In the case at point, Mason v Lewis, the Directors failed to take an active interest in the Company; they didn’t ensure that the Company kept adequate accounts; and, they failed to adequately monitor the activities of the Company’s executive manager. The Directors relied on continued verbal assurances from the executive manager and accepted inadequate accounts. The manager later turned out to be a fraudster, but this did not relieve the Directors of liability for failing to monitor the affairs of the Company.
Two key Director duties are the duty to ensure the Company keeps proper accounting records and the duty to not allow the Company to incur debts it is unlikely to be able to repay (reckless trading). In this case, the accounts were so deficient that the liquidators could not establish what debts the Company owed. To be liable for reckless trading, there must be a real risk of substantial loss to creditors as a result of the Company continuing to trade. Taking risks is a necessary part of business, however the Court has drawn a distinction between legitimate and illegitimate risks. In order to breach this duty, the risk assumed must be one that would be considered by a reasonable Director to be an improper or inappropriate risk.
Directors can rely on others, including employees, but they must act reasonably in doing so. In relation to the duty to keep proper accounts, a Director must show he or she took all reasonable steps to ensure adequate records were kept. If it turns out proper records have not been kept, the only defence is that the Director believed on reasonable grounds that a competent and reliable person was keeping them. In relation to reckless trading, Directors should insist on adequate records being prepared and presented to the board. Directors have an obligation to monitor and supervise the activities of the Company’s employees. They cannot rely simply on verbal assurances. Directors should regularly receive and consider business updates, and consider the position of the Company in light of changing circumstances. In this case the Company lost the primary contract that it had been set up to fulfil – a major event such as this puts Directors on notice that further enquiry is required.
The message from the Court is clear -“the days for sleeping Directors are over”. Director’s must play an active role in monitoring the affairs of the Company. If solvency concerns arise, Directors must consider strategic options, including stopping trading. A Director may also resign if they are not comfortable with the actions of the Company’s management or Board. A Director is not liable for debts incurred after they resign.
