UK: Directors’ and Officers’ Liability Review, Winter 2006 - News Digest

The Sarbanes-Oxley regulations are to be lightened following recognition by the US Government that the legislation has been overly onerous, and acceptance by US regulator, the Public Company Accounting Oversight Board (‘PCAOB’), that section 404 (concerned with financial reporting requirements) has been costlier than anticipated, with costs exceeding the benefit derived.

The PCAOB and the SEC are consulting and a review is aimed at reducing the burden on small- and medium-sized companies, and may also result in new provisions limiting the liability of accountancy firms.

On 30 September 2006, the US Senate finally ratified the Extradition Treaty with the UK. The Treaty was negotiated in 2003 (following the 2001 terror attacks) and brought into force in the UK in the same year, but has only now been ratified in the US.

Although the ratification has been welcomed, most commentators remain sceptical about whether the Treaty even now achieves an equal balance between the rights of the US and the UK authorities. Even after ratification, the UK has to provide prima facie evidence to a US court before it can extradite American citizens. As recent high profile examples have shown, the US, however, does not need to provide such evidence in order to extradite UK nationals or others located in the UK.

In a recent landmark decision, the Moscow District Commercial Court found former managers and directors of Agro Industrial Construction Bank ("the Bank"), liable to the Bank for approving loans to insolvent borrowers that were responsible for the Bank’s insolvency.

This decision is seen as a further move by the Russian authorities to improve transparency and attract further international investment, and the expansion of liability will extend beyond banks to companies in general. It will be difficult to predict when directors will now be held liable. In many cases, however, evidential difficulties may be encountered in seeking to prove a causal link between the directors’ conduct and any subsequent insolvency or other loss. The developing Russian D&O market will need to evaluate the underwriting impact of this decision, which may only become clear from subsequent cases.

In June 2006, changes to the Combined Code, which applies to all UK listed companies, came into force for reporting years beginning on or after 1 November 2006.

The main changes include:

• allowing an independently appointed chairman to sit on the remuneration committee;

• the need for companies to include a ‘vote withheld’ box on all proxy voting forms and not just those relating to AGMs;

• the requirement to record and publish on its website any votes by way of a show of hands vote; and

• a provision confirming that by placing information on its website, a company is now deemed to have complied with the publicity requirements.

The Fraud Act 2006 comes into force on 15 January 2007 and follows the findings of the 2002 Law Commission, in covering three key areas:

• fraud by misrepresentation;

• fraud by failing to disclose; and
• fraud by abuse of position.

The Act creates new offences of obtaining services dishonestly, and possessing, making or supplying articles for use in frauds. In addition, fraudulent trading is now extended to include non-corporate traders.

The Fraud Act also increases the penalty for participating in a fraud from seven years to 10 years and places members of body corporates charged with offences at risk of personal prosecution where they manage the business.

The Treasury has introduced a new Bill, "The Clearing House and Banking Bill", to protect UK companies listed on the LSE and other UK exchanges from onerous US regulatory obligations in situations where the LSE or other exchanges are taken over by a US exchange. The Bill will be pushed through and is expected to be in force within a year.

In Neville (as administrator of Unigreg Ltd) and another v Krikoran (2006), the Court of Appeal held that directors will be jointly and severally liable under section 341(2)(b) of the Companies Act 1985 to repay all loans made by their company to a fellow director in breach of section 330, from the time at which they first became aware that illegal loans were being made even if they were not aware of the circumstances, or even the fact, of each subsequent loan.

Furthermore, where directors fail to take steps to prevent losses to the company, such as by not preventing further loans or by not calling in those already made, they will be personally liable to indemnify the company under section 212 Insolvency Act 1986 if their co-directors are unable to repay.

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