Carillion disqualification proceedings dropped – but where next for NEDs?
The insolvency of Carillion has attracted widespread media and political interest, including two Select Committee inquiries as well as investigations by the Financial Conduct Authority (FCA), Financial Reporting Council (FRC), the Official Receiver, National Audit Office and Pensions Regulator.
The disqualification trial was due to start imminently on 16 October 2023. It was set to be a blockbuster case which, if the IS were to succeed, would have reshaped the role of NEDs in the UK. The IS’s case would have been that Carillion’s NEDs had breached a “strict duty to know the true financial position of the company” (in the Carillion defence team's formulation). The defence team would have submitted that this was inconsistent with directors’ duties under UK company law.
The proceedings, if successful, would have significantly raised the corporate governance standards NEDs are required to meet. Critics feared that this would discourage individuals from acting as NEDs, transforming the UK corporate governance landscape in the process. Yet others have hailed the potential of such ‘test’ cases to bring much needed clarification to corporate governance expectations, thereby preventing future collapses of a similar magnitude.
In this article, we examine the background of the Carillion collapse, the legal standard for NEDs and the implications of the IS’s decision to discontinue the proceedings. We also touch on other recent developments in the long-running saga, including a recent settlement between the IS and three former executive directors of Carillion.
Carillion was a major FTSE 250 construction and outsourcing company that entered compulsory liquidation on 15 January 2018. Its collapse left behind huge debts, a pension deficit and unfinished public contracts. The company’s failure had dramatic consequences for its shareholders, 43,000 employees, 30,000 suppliers, 27,000 pensioners and the taxpayers who had to fund the liquidation and the completion of vital infrastructure projects.
The collapse also raised serious questions about the governance, accounting and oversight of Carillion and its directors, who had authorised a large dividend and received generous salaries and bonuses while the company's financial performance rapidly deteriorated.
The IS’s case against the eight former directors of Carillion was, at a high level, that they had:
- knowingly caused the company to publish misleading financial statements that did not comply with relevant accounting standards; and
- paid a dividend that was not justified in circumstances where the company’s performance was faltering. On that basis, the IS sought a court order under section 6 of the Company Directors Disqualification Act 1986 (CDDA) that the former directors were unfit to be concerned in the management of a company.
The three executive directors subject to proceedings agreed to disqualification undertakings:
- 12 1/2 years for Richard Adam (finance director to 31 December 2016)
- 11 years for Zafar Khan (finance director from 1 January 2017 to 11 September 2017)
- Eight years for Richard Howson (CEO to 10 July 2017)
Statements published by the IS at the time of accepting each undertaking referred to causing Carillion to rely on false and misleading financial information, failing to report the true financial position and risks to the board and the audit committee, breaching market disclosure rules and breaching accounting standards.
The FCA also issued decision notices against Mr Adam, Mr Khan, and Mr Howson, imposing significant financial penalties for reckless conduct.
The five NEDs, including the former chairman Philip Green and the head of the remuneration committee Alison Horner, contested the disqualification proceedings, which would have formed the basis of the trial.
NEDs: a strict duty to know the financial position of a Company?
The IS’s case against the NEDs at trial would have centred on whether their duties required them to know the strict true financial position of the company, which the IS alleged they had breached by failing to know that the executive directors were giving a misleading picture of the company’s financial position. On that basis, the NEDs were said to be unfit to manage a company such that they should be disqualified under section 6 CDDA.
The starting point is that directors’ duties, as codified under the Companies Act 2006 (CA 2006), apply equally to NEDs as to executive directors. NEDs are therefore subject to the same overarching requirement under section 174 CA 2006 to “exercise reasonable care, skill and diligence” in the management of a company’s affairs.
A company with a premium listing on the London Stock Exchange is expected to comply or explain with the Corporate Governance Code (the Code). The Code states that NEDs “should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible.” While the Code is not legally binding, it is indicative of good practice which may inform the content of a director’s duty under section 174 CA 2006.
Consistent with this, the Select Committee Report in respect of Carillion had observed “NEDs are responsible for constructively challenging the executives responsible for the day-to-day of a company”.
The Select Committee Report gave a damning summary of the NEDs’ performance in this instance: “Non-executives are there to scrutinise executive management. They have a particularly vital role in challenging risk management and strategy and should act as a bulwark against reckless executives. Carillion’s NEDs were, however, unable to provide any remotely convincing evidence of their effective impact.”
As for the non-executive chairman Philip Green, the Select Committee castigated him as Carillion’s “cheerleader-in-chief” presiding over a “delusional, upbeat assessment of the company’s prospects only days before its public decline”.
The Select Committee Report also passed comment on Senior Independent NED Keith Cochrane, finding that he was aware of shareholders’ concerns about the company’s net debt and pensions deficit but showed little sign of properly challenging the position.
The defence’s position at trial was to be that the IS’s case was legally flawed: a strict duty to know the true state of the company was based on an erroneous reading of a 1998 case and inconsistent with the formulation “reasonable care, skill and diligence” standard set out in section 174 CA 2006. Section 174 CA 2006 has, historically, been widely understood to impose a contextual standard (relative to the company and the specific facts) that does not impose a strict standard.
The defence was also set to argue that more than mere negligence is required for a director to be declared unfit to be concerned in the management of a company under section 6 CDDA, and that the IS had failed to particularise any specific actions that the NEDs omitted to take by which they could be deemed unfit.
Where does this leave NEDs?
The disqualification proceedings had been widely anticipated as a case which would clarify the extent of duties owed by directors (and NEDs in particular) in respect of financial oversight of a company. Board behaviour would have come under intense scrutiny in the long shadow of damming Select Committee findings, record audit fines, and extensive government-backed IS action.
Current practice is well reflected by the recent first-instance decision Secretary of State for Business, Energy and Industrial Strategy v Selby (EWHC 3261 (Ch) ), in which ICC Judge Prentis observed that, even while the duties for NEDs are the same as for executive directors, “their application need not be”. It is therefore still necessary to look at how the particular company’s business is organised and the part which the relevant director could reasonably have been expected to play. For this reason, the IS’s hard-edged approach in the disqualification proceedings was seen as a test case for what may have been a new and more onerous judicial attitude to the duties of NEDs.
The duty of a director under s.174 CA 2006 is expressed as requiring “the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company and the general knowledge, skill and experience that the director has”.
It is arguable that the emphasised words can narrow the requirement placed on NEDs compared with executive directors. The “functions carried out by” a NED may be limited compared with the functions carried out by an executive. There is case law authority confirming that delegation and division of responsibility may be necessary and appropriate in corporate life.
For example, in Re Sherbourne Associates  B.C.C. 40, it was acceptable for NEDs who had not been recruited for any financial expertise to rely on information provided by the much more actively involved chairman.
And in Singer v Beckett  4 WLUK 505, a liquidator’s claim for wrongful trading and misfeasance was dismissed. Directors were permitted to rely on figures presented by a finance director, having considered and interrogated those figures to an appropriate extent. The judgment noted that if there had been any misfeasance because of the state of the accounting records, that would only have been misfeasance on the part of the finance director and not the others. The judge stated:
I accept that one of the duties of non-executive directors is to monitor the performance of the executive directors. I accept that the managing director of a company…has a general responsibility to oversee the activities of the company, which presumably includes its accounting operations. But I do not think that those responsibilities can go so far as to require the non-executive directors to overrule the specialist directors, like the finance director, in their specialist fields. The duty is not to ensure that the company gets everything right. The duty is to exercise reasonable care and skill up to the standard which the law expects of a director of the sort of company concerned, and also up to the standard capable of being achieved by the particular director concerned.1
This neatly sums up the widely understood position that NEDs can delegate matters or defer to the expertise of others. They do not need to be involved in every detail of the company’s affairs. What matters is that they exercise suitable oversight and interrogate information put before them to the best of their abilities and as appropriate for the company’s situation.
The recently commenced trial in the BHS litigation (Re BHS Group Ltd (in liquidation)2) is a further opportunity for an important judgment on such matters. In that case, NEDs are accused on being "asleep at the wheel". It is said by the claimants, BHS' joint liquidators, that the board played no active part in the decision to sell BHS, having appointed a sub-group to look into the sale over which they had no scrutiny. This could turn out to be the sort of excessive delegation and lack of oversight that goes too far.
The IS’s decision to drop the Carillion case at the last minute has intensified calls for new standards in respect of NEDs to be codified. The Government had previously dropped proposals to make directors personally liable for internal controls over financial reporting in 2022, which would have brought the position in England in line with the US’s Sarbanes-Oxley Act (introduced in the wake of Enron’s collapse in 2002).
The fact the case has been dropped may be of limited comfort to NEDs, particularly those in high-profile roles or on the board of companies in financial distress. The IS has laid down a marker that it will not necessarily be satisfied by directors who have not properly interrogated the position of a company. Absent a test-case, it remains possible that the Courts will be sympathetic to those arguments in a future case, and it can in any event be difficult to establish exactly where to draw the line for any given director or company. Few directors will relish the prospect of fines and scrutiny from a cadre of public bodies, or the accompanying media coverage and legal costs over more than half a decade.
We expect that this area will continue to be subject to intense political debate and the scope for judicial development remains.
This article has been co-authored by trainees Alex Abelidis and Alex Taylor.