THE LIABILITY OF COMPANY DIRECTORS FOR NEGLIGENCE
| DOI | http://doi.org/10.1111/j.1468-2230.1969.tb01230.x |
| Published date | 01 September 1969 |
| Author | M. J. Trebilcock |
| Date | 01 September 1969 |
THE
LIABILITY
OF
COMPANY DIRECTORS
FOR
NEGLIGENCE
IN
Australia, in the last ten years, several hundred million dollars
of
investors’ money has been lost in unsuccessful publio companies.
The consequences of losses of these proportions,
on
both a personal
and national plane, have of course been very serious.
In
most of
those cases where formal investigations have occurred, inspectors
have attributed company failure to managerial incompetence.
In
very few cases has fraud been found to be a significant factor.
Moreover, these failures have occurred in an economic climate
generally regarded as prosperous and expansionary. That our
system could allow this situation to arise has been the subject of
widespread public concern and criticism. In the light of these
circumstances, one might have thought that, as a first step towards
redressing the situation, extensive civil litigation against the direc-
tors involved might have ensued.
It
is a puzzling fact that this has
not at all been
so.
It
is submitted that part at least of the explana-
tion for this fact is probably to be found in the present law relating
to the liability of directors for negligence.
It
is the purpose
of
this
article to examine this law, particularly the practical application
of
it
as
it
emerges from the cases, to examine possible methods of
reform, and to attempt a general evaluation of the efficacy of
sanctions for negligence as a form of protection for investors.
I.
GENERAL STATEMENTS
OF
PRINCIPLE
There are several well-known judicial formulations of a director’s
liability for negligence.
The earliest of these occurs in the case of
Charitable Corporation
v.
Sutton
cc
[Directors] may be guilty of acts of commission
or
omission, of malfeasance
or
non-feasance
.
. .
By accepting a
trust of this sort, a person is obliged to execute
it
with fidelity
and reasonable diligence; and
it
is
no
excuse to say that they
had
no
benefit from
it,
but that
it
was merely honorary; and
therefore, they are within the case of common trustees.”
In
this case, fifty committeemen of a chartered corporation were
held liable for losses resulting from their failure to ensure that the
activities of a warehouse-keeper, whose responsibility
it
was to make
loans to poor people
on
the security of suitable pledges, were
adequately supervised. This case has been regarded as something
where Lord Hardwicke said:
1
(1742)
2
Atk.
400,
405,
406.
499
500
THE
MODERN
LAW
REVIEW
VOL.
32
of a high point in the duty of care the law has demanded of
directors.
If
this is the high point, the view of Lord Hatherley
L.C.
in
Turquand
v.
Marshall
is
probably the low point. There, in rela-
tion to a loan made by the board to one of their number who died
insolvent and never repaid the loan,
it
was said
3:
‘(
It
was within the powers of the deed to lend to
a
brother
director, and however foolish the loan might have been,
so
long
as it was within the powers of the directors, the Court could
not interfere and make them liable
. . .
Whatever may have
been the amount lent to anybody, however ridiculous and
absurd their conduct might seem,
it
was the misfortune of the
company that they chose such unwise directors; but as long
as they kept within the powers of their deed, the Court could
not interfere with the discretion exercised by them.’’
This formulation of a director’s liability for negligence
(or
lack
of it) has been likened to the
‘(
business judgment rule
”
which has
developed
in
some jurisdictions in the United
state^.^
This rule-
at least in its extreme form-holds that, provided any judgment
which
.a
director
is.
required
or
permitted to exercise under his
company’s constitution has been exercised bona fide, there is
no
liability for the consequences of a faulty judgment.
Numerous cases espouse the proposition that a director is not
liable for
cc
mere
”
negligence
or
“
mere
”
errors of judgment
:
he
is
liable only for
u
gross negligence.”
It
is also said that a director
is expected to display the same standard of care in his company’s
affairs as a reasonable man would in his own affairs.‘ This formula-
tion has apparently been adopted from the law of trusts
s
(directors
2
(1869)
L.R.
4
Ch.App.
376.
3
Ibid.
at
p.
386.
4
For similar statements, see
Ile New Mashonaland Ezploration Company
[1892]
3
Ch.D.
577, 585,
per
Vaughan Williams J.;
Re Forest
of
Dean Coal Mining
Company
(1878) 10
Ch.D.
450. 453,
per
Jesse1 M.R.;
Re Faure Electric
Accumulator Company
(1888) 40
Ch.D.
141, 152,
per
Esy J.;
Grimwade
v.
Mutual Socie!?
(1885) 52
L.T.
409, 416,
per
Chitty
J.
Personal Liability
of
Directors for Corporate Mismanagement,”
(1916) 65
U.
of Pa.L.R.
128, 130;
Turquand
v.
Marshall
was followed in
the leading America: case
on
this rule,
Spering’s Appeal,
71
Pa.
11 (1872).
See also Farflagia, The Business Judgment Rule:
A
Guide
to
Corporate
Directors’ Liability,”
(1962) 7
St. Louis Univ.L.J.
151;
Feuer,
Personal
Liabilities
of
Corporate Ofiicers and Directors,
at
p.
19
et seq.
6
See,
e.g., ODerend
B
Gurney Co.
v.
Gibb
(1872)
L.R.
5
H.L.
480, 487,
per
Hatherley L.C.;
Re Brazilian Rubber Plantations
ct
Estates Ltd.
[1911] 1
Ch.D.
425, 436, 437,
per
Neville J.;
Re National Bank of Wales Ltd.
[1899]
2
Ch.
629, 672,
per
Lindley L.J.;
Re Faure Electric Accumulator Company
(1888) 40
Ch.D.
141, 152,
per
Kay J.;
Lagunas Nitrate Company
v.
Lagunas
Syndicate
[1899]
2
Ch.
392, 435,
per
Lindley L.J.;
Marzetti’s Case
(1880) 28
W.R.
541, 543,
per
Brett L.J.
7
See,
e.g., Ouerend
1
Gurney Co.
v.
Gibb
(1872)
L.R.
5
H.L.
480, 487,
per
Hatherley L.C.;
Re Brazilian Rubber Plantations
ct
Estates Ltd.
Ltd.
[1925]
Ch.
407, 428,
per
Romer
J.
Law
of
Trusts in N.S.W.
(2nd
ed.),
p.
388.
5
See Rhoads,
Ch.D.
425, 437,
per
Neville J.;
Re City Equitable Fire Insurance
8
See,
e.
.,
Underhill,
Law
of
Trusts
ct
Trustees
(11th
ed.),
p.
323;
Jacobs,
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