How Much Diligence is Due?

Understanding what it takes to be 'duly diligent'

Last week I presented to a newly formed board of directors. We introduced the concept of directors’ duties and the sanctions that exist for directors who fail to apply the required standards of diligence. These include:

• Jail
• Fines
• Legal fees
• Banning orders
• Reputation damage
• Loss of other directorships
• Loss of future directorships
• Time spent fighting a legal case
• Stress, personal pain and suffering, and
• Harm caused to a company they (presumably) care about.

Eyes glazed. Passive disbelief floated in an almost tangible cloud around the room. Then came the slide with headlines about directors of similar businesses who had been jailed in the past 18 months. None were from the major national or financial press. A personal tragedy for directors of small, unlisted, not-for-profit, or government sector businesses does not make big international headlines; it just wrecks the life of the persons concerned.

Disbelief became engagement. Fast!

What can you do?

The first step to discharging your duty is know what it is. For directors there are a mixture of statutory duties (written down in law somewhere) and fiduciary duties (arising from the implicit relationships between people who have power and those who must trust them to use it wisely).

fiduciary duty is “the highest standard of care”

The Cornell Legal Information Institute defines fiduciary duty as “the highest standard of care”. It changes with societal expectations so directors need to be aware of current expectations and trends. Lawsuits can arise many years after the relevant actions that gave rise to them and will be judged by the standards of the day in both the court of public opinion and the courts of law.

Six Steps to Diligence

Michael Tooma published six steps to diligence in 2016. They make very good sense and provide a useful framework for directors – aspiring and serving – to check that they have been properly diligent. Michael wrote them for health and safety concerns and they can be easily extended to any other area of board responsibility.

1 Know –

It is a directors’ obligation to know the obligations imposed on their company and have a working knowledge of the type of information that will be presented to the officers as part of their role. A director must be financially literate; even in a not-for-profit or for-purpose enterprise. A director must understand the company’s liabilities and duties under taxation, fair trading, antitrust, employment, environment, and many other laws, rules, guidelines and obligations. A director must acquire knowledge in relation to work health and safety matters. This is the work health and safety equivalent of being financially literate. Some of these pieces of legislation may contain provisions for a reversal of the onus of proof, or for automatic personal culpability of directors if corporate culpability is proved.

A director must be financially literate

2 Understand –

A director must gain an understanding of the nature of the operations and the risks associated with the operations. That means officers must focus their minds on the core activities of the business and the critical risks arising from those activities. This includes competitive risks (such as disruption by new business models) as well as operating risks (such as changes to the costs of various inputs), key personnel risks, hazard risks, and many more.

officers must focus their minds on the core activities of the business and the critical risks arising from those activities

3 Resource –

It is not enough to be aware and become informed of the risks. A good director will then ensure there are adequate resources and processes for discharging the duties of the company and managing the risks. Remember that resources can include financial, brand, HR. technology and other resources. Obviously, it is impossible to identify, plan and resource a good response to every risk that exists but a good board will know which are the most likely and most impactful and have strategies in place. There is no law against corporate failure. Directors will not be at as much personal risk if they have diligently made a decision that turns out to be incorrect. Failure to plan, however, looks much like failure to be duly diligent and will incur a greater personal risk for directors.

resources can include financial, brand, HR. technology and other resources

4 Monitor –

Once plans and contingency plans have been made the diligent director will ensure that monitoring systems are in place to monitor the performance of the company in terms of both incidents and risks. Incident reporting is the easiest; whenever something happens the board should hear about it. If it is something bad they should hear about it very quickly. Risk reporting is more difficult; it requires systems to scan the environment and alert the board when the risk (or opportunity) levels are changing and may indicate that a change of response is required. Ideally directors will look for leading indicators of impending change rather than lagging indicators of change that has already occurred.

look for leading indicators of impending change

5 Comply –

A board must then ensure legal compliance. This involves the steps above and also the requirement to establish a culture of compliance so that people working with the company will naturally come to the board with information if they have any suspicion that all is not as it should be. Culture starts and ends with the board so it is important for directors to know the desired culture, model it, and have serious conversations with their boardroom colleagues about how it is being developed.

Culture starts and ends with the board

6 Verify –

Directors delegate almost everything that is done within their companies. They must ensure that the above steps are implemented to the satisfaction of the board every day and in every way. Failure to ensure that desired actions are the same as the actions taken does not meet the required standards of director diligence.

Prove that verification was done, and done thoroughly. Under this heading boards must ensure that their boards don’t just do the necessary work but also that they complete appropriate records to prove that they did after the fact and when sceptical audiences (such as opposing barristers) are checking.

No guarantees

There are never any guarantees that the actions taken by a board will be sufficient to avoid or avert disaster. However, when disaster strikes the diligent board is able to prove that they had done everything possible to place their company in the best possible position for continued survival.

There are never any guarantees

Actions that will meet with approval from courts and others are those that demonstrate that the board is serious about its performance and about the discharge of its duties. Thorough induction for new board members, ongoing education for serving directors, regular rigorous board performance assessment and processes to improve, strategic planning, thoughtful board composition and succession planning, all have their place in helping your board to demonstrate, beyond any reasonable doubt, that your directors did everything they could and applied ‘due’ diligence. The worst may still happen; but you, and your co-directors, may have a better chance of surviving unscathed.

So – now that you know how diligent is ‘due’ diligence; is your board up to the challenge of demonstrably due diligence?

About the author:

Julie Garland-McLellan is a board expert. She is also a public speaker and professional conference MC in demand for courses, seminars and conferences, combining personal anecdotes, humour, world-class expertise and extensive experience as a director to engage, stimulate and educate.

As the author of many books and training materials for company directors, Julie is an acknowledged expert on resolving a wide range of complex governance issues. Her newsletter 'The Director's Dilemma' reaches readers in 33 countries. Get your copy free at https://www.directorsdilemma.com/