply to the exporter is claimed back by the exporter (known as 'the broker') from HMRC. However, the original importer (the 'defaulter') disappears and defaults on the payment of VAT it has received on resale and owes to HMRC. Thus HMRC loses receipts.

In this case, HMRC discovered the fraud. The company was also placed in creditors' voluntary liquidation, with liabilities to creditors of over £4 million. The Insolvency Service brought directors' disqualification proceedings against the executives, as well as the non-executive director. The court found that the executives caused or allowed the fraud and disqualified each of them for periods of between 11 and 14 years.

The disqualification of the non-executive director, however, was on grounds of unfitness for 'abdication of responsibility'. The executives, it seems, had already served time in prison, one for previous instances of VAT fraud and for money laundering. Although Mr B knew that they were ex-offenders, he did not conduct further diligence, except to 'rule out something really grotesque'. He said that he 'believed in giving people a second chance'. He did not question sufficiently large changes to the turnover and profits in the management accounts which could have revealed the fraud, had he enquired further. He accepted instead a somewhat weak explanation of the increase being due to some product trials (which as the Judge pointed out would have been an expense rather than turnover). He also took the word of the other executives that there had been no fraud, even when questioned were raised by HMRC. On receiving directly himself written requests for evidence from HMRC, he relied on the fraudster directors to provide it, and took no responsibility himself for delivering it or taking over conduct of the enquiry.

Comment

This may seem like an extreme case. However, it is a significant one. Non-executives are widely regarded as fulfilling an important function in a sound system of corporate governance – they are expected to bring diversity of thought to decision-making and constructively challenge the management team. However, it is true that they often do not have the same visibility of what is happening at the company as executives. Expecting them to uncover fraud may - in many instances - be unrealistic. However, what this case demonstrates, is that placing too much trust and taking explanations at face value, especially where they would appear flawed to a competent director, will not be enough. A court will also take a dim view of an argument that, relying on others, a director had no responsibility.

Secretary of State for BEIS v Selby, Al Sayed, Awan and Bamford [2021] EWHC 3261 (Ch)

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