The buck: where does it stop?

Richard Furlong considers the liability of company directors for criminal wrongdoing by their employees.

The Economic Crime and Corporate Transparency Act 2023 expanded corporate liability by widening the identification doctrine from the old “directing mind and will”test to a new “senior manager”test. My colleague Vanessa Reid wrote a very helpful article on these changes in December, available here.

However, liability for offending within a company does not stop either at the offender or the company. There are many circumstances in which directors themselves can be held liable for wrongdoing by their subordinates. Vicarious liability, it is said, has no place in criminal law. But there are limits to that proposition.

The old law that a company is a separate legal person and that by setting up a company, directors are limiting their liability tends to blur the reality that directors are often – and increasingly – prosecuted for wrongdoing on the part of their employees, without the need to involve the company itself as a defendant. Directors should not fool themselves that the limitation on their liability extends to criminal wrongdoing.

There are broadly, three states of mind for which directors can be held criminally liable in certain (different) circumstances. These are knowledge, consent or connivance, and negligence or neglect. Proving each of those states of mind, however, is arguably easier with company directors than with other individuals, because of the statutory background of duties imposed on company directors.

The relevant states of mind

1. Knowledge

If a director has knowledge of financial wrongdoing within the company relating to the operations of the company, and is nonetheless involved in the running of that company, the director may well be guilty inter alia of fraudulent trading.

Section 993(1) of the Companies Act 2006, which creates the modern offence, states “If any business of a company is carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, every person who is knowingly a party to the carrying on of the business in that manner commits an offence.”

The carrying on of a business with intent to defraud creditors, need of course only involve one creditor and one transaction, as long as it takes place in the course of a business (see Morphitis v Bernasconi [2003] Ch. 552, following Re Gerald Cooper Chemicals Ltd [1978] Ch. 262).

The meaning of “for any fraudulent purpose” is wide, following Kemp [1988] QB 645. Henry J concluded that the words meant what they said, and should not be limited in any way by the reference to creditors earlier in the section.

The question then arises as to the limits of liability for being knowingly party to the carrying on of the business in that manner.

In the earlier authorities, Gerald Cooper Chemicals (qv.) and In re Maidstone Buildings Provisions Ltd. (1971) 1 W.L.R. 1085 the view was taken that for example a company secretary who fails to give appropriate advice to the directors is not thereby a party to the carrying on of the business in a fraudulent manner. The approach was a narrow one. Maidstone Buildings sets out that to bring a person within the section it must be shown that they have taken “some positive steps in the carrying on of the company’s business in a fraudulent manner”.

In R v Miles [1992] Crim LR 657, the Court of Appeal held that section 458 of the Companies Act 1985, the previous statutory provision creating the fraudulent trading offence, was designed to include only those exercising a controlling or managerial function within a company, in other words those “running the business”.

The modern approach however, was firmly established in Tradition Financial Services Ltd v Bilta (UK) Ltd [2023] EWCA Civ 112. The Court of Appeal Civil Division considered the question in the context of section 213 of the Insolvency Act 1986, and reviewed all the earlier authorities.

The words of Bank of India v Morris [2005] EWCA Civ 693 at 129 cited in Tradition had to be borne in mind: “the severing of criminal and civil liability for fraudulent trading means that there is no question of any conclusion, in principle or on particular facts, as to civil liability affecting the basis on which criminal liability is assessed.”

However, in Tradition, the Court concluded that section 213 was not limited to those exercising a controlling or managerial function, and merited a wider rather than narrower interpretation. Indeed they did not expressly exclude the possibility that an “outsider” might be party to the carrying on of the business, as long as ‘some positive steps’ were taken.

Bank of India is also authority for the proposition that the “blind eye knowledge” test from Manifest Shipping Company Ltd v Uni-Polaris Company Ltd [2003] 1 AC 469 (a firmly grounded suspicion targeted on specific facts, that the relevant facts do exist, and a deliberate decision to avoid confirming that they exist) is relevant for fraudulent trading.

R (Palmer) v Northern Derbyshire Magistrates Court [2023] UKSC 38 reached the Supreme Court on the issue of whether an (insolvency) administrator was an “officer” of the company under the Trade Union and Labour Relations (Consolidation) Act 1992 (on an issue of consent or connivance). The Supreme Court decided that they weren’t – but it took the Supreme Court to decide.

2. Consent or connivance

A wide range of offences may be proved against a director whose state of mind was “consent or connivance”. Where an offence is proved against the company itself, directors may be liable as secondary parties if it can be established that the offending occurred with the consent or connivance of the director, or if it was attributable to the neglect of that director. This principle applies in respect of most health and safety, consumer protection and regulatory offences, including the majority of situations where statutory duties are imposed on companies.

A particular example of this wider liability of directors is section 14 of the Bribery Act 2010 which establishes that where an offence under section 1 (bribing another person), section 2 (accepting bribes) or section 6 (bribery of foreign public officials) is committed by a company and that offence is proved to have been committed with the consent or connivance of a senior officer (director, manager or secretary) of the company, the senior officer as well as the company will be guilty of the offence. It should be noted however that this provision does not apply to the offence of failing to prevent bribery.

These criminal liabilities arise in addition to quasi-criminal consequences for example from Insolvency Service (Companies Investigations Branch) investigations into the conduct of directors.

Looking at the meaning of “consent or connivance”, Attorney-General’s Reference (No.1 of 1995) [1996] 2 Cr.App.R. 320, adopted in R v Chargot Ltd (t/a Contract Services) [2008] UKHL 73, established the proposition that in relation to offences with a mens rea of consent or connivance (in AG Ref, an offence under the Banking Act 1987, s.96(1)), a director was liable if it was proved that he knew the material facts constituting the offence by the company and gave his agreement to the business conducted. This agreement could be proved by inference as well as express evidence. The fact that a director was ignorant of the requirement for a banking licence was no defence. That this state of mind also encompasses “wilful blindness” was established by Huckerby v Elliott [1970] 1 All ER 189.

Chargot Ltd concerned proceedings under the Health and Safety at Work etc. Act 1974, s.2(1) and s.3(1), and insofar as the director was concerned, s.37, which was a consent, connivance or neglect offence. So far as the director was concerned, the prosecution had to prove the s.2 or s.3 offence and then had to prove that the body corporate committed it with the director’s consent or connivance, or that its commission was attributable to any neglect on the director’s part.

Lord Hope observed that no fixed rule could be laid down as to what the prosecution must identify and prove in order to establish that the officer’s state of mind was such as to amount to consent, connivance or neglect. He took the example of a case where the officer’s place of activity was remote from the workplace or what was done there was not under the officer’s immediate direction and control. In that situation, Lord Hope considered that proving the mental element might require the leading of quite detailed evidence of which fair notice would have to be given. In other situations, where the officer was in day-to-day contact with what was done at the workplace, very little more might be needed.

Where it is shown that the body corporate failed to achieve or prevent the result that those sections contemplate, it will be a relatively short step for the inference to be drawn that there was connivance or neglect on the part of the director if the circumstances under which the risk arose were under the direction or control of the officer concerned. The more remote the officer’s area of responsibility was from those circumstances, the harder it would be to draw that inference. 

3. Neglect

The negligent director may find themself in difficulties on the same basis as the ‘blind eye’ director who is found to have consented or connived in the offending where the company is prosecuted. Many of the statutory provisions in the areas of law set out above talk of consent or connivance on the one hand, and neglect on the other.

In R v P Ltd & another [2007] EWCA Crim 1937, a health and safety case, Latham LJ endorsed the approach that the question would always be whether the officer in question should have been put on inquiry so as to have taken steps to determine whether or not the appropriate safety procedures were in place.

Huckerby v Elliott (qv.) is very old, and it is not clear that it would survive modern scrutiny, on the basis of the statutory duties set out below, but is on its face authority for the proposition that a company director who fails to enquire about certain matters which are dealt with by a fellow director cannot be said to be neglectful. On its facts, the company pleaded guilty to a charge of providing gaming premises without an appropriate licence contrary to s.13(1) of the Finance Act 1966 s.13(1), and one director pleaded guilty to a consent offence. The appellant, also a director, pleaded not guilty to a charge under the same Act in that the offence was attributed to her neglect. The evidence showed that she knew little of the conduct of the premises, nor did she have any knowledge of whether or not a licence had been obtained. The Divisional Court held that she was entitled to leave certain matters to her fellow director, and that the prosecution had failed to prove neglect on her part. Lord Parker observed that he knew “of no authority for the proposition that it is the duty of a director to, as it were, acquaint himself with all the details of the running of the company.”

The statutory duties on directors and the consequences for proving a director’s state of mind

There are, as is well known, seven modern statutory duties on a company director set out in sections 171 to 177 of the Companies Act 2006. These are as follows:

i. to act within their powers and in accordance with the company’s constitution;

ii. to promote the success of the company;

iii. to exercise independent judgment;

iv. to exercise reasonable care, skill and diligence;

v. to avoid conflicts of interest;

vi. to not accept benefits from third parties; and

vii. to declare interests in proposed or existing transactions or arrangement with the company.

Where wrongdoing takes place inside a company, a prosecutor may point to the statutory duties of a director. The implication of becoming a director is that those duties are accepted. A prosecutor may invite the court to draw an inference that having accepted the duties the director abided by them. If the inference is that the director abided by the duties, and the employees, over whom the director had a duty to exercise reasonable care, skill and diligence, were up to no good, then the (rebuttable) inference may follow that the director knew what the employees were doing.

The director then is in a difficult tactical position. It may fall to them to seek to raise an issue that they did not know, on the basis that they neglected their statutory duties. The consequences of running a defence along those lines may be that the director defendant is effectively asserting that they are unfit to be a director.

The case law appears to have been left well behind.

Romer J in Re City Equitable Fire Insurance Co Ltd [1925] Ch. 497 at 428–430 considered the position prior to the existence of any statutory duties on company directors. Adopting the words of Lord Macnaghten in Dovey v Cory [1901] AC 477 at 488, Romer J agreed: ” I do not think it desirable for any tribunal to do that which Parliament has abstained from doing—that is, to formulate precise rules for the guidance or embarrassment of businessmen in the conduct of business affairs. There never has been, and I think there never will be, much difficulty in dealing with any particular case on its own facts and circumstances ; and, speaking for myself, I rather doubt the wisdom of attempting to do more.”

On the basis of that approach, Romer J observed that in discharging those duties, a director must (a) act honestly, and (b) exercise such degree of skill and diligence as would amount to the reasonable care which an ordinary person might be expected to take, in the circumstances, on their own behalf. 

But the director need not exhibit in the performance of their duties a greater degree of skill than may reasonably be expected from a person of their knowledge and experience.  In other words, the director is not liable for mere errors of judgement; they not bound to give continuous attention to the affairs of the company. Their duties are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee to which they appointed, and though not bound to attend all such meetings they ought to attend them when reasonably able to do so. In respect of all duties which, having regard to the exigencies of business and the articles of association, may properly be left to some other official, they are, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.

Whilst on its face a rather light-touch approach given the statutory duties of directors in the 2006 Act and the modern conduct of business, this case remains, in the civil context at least, good law (see Sharp v Blank [2019] EWHC 3096).

Conclusion

The idea that an executive director’s duties are of an intermittent nature, on the basis of a presumption of trust between gentlemen, appears somewhat antediluvian. While in larger corporations, that approach might be valid for the non-executive director, these days the executive director who popped into the office to tell the staff “You’ve all done very well”, in the manner of Young Mr Grace from “Are You Being Served?” and then went off to his gentlemen’s club, while the staff were engaged in some Ponzi fraud, might recevie rather short shrift from the courts. 

Times have changed, and the sooner that directors realise that their responsibilities are now considerably more onerous, the better.