Directors' duties and the auditor's defence of contributory negligence:
The issue of contributory negligence took a central role in both appeals. When the company's losses were occasioned by the acts of a third party, the court will look at the circumstances of each case to apportion the loss as between the company and its auditors.
The Court of Appeal in Gaelic Inns set out two broad situations where the contributory negligence of the company may arise:
(a) where the company has, by its acts, positively prevented or hindered the auditor from carrying out his duty with due skill and care; or
(b) when there has been such negligence that the company may be found to have failed to look after its own interests even though it has appointed an auditor.
Contributory negligence is an important defense that will almost invariably arise in cases involving fraud or misfeasance by a company's directors or employees. After all, if statutory auditors act as an ex post check on the company's dealings for a particular financial year, the company's directors may well be hard pressed in most cases to explain how they allowed the fraud to take place under their watch, in the day-today management of the company's affairs.
In finding GIPL to be “contributorily negligent by reason of its own patent failure to safeguard its own interests”, the Court of Appeal found that “… Crowhurst, Lew and Shaw had been guilty of serious maladministration of the company's affairs, with the result that [GIPL] failed to detect [D's] defalcations until May 2004”.
As to the precise factors that led to the Court of Appeal's opinion that a “serious maladministration” gave rise to contributory negligence on the part of Gaelic Inns, the court was cognizant of the trial judges' findings that “there was ample justification for being critical of the management's shortcomings”:
(a) The managing director was responsible for the day-today running of the company. He confirmed receiving monthly bank reconciliation statements but never bothered to look at them.
(b) The managing director had (under cross-examination) admitted to not monitoring the company's banking procedures which were breached over time.
Similarly, in JSI Shipping, the Court of Appeal observed that it was “complainants indifference, laxity in management and failure to properly carry out his fundamental obligation to oversee and monitor the appellant that permitted respondents defalcations”. The Court of Appeal also observed that s 199(1) and s 201(15) of the CA “unequivocally state that the financial statements of a company are the responsibility of its directors”.
As such, it is fairly certain that the courts will look first to the conduct of those managing or executive directors who supervise and are responsible for the day-to-day management of the company. The management shortcomings of such persons will have a direct impact on a court's determination as to contributory negligence on the part of the company.
One interesting question that arose in Gaelic Inns was the responsibility of the non-executive directors, namely, Lew and Shaw. The Court of Appeal in Gaelic Inns emphasised that “the mere fact that … non-executive directors … took a backseat in the management of the company did not exempt them from the need to exercise a modest level of scrutiny as to the goings-ons in the respondent”.
As such, the Court of Appeal held that non-executive directors, regardless of whether or not they received copies of the company's accounts in the regular course of business, remained under a duty to ensure that the company's accounts were in order:
The nub of the issue is whether they remained under a duty to take positive steps to ensure that the accounts were in order (at least on their face), despite their designation as non-executive directors. This question ought to be answered in the affirmative.
As such, not only is it clear that non-executive directors are under a duty to take positive steps to ensure that a company's accounts are in order, but that their failure to do so may support a court's finding that the company was contributorily negligent for the loss, as part of the “cumulative lapses” on the part of both the managing director and non executive directors which constituted “serious management failure and ought to be treated as fault for the purposes of a defence of contributory negligence”.
