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UK: Managing nominated directors’ liabilities01/01/2006. Source: SJ Berwin. Tim Wright
 Directors nominated by private equity investors to sit on the boards of portfolio companies are subject to the same duties and liabilities as any other directors says SJ Berwin. However well insured they may be, nominated directors should understand their duties to help them avoid litigation.
A director’s basic duty is to act with absolute honesty and reasonable skill. Unfortunately there is currently no single list of duties that a director must discharge to meet this standard. Nominated directors should therefore observe a number of key principles: act within the powers granted by the company’s constitution and in the interests of the company; use independent judgement as well as reasonable care, skill and diligence; take account of stakeholders; and avoid conflicts of interest, misuse of company property and secret profits. This article suggests some basic guidelines to help nominated directors avoid liability and handle difficult situations.
Core duties
Directors should be aware of the company’s constitution as set out in the memorandum and articles to ensure they do not exceed their authority. Although financial restrictions on borrowing money or allotting shares are rare in private equity investee companies, directors should nevertheless check for any such limitations.
Even though an investor nominates a director to a portfolio company, the director must have regard to the interests of all shareholders, not just those of his appointor. A director should also use his independent judgment, rather than simply act upon the investor’s instructions. Furthermore, directors should maintain accurate board minutes to demonstrate that they considered all material facts and stakeholders before reaching a decision.
Conflicts of interest
Nominated directors must take particular care when the interests of the company and the appointing investor diverge, and must remember their overriding duty to the company. A nominated director should also make it clear at all times whether he is communicating in his capacity as director, or as a representative of the investor.
Company information can cause problems. Nominated directors must take care not to disclose any information about the company acquired as a result of the directorship without the company’s prior authorisation (often contained in a well drafted shareholders agreement), not even to their appointor. Similarly, they should not take advantage of any opportunities arising from their position as director as this could amount to making secret profits.
Companies in financial difficulties
If a company is in financial difficulties and there is no reasonable prospect of avoiding insolvency, directors’ duties increase. Nominated directors should take care to take decisions with a view to minimising creditors’ losses to avoid claims of wrongful trading. Simply resigning and attempting to walk away from the situation will not mean an end to their liability.
As a general rule, nominated directors should seek professional advice if necessary and follow the portfolio company’s decision-making procedures at all times as these will help them demonstrate that they are acting absolutely honestly and with reasonable care.
If, however, nominated directors fail to discharge their duties and face legal proceedings, they may benefit from new indemnities available to directors since April 2005. In the UK, a company may now pay a director’s legal costs in defending a claim brought by the company or a third party, as these costs are incurred. The director will only be liable to reimburse the company if a claim brought by the company itself is successful.
Additionally, a company can indemnify a director for the financial costs of an adverse judgment, but not criminal or regulatory penalties, arising from a third party’s claim. If such indemnities are offered, the directors must make copies available to shareholders for inspection and disclose the indemnities in the annual report and accounts. The private equity community should assess whether to seek these indemnities, or to rely on existing insurance arrangements.
In any event, strong procedures that enable a nominated director to deal with a conflict of interest as it arises are critical. Having clear procedures, and following them can avoid unpleasant litigation if things go wrong, and the consequent risks to reputation that this can entail. The financial losses may be covered by insurance or indemnities, but the wasted management time and damage to the good name of the investor may pose even more significant risks.
Tim Wright
Tim Wright is a partner in the private equity team at SJ Berwin LLP. He can be contacted on: T +44(0)20 7533 2575 - E tim.wright@sjberwin.com.
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com
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