The issue: Are directors fully aware of the personal implications of corporate litigation and what steps should be taken by them when corporate governance goes wrong?
Many directors still believe setting up a limited company – as opposed to remaining as a sole trader or partnership – will constrain their liabilities if their corporate governance fails and leads to a catastrophic event, such as an accident at work or the collapse of their business. Yet recent pieces of legislation have allowed regulators and prosecutors to pursue directors they suspect of wrongdoing, lifting the protection of the corporate veil and opening up individuals to personal liability.
The impact of such changes was at the heart of the discussion during the latest BQ Live Debate, which was held at the Blythswood Hotel in Glasgow. Laura Gordon, Glasgow chair of leadership training organisation Vistage and a regular chair of BQ’s debates, opened the evening’s proceedings by highlighting the relevance of corporate governance following the collapse of part of Didcot A power station in Oxfordshire, which had occurred just days earlier. “It shows just how serious these issues can be,” she said.
One of the key themes participants returned to again and again during the debate was the concern that few directors understand their personal liabilities. “Over recent years, a lot of our micro-businesses – that historically would have been sole traders or partnerships – have converted themselves into limited liability companies,” noted Newell McGuiness. “I worry that these businesses think that their liability is completely limited; they simply don’t understand that it’s not quite like that. So the challenge for me and my sector is to educate these companies about what their potential liabilities are and what they can do to cover themselves.”
“As a consultant, I’ve seen bad governance and I’ve seen good governance,” said Ian Gracie. “Are directors equipped for directorships? In a lot of cases, particularly with SMEs, they’re not.”
David Watt explained how the Institute of Directors (IoD) in Scotland educates directors about their responsibilities and liabilities. “We’re committed to getting the message out there,” he said. “So many people just fall into being a director without understanding their responsibilities – we shouldn’t be allowing people to do that.”
The lawyers taking part in the debate are all too aware of the consequences when things go wrong. “I see first-hand how directors in small businesses can let corporate governance slip and directors’ duties become blurred with their own personal interests, which often results in closer scrutiny and claims arising after a formal insolvency,” said Leon Breakey.
“As a litigator, I get to see how directors handle these situations, day-in, day-out,” agreed Jennifer McKay.
Lesley Carruthers said corporate governance issues are particularly acute in the charity sector because the selection of directors was often arbitrary. “The directors are often unpaid volunteers,” she said. “Charities are facing financial struggles but, at the same time, the people the charities employ have a drive to do the very best they can for their customers. If this isn’t very carefully managed then it can get out-of-hand, like we saw with Kids Company.
John Morrison explained how he worked with many companies in “crisis” situations, during which they need to manage reputational issues. He highlighted the need for clients to also consult their lawyers during such crises.
Corporate governance is one of the risks Clydesdale Bank’s Emerging Technology Unit considers when it receives an application for funding, explained Tom Brock, who also chairs the risk committee for Parkhead Housing Association.
Nicola Taylor highlighted the vast range of legislation with which businesses in the hospitality sector have to deal, from health and safety through to food handling and hygiene. She pointed out a recent change in the law concerning the sale of alcohol; previously only directors were prosecuted if alcohol was sold inappropriately, but now frontline members of staff face the consequences. “You’ll have noticed that more people are now being refused alcohol,” she said. “I think if you move the responsibility down the chain then you get the result you’re after.”
Chardon Trading currently runs six hotels in Scotland under the Holiday Inn and Holiday Inn Express brands. Up until two years ago, the business also ran around 60 hotels throughout the UK on behalf of other owners. During that period, the health and fitness club manager at a hotel in the Peak District brought a chemical onto the premises that was not listed for use in the hotel and stored it in a cleaning cupboard, from which a cleaner took it and burned her hands when cleaning a bathroom without any gloves.
“I found myself pleading guilty in court to something that I had absolutely no way of controlling,” Taylor said. “We had ticked all the boxes for training, but it still happened. Clearly I felt dreadful that someone had been disfigured, but this wasn’t even my business – I was running it on behalf of a client.”
“What strikes me about corporate governance is that people often see it as a defensive tool but, as a corporate lawyer as opposed to a litigator, I like to think of corporate governance as a more positive and constructive tool,” said Michael Kelly. “I use corporate governance as a tool for helping people to build a better and more-efficient business.”
Michael Willis, who delivers directors’ training for the IoD in Scotland, agreed corporate governance could be a useful tool, especially for small or medium-sized enterprises (SMEs) or family businesses that needed to professionalise to fulfil their duties of care as directors.
John McGovern established the corporate defence group at MacRoberts in April 2015 and his team has already swelled from three solicitors to ten, reflecting how active regulators have become. “We protect directors from regulatory investigations from the likes of the Health & Safety Executive (HSE), the Scottish Environmental Protection Agency (Sepa) and the Food Standards Agency (FSA),” he explained.
“When we can’t stop a prosecution emerging then we go into court to defend the directors. The corporate veil has been lifted and regulators are looking at what individual directors are doing and are accountable for, rather than the corporate body. It’s difficult and worrying, but there are ways and means of dealing with it.”
Gordon emphasised how damaging unfounded allegations could be. Morrison agreed: “That’s why you need legal advice around these issues too. Your instinct is that if you’re being chased by journalists then you could always have a comment ready. But clearly there is a change of mood in the country and so sometimes it’s better not to respond.”
“People are baying for blood and want someone to take responsibility,” nodded Gordon. “I think that’s become more prevalent since the financial crisis.”
“I don’t think the public is looking for someone to take responsibility – I think they’re looking for someone to blame when things go wrong,” suggested Carruthers. “They think that someone must be at fault.”
Carruthers added: “I also have a particular personal interest in this question about the steps you can take when corporate governance goes wrong. A business colleague is living through a nightmare as we speak. He identified an issue of corporate mismanagement and highlighted it to his chief executive and was told not to worry about it. He flagged it up again to the same person and was told ‘This is how it’s going to be, just get on with it’.
“He left the company six months later, but 12 months after that, they came after him. He’s now being sued because, although he flagged it up, it was in the financial services industry and he didn’t ‘whistle-blow’. But he knew that if he whistle-blew then he wouldn’t get another job within the sector. He felt he had done what he needed to do to keep himself right, but in fact he’s going to be poleaxed for it. It’s quite worrying.”
“Hindsight is a wonderful thing,” said Breakey. “Lesley’s colleague may have thought he was doing the right thing, but in financial services there are specific rules and regulations about whistleblowing.”
“It’s about a cultural shift as well,” interjected McKay. “At the moment, whistleblowing is not looked upon kindly at all. We’re still in a culture where you’ll do what you can to protect your own back; what the regulators actually want is a situation in which you blow the whistle as soon as possible and then there are leniency provisions for the company or the individual to protect them to a certain extent. It’s really important that we have that cultural shift and that the knowledge is put out there that there are ways to protect yourself if you stand up.”
“There’s the carrot and then there’s the stick that’s used in competition law,” said Breakey. “The punishment for major competition law breaches can be 10% of turnover and there’s a huge reduction – I think it’s 100% – for whistle-blowers. So there’s an incentive for companies to bail out.”
McKay agreed: “That’s how a lot of the cartels in the construction sector were brought to an end. That’s what it took to get that cultural shift. There have been shifts in some sectors, but it’s not enough.”
“One of the challenges we face is raising awareness among SMEs about the landscape they’re in,” pointed out McGuiness. “In my industry, electrical installation is a tough game. These people have to fight to get paid. It’s a certain type of person that goes into that industry. It breeds a person who’s strong-willed. They’ll take guidance on technical issues, but if we try to tell them how to run their businesses then they don’t like it.”
As the debate moved on, diners discussed the regulators’ role. “Some of the regulators are very aggressive,” said Willis. “There’s this paradigm that suggests capitalist companies are trying to abuse the regulations and get away with it, and the regulator is the good guy. But so often, especially with new regulators that are trying to prove themselves and get prosecutions, it’s best to fight the regulator and get that balance. They’re not always right – I think they’re often overly vicious.”
Gordon pointed out the need to question how regulators were incentivised to carry out prosecutions. “Is it in the best interest of the public all of the time?” she asked.
“When I ran a company, the first item on our board meeting’s agenda was health and safety,” said Gracie. “We had very good relations with the Health & Safety Executive because we worked with them. But again not every company takes that approach.”
“Regulators are becoming more robust,” McGovern agreed. “For example, if the HSE finds a breach on your premises then the whole cost of its investigation falls on your company. What I can’t quite get my head round in corporate defence over the past few years is why directors don’t push back much more? I know there’s a financial aspect to it, but most people will have some form of insurance cover for defence costs. Often the quality of the investigation isn’t what it should be.”
“Does that come back to reputation issues?” asked McKay. “Do they think they can’t face the prosecution and the time in court?”
“It could be, or it could be the fact that they’ve been fingered by the regulator and they think ‘There’s no smoke without fire’ even though the evidence could be very flimsy,” mused Morrison.
Brock said: “Banks have built up huge systems of checking, offering a first line of defence and then a second line of defence and so on. At some banks, there are processes where 14 people will have carried out checks and they will still get it wrong, because there’s this human capacity that says ‘If someone is checking it then it’ll be ok’. The accountability has shifted with the number of people carrying out checks along the line.
“You can get lost in the world of control. Sometimes the more controls you put in place then the less effective they are.
“I think the banks are now at the stage where they’re going to have to use technology to handle all of this in a smarter way. They’re dealing with huge volumes of data and no one individual can make sense of it all.
“Proving your competence is also difficult. You may be qualified and you may have years of experience, but you still might not be very good at what you do.”
Building on Brock’s point, Gordon asked: “Governance is about putting the right processes and systems in place – but can we overdo it?”
“Absolutely,” replied Kelly. “It’s about balance and what’s appropriate for a business. Excessive controls or governance can constrain a business.
“In the SME world, the reason why directors are held responsible for the actions of the business is because to a very large extent they do shape the culture of the company. There will clearly be times when the regulator’s approach is excessive, but a lot of the time it isn’t actually unreasonable. Business owners and directors are responsible for the business and you can’t be cavalier about that.”
Taylor pointed again to the example of selling alcohol. “It would be impossible for a company director on holiday in Mauritius to see what’s going on in a pub in Glasgow,” she said. “In changing where that responsibility lies – in that it’s now down to the people on the shop floor who are in control of it – has completely changed the industry. The further down the chain you make the responsibility lie then the safer it is for people.”
Gordon asked Watt and Willis if the need to filter information down through the company was an issue that was included in training for directors.
Willis said it was: “It’s part of how directors deal with risk. Directors should have a handle on risk. They can’t possibly hope to understand each regulation that’s going to hit them, so they need specialist advice from professional service companies or trade associations. But they need to understand the individual risk for directors and have a risk strategy, getting this balance between building a company and making sure it’s under control.”
Dave Townsley pointed to the number of emerging entrepreneurs that read BQ Scotland, who will have grown successfully from being sole traders to limited companies at great speed. He highlighted the risks associated with a fast-growing company and asked how corporate governance could be put in place. “When it comes to your own personal liability, I’m guessing that ignorance isn’t an excuse?” he said.
Watt said the benefit of training was that it helped people to go from running a business to directing a business. “It’s not the same thing,” he said. “There’s a very significant difference.”
“You have to go from working ‘in’ the business to working ‘on’ the business,” Gracie agreed. “You need to bring in advisors and non-executive directors, who have experience and who you can bounce ideas off.”
“In an owner-managed business that’s grown very quickly the mentality has remained the same and they haven’t developed their corporate governance,” said Breakey. “When they fall into insolvency then you see the directors have used the company’s money as their own slush fund, they don’t have any accounts, and it’s just a product of operating a single ownership business.”
McGuiness argued: “I don’t think entrepreneurs set out to break the law – they just don’t know what they don’t know.”
“I don’t think it’s a conscious decision,” agreed Breakey, “but often they don’t keep up with the growth of the business and when it all unwinds you find they don’t have a clue that they’ve got a group of companies each of which should be a separate corporate entity with separate bank accounts and financial accounts. I guess it comes back to education.”
“There’s a question about where the buck stops,” said Townsley. “If a manager is supposed to have trained their staff to handle chemicals and they’ve not done it properly then can you argue it’s not your fault but the fault of your manager?
“We talk about setting up a limited company to limit liability – so if something catastrophic happens and a big claim is going to sink the business then you can strip the assets, wind down the business and open again in a few weeks’ time to begin trading as something else. There’s confusion about where the line of personal liability sits with directors of that company.”
Taylor pointed out that insurance companies often made pay-outs that would make the policyholder liable for an incident. “They do it because it’s cheaper for them than actually fighting it – that’s something I have a major issue with, and so I don’t allow any pay-outs unless I’ve authorised it,” she said.
“That’s a good point,” said McGovern, “because when it comes to paying out claims, insurers make the decision.”
Gracie suggested that if banks are lending money to a business then they should insist there is an experienced non-executive director on the board with experience of corporate governance.
Kelly pointed out that there is a cost associated with a credible non-executive director coming into the business.
Brock said banks looked at the professionalism of a team before lending money. “The challenge has always been that when banks put a non-executive director on a board then they’re crossing the line in becoming a ‘shadow director’ because they have too much influence. Banks have always been nervous about that.”
Morrison asked if directors were still responsible for their actions after a company had been liquidated?
McGovern replied that regulators and prosecutors could lodge caveats at Companies House so they could continue their investigations even if a director was trying to wind-up a company.
“It would help corporate governance enormously if we could get across the message that you can’t hind behind the cloak of corporate entity – you have a responsibility as an individual,” said Carruthers. “I don’t think that message is out there among the general public.”
“Part of the problem is that we’re pushing this idea of the entrepreneurial economy all the time and we don’t talk about failures,” explained Willis. “We don’t talk about the pain of insolvency. If you don’t understand the accounts then you have a duty of care as a director to educate yourself so that you do understand the accounts.”
“You need very good reporting procedures and processes to give directors the right information,” Gracie pointed out. “Directors need good reporting in order to make decisions. A lot of companies don’t have that – they don’t produce monthly management accounts. Cash management is paramount.”
Townsley asked whether trustees should be held accountable for the actions of a charity if they are volunteers. Carruthers replied: “It’s a valid question – but yes, they should be held accountable. It doesn’t matter if they’re not being paid or if they’re doing it out of the goodness of their heart. If you’re the director of a board then the buck stops with you, but I don’t think that message is universally acknowledged.”
Watt asked McGovern how many directors were prosecuted each year. McGovern said an increasing number were being prosecuted by regulators, pointing to directors being jailed following Sepa investigations.
McGovern also highlighted the increasing scrutiny on who is donating money to charities. “Are charities doing due diligence on donors?” he said. “That’s the way regulators are going.”
Breakey and Gracie questioned what amounted to due diligence on donations, while Morrison said probing too far would cast aspersions on the character of the donor and McKay asked whether in-depth checks were a good use of a charity’s limited resources.
Townsley highlighted the long chain of command between directors and the operational staff.
“Ultimately, corporate governance is about ensuring that what you think is going on is actually going on,” said Watt. “How do you do that? For example, I sit on the board of a sport and leisure trust and our members go out and visit sports centres to make sure health and safety policies are being implemented.”
Gordon asked if such visits crossed a line between being an executive and non-executive director. “Being a non-executive director is about keeping your nose in and your fingers out,” she said.
Willis argued such visits flew the flag for health and safety and raised standards, rather than interfering.
“It’s about finding the balance between asking questions but not undermining the senior staff,” added Watt. “You’re allowed to carry out stress tests to find out what’s going on.”
Kelly highlighted the need to take “reasonable steps” in corporate governance, while McGovern pointed out that what staff judged to be reasonable steps in the workplace could be different to what a judge decides is reasonable when they come to analyse the case several years later.
“The biggest cause of these situations that lead to litigation is a lack of communication,” added McGovern. “It’s about trusting the people you put in charge of areas such as health and safety and communicating with them about what they’re doing.”
Brock said: “A lot of the business plans that come across my desk contain strength, weakness, opportunity and threat (SWOT) analysis that have been copied out of a textbook. So we ask applicants ‘What risks keep you awake at night?’ and often that’s the first time they’ve really drilled down into the real risks. “If people use the word ‘risk’ then it changes how they view things; ‘corporate governance’ comes across as just being controls, but when you start talking about personal risk and liability then you shift how people view it.”
Gordon asked Brock about the checks and balance the bank would want in place before it agreed to lend. Brock said he would ask questions about non-executive directors and what professional advice had been taken.
McGovern highlighted the need for directors to have policies in place about tackling cybercrime. Townsley said the threat was so significant that it would be the topic for a future BQ Live Debate.
Gordon asked about the liabilities of non-executive directors. McGovern highlighted that regulators tended to target the “controlling mind”.
Willis said all directors should check their insurance policies and that policies should be tailored to suit each director’s circumstances on each particular board on which they serve, especially whether they have tail-off cover for once they leave a board.
Townsley questioned the responsibilities of non-executive directors compared with executive directors, with McGovern and Kelly pointing out that regulators would look at an individual’s knowledge and conduct, rather than their executive or non-executive status.
Gordon questioned whether the same individual could still serve as both chief executive and chairman.
“It depends on the size of the company,” replied Gracie. “For large companies, you need a chairman who is divorced from the day-to-day management of the organisation. But for small companies, the same individual could be the owner, chairman and chief executive.”
Watt said: “The same individual serving as chairman and chief executive has never been accepted by the stock market – it’s seen as bad practice when it comes to corporate governance.”
Brock said: “You have a similar situation in the social housing sector, with the regulator asking if someone should still be a non-executive director after they’ve served for seven years. That’s a problem if you’ve had tenants sitting on a board for 15 or 20 years.”
“The IoD recommends two terms of four years each would be the maximum length for a non-executive director to serve on a board,” Watt added.
As the debate came to its conclusion, Townsley asked McGovern what directors should do if they’re faced with an investigation by a regulator. McGovern explained that an insurer would insist on an internal investigation following an incident and he advised that the company’s lawyer should conduct that investigation. “The beauty of that is that we as lawyers can then exert legal professional privilege,” he said. “What we uncover in these investigations tends to be culpability. The HSE would uncover that too. But invariably, if the internal report is not protected by privilege then it will highlight the evidence for the HSE. It’s about protecting the business.”