To What Extent Can Directors Delegate To and Rely on Others?

By Low Chee Keong

The MTR announced a two-year delay in its Express Rail Link project leading Professor Anthony Cheung to express that he was ‘totally caught by surprise’.

On 15 April 2014, the MTR Corporation Limited (“MTR”) announced a two-year delay in its Express Rail Link project leading the Secretary for Transport and Housing Professor Anthony Cheung to express that he was ‘totally caught by surprise’. He later admitted that he had wanted to inform lawmakers that the rail link might not be ready by the target date of 2015 at a meeting on 22 November 2013 but was persuaded not to do so by Mr Jay Walder, Chief Executive Officer of the MTR, who assured the former that the existing schedule remained feasible. At the Legislative Council Panel on Transport Subcommittee Meeting on 5 May, Mr Walder stated that despite the exploration of ‘every possible alternative ... the obstacles were just too great’. Subsequently, during an interview with RTHK Radio, Mr Michael Tien, a legislator and previous Chairman of the KCRC before its merger with the MTR, raised a pertinent question namely “Did (Mr Walder) ask the necessary questions to check if the team could really deliver the project on time before calling the Transport Minister? If he didn't, then it's serious negligence.”

The foregoing raises an important issue in company law namely to what extent can directors delegate their responsibilities and the extent to which they may place reliance upon third parties. The crux of the issue goes to the standard of care expected of directors which has since 3 March 2014 been codified in section 465(1) of the Companies Ordinance (Cap 622) as requiring directors to ‘exercise reasonable care, skill and diligence.’ Section 465(2) defines this to mean the care, skill and diligence that would be exercised by a reasonably diligent person with (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and (b) the general knowledge, skill and experience that the director has.

The decision of the Federal Court of Australia in Australian Securities and Investments Commission v Healey [2011] FCA 717 provides some useful guidance. In a nutshell the case involved alleged breaches by directors of their duty of care and diligence owed to Centro, the company on which board they serve, as they approved consolidated financial accounts that had incorrectly classified A$1.5 billion in debt as ‘non-current liabilities’ as well as failing to disclose the provision of A$1.75 billion in guarantees to an associated company after the balance date. Significantly, both transactions had been reviewed without query by its Audit Committee as well as by PricewaterhouseCoopers, its external auditor. In finding the directors liable Middleton J. opined that the “importance of the financial statements is one of the fundamental reasons why directors are required to approve them and resolve that they give a true and fair view.” His Honour emphasized that “case law indicates that there is a core, irreducible requirement of directors to be involved in the management of the company and to take all reasonable steps to guide and monitor” and that they have “a duty greater than that of simply representing a particular field of experience or expertise.”

Crucially, the learned judge noted that although “a reasonable step would be to delegate various tasks to others ... this does not discharge the entire obligation upon directors” echoing an earlier judicial pronouncement by Lord Wolff in Re Westfield Parking Services Ltd [1998] 2 BCLC 646 that while “a proper degree of delegation and division of responsibility is of course permissible, and often necessary, but total abrogation of responsibility is not.” These views were embraced wholeheartedly by Lord Goldsmith in the Lords Grand Committee during the parliamentary debate on the proposed codification of the duty of directors to exercise independent judgment – now section 173 of the English Companies Act 2006 – when his Lordship opined that:

The duty does not prevent a director from relying on the advice of work of others, but the final judgment must be his responsibility. He clearly cannot be expected to do everything himself. Indeed, in certain circumstances directors may be in breach of their duty if they fail to take appropriate advice – for example, legal advice. As with all advice, slavish reliance is not acceptable, and the obtaining of outside advice does not absolve directors from exercising their judgment on the basis of such advice.

Thus, although they are allowed to delegate some of their responsibilities, directors are not entitled to rely blindly on advice without applying his or her mind independently to the facts. Indeed this was a key observation by Middleton J. in Centro as his Honour took great pains to emphasise that:

Nothing that I decide in this case should indicate that directors are required to have infinite knowledge or ability. Directors are entitled to delegate to others the preparation of books and accounts and the carrying on of the day-to-day affairs of the company. What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her.

Although the decision in Centro revolved principally around the issue of disclosure in financial statements, its application extends much further as the learned judge reviewed the extent to which directors could reasonably rely on advice from third parties. With the operational complexities of companies continuing to expand significantly – both technically and geographically – there will inevitably be an increasing degree of reliance on internal and/or external expertise. In such circumstances the key consideration for directors must be whether they have – collectively as a board – directed their minds independently to the robustness and accuracy of the periodic reports and/or board papers which are provided to them by the management of the company. Any failure to do so may render them in breach of section 465(2)(b) of the Companies Ordinance which require that they apply their ‘general knowledge, skill and experience’ to the facts in hand.