Nov 10,2010 / News / Legal Brief

The esteem associated with multiple non-executive directorships is fading fast. If sued for losses incurred on their watch, non-executive directors with irons in too many fires could be hard pressed to prove they acted properly.

“The law, including the new Companies Act, makes no distinction between executive and non-executive directors,” says Eric Levenstein, director at Werkmans Attorneys. “So when it comes to personal liability matters, it is a mistake to think that a non-executive director has more latitude than an executive director.”

Levenstein says it is a misconception that the liability of non-executive directors is limited because they are not involved in day-to-day management. “The courts do not make that distinction. They will of course look at the facts and circumstances of each case but this does not make the duties of non-executive directors less onerous. Essentially, the legal rules are the same for all directors.”

In other words, all directors, executive and non-executive, can expect their actions to be judged by the same standards of accountability.

“You can defend yourself against any liability claim if you can show in court that you acted rationally in the best interests of the company, had no conflict of interest and took reasonably diligent steps to be informed about the matter,” Levenstein says. These are the key elements of the business judgment rule, which has been included in the new Companies Act to allow directors to take justifiable business risks.

“The question is: Can directors who sit on multiple boards cope?” he says. “Can they properly apply their minds and give sufficient time to efficiently deliver on what’s expected? With so much information to go through and so many board meetings to attend, can you say with your hand on your heart that you are giving enough attention to the duties expected from board membership?”

Levenstein believes that the increased emphasis on directors’ liability in the Companies Act, which comes into force in April 2011, should make leaders in business think twice about overburdening themselves with board memberships.

However, it is not only multiple directorships that have the potential to trip up non executive directors . A second issue with major personal liability implications is that of reckless trading.

“The new Companies Act prohibits reckless trading or trading in insolvent circumstances,” Levenstein says. “For the first time, it will be a criminal offence if a director allows his or her company to continue trading, knowing full well that it can’t pay its debts.”

On conviction, offenders can be sentenced to 10 years’ imprisonment, up from the 2 year sentence previously imposed. They can also be sued in their personal capacity by their creditors. “Directors need to understand that rather than trading in insolvent circumstances, they should call it a day, either by following the business rescue process or liquidating the company,” he says. “If they take on credit, knowing the company can’t pay, they will be held personally liable.”

Yet another issue for non-executive directors to be aware of, is the importance of exercising their independence and avoid the pitfalls of being a “puppet director” (also known as a nominee director). A puppet director is a director who is placed on the board by a shareholder to only look after that shareholder’s interests and so is no longer independent.

“Yes, a shareholder can nominate a director but that person must still exercise independent judgment and not blindly follow the shareholder’s instructions,” says Levenstein. “Directors are required to act in the best interests of the company, not the shareholder, meaning they must take independent decisions – even where a decision may conflict with the interests of the shareholder.” He says a director who fails to act independently is breaching his or her fiduciary duties, again with implications for personal liability.

“With the implementation of the Companies Act only months away, companies need to get the message that one set of rules applies to all directors,” says Levenstein. “Don’t think if you’re a non-executive director that you have more latitude to meet – or fail to meet – your fiduciary duties. Executive or non-executive, you will be judged by the same set of standards.”