Advisers advise but directors decide

Litigation poses significant risks to companies. If a company embarks upon a misconceived claim, it could result in significant legal costs and divert management’s focus away from business, all without any realistic prospect of achieving the company’s objectives. Conversely, if a company acts passively, it will fail to enforce its legal rights, which could spell disaster for the company’s future fortunes.

Ultimately, if a director makes a decision about litigation without proper thought to the matters that they should have considered, then they could face removal from office. Worse, if the decision causes the company to suffer loss, the director could face a claim by the company and the prospect of personal liability.

Directors should, therefore, pay close attention to the statutory duties that they owe to the company when making a decision about litigation. This will ensure that they can properly justify their decision, if it becomes necessary to do so at a later date.

Key statutory duties to note

Section 172 of the Companies Act 2006 (“the Act”) states that a director must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and in doing so have regard (amongst other matters) to:

1. the likely consequences of any decision in the long term
2. the interests of the company's employees
3. the need to foster the company's business relationships with suppliers, customers and others
4. the impact of the company's operations on the community and the environment
5. the desirability of the company maintaining a reputation for high standards of business conduct
6. the need to act fairly as between members of the company

It also makes it clear that a director may in certain circumstances, need to consider or act in the interests of creditors of the company.

Section 173 of the Act provides that a director must exercise independent judgment.

Section 174 of the Act provides that a director must exercise reasonable care, skill and diligence i.e. the care, skill and diligence that would be exercised by a reasonably diligent person with:

1. 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
2. the general knowledge, skill and experience that the director has

The key actions for directors to take

Assess the legal merits of the case

In most cases, directors should seek specialist legal advice, whether from in-house counsel or external lawyers. Whilst of course this advice should address the pure legal merits of the claim, advice should also be sought on:

• the value of the claim
• future costs to trial
• the risk of having to pay the other side’s legal costs (and what those costs might be)
• risks concerning the enforcement (recovery) of any award ordered by the Court

On the issue of costs, directors should also consider the different financing options that might be available to the company, including existing insurance coverage.

Take steps to preserve privilege, minimise the creation of new documents and preserve existing documents

At the outset, directors should work with their legal advisers to ensure that the company has a clear system in place to preserve legal professional privilege in respect of the privileged documents that the company currently holds and the documents that the company will create / receive in the future.

The Company also has a duty to preserve all documents and electronic data potentially relevant to the dispute. Document retention policies, which can automatically delete data, should be suspended.  It may be necessary to engage an expert to forensically preserve electronic data.

Consider reputational risks

Litigation can impact on a company’s reputation. Directors should consider how clients, suppliers and employees will react. If press interest is likely, they should also consider a media and PR strategy.

Options available

Is this a case where the company needs to seek urgent injunctive relief from the Court, or should the company carefully set out its case in pre-action correspondence?

Whilst it may be tempting for a director to pick up the phone to his or her counterpart with a view to seeking a “commercial solution”, could this prejudice the company’s position and show weakness? Often legal and commercial approaches work best in parallel.

Take decision

Once they have informed themselves of the issues above, it is for the directors to weigh that information and to come to their own decision. This should involve careful analysis of the costs vs benefits. The company’s interests should be at the front of the director’s mind at all times.