Carillion director disqualification proceedings – Insolvency Service drops proceedings against non-executive directors in so-called "test case"

On the eve of trial, the Insolvency Service (IS), acting on behalf of the Secretary of State for Business and Trade, has discontinued disqualification proceedings brought in January 2021 against five former non-executive directors (NEDs) of Carillion plc. The trial, which had been listed for around 13 weeks (and originally as long as 6 months) had been due to start on Monday 16 October 2023.

The IS had been seeking to disqualify the NEDs from being involved in the management of any company on grounds that they did not know the alleged true financial position of Carillion (in particular alleged fraudulent misstatements of group accounts) at all times, including from the date on which they were appointed – ie a strict liability for the directors.

The IS's case contrasted with established principles as to the standard of conduct expected of directors, including under the Companies Act 2006. If the IS's claim had succeeded, it would have had serious and immediate consequences for corporate governance practices in the UK, no doubt impacting the willingness of individuals to act as non-executive directors of UK companies, particularly large and complex corporate groups.

Background

The Carillion Group, until it went into compulsory liquidation in January 2018, operated a leading construction, project finance and support services business in the UK and across a number of other jurisdictions. It encompassed over 350 operating subsidiaries with Carillion plc as their ultimate (listed) parent company. Its liquidation followed the announcement of a provision of £845 million in July 2017, the majority of which related to certain key construction and public infrastructure projects, and despite the Board's considerable efforts to save the company in the six to seven months thereafter.

Amidst significant media and political interest in the insolvency of the Group, various investigations and legal proceedings were commenced, including by the Financial Conduct Authority, the Financial Reporting Council, the Pensions Regulator, the Official Receiver and the National Audit Office. Two separate joint Select Committee inquiries were also established in early 2018 into the causes of the insolvency.

The disqualification proceedings brought against certain of the former directors of Carillion plc was a follow-on from the investigation conducted by the Official Receiver between 2018 and 2020 into the company's failure and the conduct of its former directors. Up against a limitation deadline, following which any claim against the directors would have become time-barred, director disqualification proceedings were commenced against eight of the former directors of Carillion plc, including each of the NEDs and three former executives – the former CEO and two former Finance Directors.

The IS issued proceedings against those individuals in the High Court in January 2021 under s.6 of the Company Directors Disqualification Act 1986 (CDDA), seeking disqualification of each of them for varying periods. (By statute the court has discretion to order disqualification of between 2 and 15 years.)

Case against the executives

The IS's case against the Finance Directors was essentially one of fraud, namely that they (as applicable) knowingly caused Carillion plc: (1) to publish accounts which they knew did not comply with relevant accounting standards in respect of seven specific contracts and transactions; (2) to publish related market announcements which were said to be misleading as to its financial performance, position and prospects, and in breach of Listing Rule 1.3.3 and the UK Market Abuse Regulation; and (3) to pay a dividend which could not be justified in view of the "true" financial position.

The IS's case against the former CEO was that he ought to have known that accounts were non-compliant in the way alleged, but allowed the company to publish its accounts and pay the dividend notwithstanding.

Between 29 June and 4 October 2023, each of the executives gave disqualification undertakings, in which they agreed not to be concerned in the management of a company for 12.5, 11 and 8 years respectively. None of the undertakings involved any admissions by the executives as to the alleged fraud or indeed any direct knowledge or involvement in the preparation of incorrect accounts.

As such, this left the NEDs as the sole remaining defendants to the claim.

Case against the NEDs

The central plank of the IS's case against the NEDs alleged that, during the relevant period, they were in breach of a strict duty to know the "true" financial position of Carillion at all times (described as the so-called "NED Duty"). It was originally alleged that this "failure to know" meant that the NEDs ought to be held responsible for the unfit conduct of the executive directors and disqualified on that basis. However, that element of the IS's case was later dropped.

The remainder of the IS's case argued that (irrespective of the executive's conduct) by virtue of their breach of the alleged strict duty and as a result of the NEDs not knowing about the alleged fraud, without anything more, they were unfit to be involved in the management of any company (which is the statutory test under s.6 of the CDDA).

The IS also advanced separate allegations that the NEDs were directly responsible for the publication of misleading accounts (and payment of the dividend) on the basis that they ought to have known that those accounts were misleading by virtue of various alleged "warning signs".  However, even as part of this alternative case, the IS did not advance any allegation as to any specific acts or omissions by the NEDs and stated that its case did not involve "any inquiry into fault or reasonableness".

The NEDs' defence

In response, the NEDs argued that the IS's case was permeated by a fundamental misunderstanding of the law on directors' duties as well as to the role of a non-executive director. Indeed, the NEDs set out in extensive evidence the many diligent steps which they did take in the proper discharge of their duties and as might be expected of them given the nature of their role.

The alleged "NED Duty"

Specifically regarding the NED Duty, the IS acknowledged early on that no equivalent disqualification case on the basis of the NED Duty had ever been brought. Indeed, such was its novelty that it was described by the IS's Kings Counsel as a "test case" at an early case management hearing (and as "novel" by the judge).

According to the IS:

1. The existence of the NED Duty stems primarily from the 1998 case of Re Westmid Packing Services (No.2) and survived the codification of directors' duties in the Companies Act 2006.
2. Unlike the duty under s.174 Companies Act 2006 (to exercise reasonable care, skill and diligence), for the purposes of the NED Duty the reasonableness of any steps taken by the NEDs was irrelevant.
3. It was not necessary for the IS to particularise any specific omissions on the part of the NEDs or any further enquiries which, on its case, they should have made.
4. The NEDs' reliance on Carillion's executive management and advisors was irrelevant to the discharge of the NED Duty, regardless of whether that reliance was reasonable.

The NEDs said that the IS's reliance on Westmid was erroneous in that the case is not in fact authority for the existence of the NED Duty. The strict liability regime advocated by the IS, they said, was misguided as a matter of law.

In particular:

1.  A strict duty to know would be inconsistent with, and would contradict, the statutory codification of directors' duties (in particular s.174).
2. Such a duty would be fundamentally impractical and impossible to comply with. It would therefore be patently unfair and unworkable and clearly not something the law would impose.
3. It would also contradict the understanding and expectations of those serving on boards and those advising them. Were it to be imposed, it is not difficult to see that it would be likely in practice virtually to eradicate the non-executive director from the UK corporate landscape.

Further, the NED's position was that even a breach of s.174 (if such could be proved, which they denied) is still not sufficient on its own to justify disqualification under s.6 CDDA. The test is "unfitness", which is a substantially higher standard than mere negligence and requires either a want of probity or really gross incompetence to be established. At no stage in the proceedings did the IS advance a proper basis for demonstrating that that latter test was met, arguing instead that unfitness followed a breach of alleged duty to know the true financial position of a company "per se".

Comment

In our view, the case pursued by the IS has never reflected the law. Notably, there was also no action brought against any of the NEDs by the expert regulators on disclosure, the FCA and the FRC. So called “test cases”, running for years, alleging duties which are not consistent with the Companies Act in our view are unhelpful for the UK's efforts to sustain itself as a jurisdiction where businesses can operate with a clear and trusted corporate governance regime.

The IS's abandonment of its case will come as welcome relief for all company directors. Had the IS's case on the NED Duty succeeded at trial, it would have subjected directors, particularly those appointed to large and complex companies, to an almost impossible standard –  akin to omniscience extending to every aspect of a company's business. That standard is even more obviously incompatible with the concept of non-executive directorship, where the expectations of a non-executive's role are fundamentally different to that of an executive director, and is, in any event, not an appropriate standard even for executive directors.

The NEDs were represented by Herbert Smith Freehills, led by partners John Whiteoak and Natasha Johnson, and supported throughout by senior associates Richard Mendoza and Chris Cox and associate Pete Thompson.