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The art of law - a director's legal duty does not require him to resign just because he disagrees with a course of action decided on by the board

The judgment in the Madoff case clarifies a director's duties in the context of a modern company

The Madoff investment scandal broke in December 2008 when Bernard Madoff, the king-pin of an investment company, admitted that the wealth management arm of the business was a Ponzi scheme, that is to say, a fraudulent scheme promising high rates of return with little risk to investors, in which the first investors are paid the promised returns, not out of profits genuinely made, but out of moneys invested by later investors. Such a scheme inevitably collapses when new investment dries up.

Madoff was arrested and pleaded guilty to eleven federal criminal offences, admitting to operating the largest Ponzi scheme in history. He was sentenced to 150 years in prison, and it was reported that Madoff's firm had liabilities of approximately US$50 billion.

A judgment of the English High Court regarding the liability of the directors of Madoff's London-based company

The judgment of the English High Court in Madoff Securities International Ltd v Raven [2013] EWHC 3147 centred on claims brought by the liquidators of a London-based company (in which Madoff was the chief executive and chairman and held the majority of the voting rights) against its former directors.

The liquidators averred that, in respect of several payments by the company, the directors had breached their now-codified duties under the English Companies Act of 2006, in particular the duty to promote the success of the company and the duty to exercise reasonable care and diligence.

It is unlikely that a South African court would find any significant distinction between directors' codified duties under the English Companies Act of 2006, and the duties imposed on directors in the partial codification of their duties under South Africa's new Companies Act 71 of 2008.

A director can properly defer to the views of his fellow directors

The judgment affirms that a director is not in breach of his duty simply because he decides to defer to the views of his co-directors, even if he himself is not persuaded by them, provided he believes that those views are advanced in what those directors believe to be the best interests of the company. Moreover, the court said -

"A director is not in breach of his core duty to act in what he considers in good faith to be the interests of a company merely because if left to himself he would do things differently."

The directors had acted on Madoff's instructions to pay him for suspect research

In this case, the liquidators of an English company within the group alleged that its directors had acted dishonestly and had breached their duty to the company when they acted on Madoff's instructions to pay substantial sums for so-called "research" that had allegedly been plagiarised and was of no use to the company.

The director in question deferred in this regard to Madoff and contended that it was not a breach of duty on his part for him to assume that Madoff's high standing in the financial world equipped him to know what was best for the company. The court found no fault in the director's acting in this way.

Key principles re-stated

The judgment endorses the following key principles, none of which are novel, but which are interesting on account of the manner in which they were found to be applicable to the facts of the case:

  • The criterion as to whether a director believed he was acting in the best interests of the company is a subjective test.
  • It is legitimate and often necessary for there to be division and delegation of responsibility for particular aspects of the management of a company. However, each director owes a duty to the company to inform himself of the company's affairs.
  • It is a breach of duty for a director to allow himself to be dominated, bamboozled, or manipulated by a dominant fellow director where this amounts to a total abrogation of his responsibility.
  • A director who has knowledge of his fellow director's misapplication of company property and stands idly by, taking no steps to prevent it, will be in breach of the duty of reasonable care and skill.
  • A director is entitled to rely upon the judgment, information and advice of a fellow director whose integrity skill and competence he has no reason to suspect.
  • It is the duty of each director to form an independent judgment as to whether acceding to a shareholder's request would be in the best interests of the company.
  • A board of directors may reach a decision as to the commercial wisdom of a particular transaction by a majority. A minority director who disagrees with the decision is not obliged to resign and refuse to be party to the implementation of the decision.

The judgment acknowledges that directors bring different experience and expertise to the joint exercise of corporate management. Whilst each director is required to exercise his independent judgment, he may legitimately defer to the views of those with greater experience or expertise than him.

Where there is a director who has a record and reputation for outstanding skill and experience in the company's business activity, his fellow directors are entitled to accord him a high degree of deference and trust his views as to what is in the company's best interests

It would be unfair and unrealistic to have expected the other directors not to attach great weight to Madoff's views

In the case at hand, the judge found that it would have been unfair and unrealistic to expect the directors to have done anything other than attach great weight to the views of Madoff in deciding what was in the interests of the company. Madoff was both a director and shareholder of the company. For a director of the company to have taken the view that Madoff knew best was not a dereliction of the duty to exercise an independent judgment.

Such an attitude was held to be a legitimate recognition that Madoff's high standing in the financial world reflected a level of skill and experience that equipped him to know what was best for the company and put him in a much better position to make that judgment than the other directors. The judge held that the allegations of dishonesty on the part of the directors in this particular matter were unfounded, as the modern approach of the English courts was that-

"in order to prove dishonesty, it is necessary to show that a [director] deliberately committed a breach of [duty] which he did not honestly believe was in the best interests of the [company]."

The court said that this case was a reminder of the dangers of assuming that, simply because there has been fraud, the members of the board of directors must have been implicated in it.

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