1.0 THE FUNDAMENTALS OF FINANCIAL STATEMENTS
Financial statements are crucial reports which provide information about a company’s financial results, its financial position, and cash flow. They provide essential accounting information that help businesses track financial activities, assist potential and existing investors in making investment decisions and government regulators make fiscal assessments.
To this intent, this article shall examine the liability of directors’ breach of duty of care, skill, and diligence, arising from presenting misleading financial statements, which could amount to either fraudulent or negligent misrepresentation, and the extent to which directors can rely on the advice of professionals such as independent auditors, the company’s audit committee and executive officers of the company.
Due to the transnational nature of corporate law, judicial decisions of the English and Australian jurisdictions are considered in establishing liabilities connected to a person discharging managerial responsibility who makes disclosures in financial statements which are not only untrue thereby capable of reasonably influencing users of financial information place reliance on them.
2.0 ISSUES ARISING FROM RELIANCE ON FINANCIAL STATEMENTS
The Companies & Allied Matters Act 2020 confers responsibility of preparing financial statement on directors of both private and public limited liability companies on an annual basis (also quarterly for public companies) and further provides for the type of accounting information directors are expected to include when preparing financial statements . These information are usually retrieved from a company’s financial activities and performance, providing an invaluable resource for assessing the financial liquidity, and capacity of a company to maximise shareholders’ value. It is also used by directors of a company to evaluate financing, investment, and taxation objectives. While auditors are to provide expert advice to directors, statutory provisions, and judicial decisions maintain that directors are primarily responsible for preparing accurate financial statements. On the other hand, the Chief Executive Officer, Chief Financial Officer or persons providing similar functions are responsible for certifying audited financials and are further mandated to discharge this corporate responsibility in accordance with specified standards.
For instance, the accountant certifying the financial statement complies with accounting standards i.e International Financing Reporting Standards (IFRS) for public companies and in the case of a private company, Accounting Standard for Private Enterprises (ASPE). Failure to discharge this duty accordingly amounts to a conviction specified in the CAC Regulation.
In the business world, buying, keeping, and selling company shares entail enormous risk taken by local and foreign investors because of the high degree of reliance made on financial statements which may sometimes be inaccurate. Global events are replete with instances where companies present false trajectories on liquidity, dividend and bonus shares pay out in order to attract users of financial statements i.e investors, financial institutions. The outcomes of such failings are usually tied to directors’ duty of care and diligence, poor corporate governance practices which could lead to the removal of any director found wanting.
In a recent Autonomy and HP litigation, ACL Netherlands BV & Ors v Lynch & Anor , The High Court found two executive directors, Mike Lynch and Sushovan Tareque Hussain, liable for making false financial statements in Autonomy’s annual report. The court held these directors responsible for providing false information regarding the company’s financial performance on its software product known as IDOL. They claimed that Autonomy was solely a software company, but in reality, Autonomy engaged in reselling computer hardware to generate more revenue. By combining the sales of hardware and software in Autonomy’s quarterly and annual reports, the directors created a false impression that Autonomy was a very successful technology UK start-up. Based on these presentations, the claimants acquired Autonomy, and purchased it at an overpriced value. On discovery of the true facts, they commenced an action I damages against the directors of autonomy and amongst other relief sought for their removal.
On the issues of fraudulent information, the court ruled that for the financial representation of the defendants to qualify as a misleading statement, it is sufficient that the misleading statements “has an impact on the mind” which led the claimants into making an investment decision . The court also held that in establishing liability connected with damages associated with a misleading statement, a person discharging managerial responsibility in this case a director, must have been aware that the statement is untrue at the time it was made or appreciate that relevant information was not being disclosed. Additionally, the court emphasized that the company’s auditors cannot be considered as the ultimate test or a safe guarantee for matters that fall under the directors’ responsibility .
On the issue of relying on negligent misrepresentation, the director duty of care, skill and diligence is essential in assessing the liability of the director. In Australian Securities and Investments Commission v Healey also referred to as the Centro case, the court considered the issue of whether an omission made by the director would give rise to liability in damages against such director.
Here, the directors of Centro Property Group (CNP) and Centro Retail Group (CER) classified current liabilities incorrectly as non-current liabilities. CNP also provided guarantees to an associated company which amounted to US$1.75 billion after the balance date, without disclosing this material post balance date as required by accounting standards. In one of the reliefs sought against the directors, the claimant maintained that the directors were in breach of sections 180 and 344 of the Corporations Act 2001. While Section 344 mandates directors to take “all reasonable steps to comply with, or secure compliance with sections 296 and 297”. Section 296 requires financial reports to follow applicable accounting standards, while section 297 stipulates that financial statements present a true and fair view of the company’s financial position and performance, and section 180 requires directors to exercise their duties with care and diligence. The claimant, thereafter, sought a declaration that the directors had contravened sections 180 and 344 and claimed damages and further sought an order disqualifying the directors.
Although the directors maintained that it was unrealistic to expect them to review voluminous board papers alongside the draft financial statements and they claimed that they were unaware of the specific pages containing CER’s debt, the court held that the directors could have prevented the information overload and held them responsible for not identifying the errors in the financial statements or seeking clarification from management and auditors. Consequently, the directors were liable to the breach pursuant to sections 180 and 344.
We also note that the court held that while directors can rely on expert advice, they cannot abdicate their own fundamental responsibility to review and approve the company’s financial statement.
From the foregoing cases, the courts consistently require directors to exercise care, skill, and diligence when preparing financial statements, regardless of whether any misleading statements were occasioned by fraudulent misrepresentation or mistakes arising from negligent misrepresentation. This position was also emphasised by the Court of Appeal in our jurisdiction, as demonstrated in the case of Okeke v. SEC & ORS where the Court of Appeal held that “the provisions of Sections 331 – 333 of the CAMA 1990 impose a duty upon a company to keep proper and accurate records of accounts and the penalties for non-compliance therewith. Likewise, Sections 334 – 337 impose a duty upon Directors of the Company to prepare annual accounts. Sections 345 – 348 of the Act have equally imposed a duty on Directors to deliver financial statements, and the penalties for non-compliance therewith”.
From the judicial decisions and statutory provisions cited, there’s a mandatory requirement by law imposed on directors of companies to prepare accurate financial statements, which is connected to their duties of care and skill. Failure to comply inevitably incurs penalties, extending from damages to removal of such director from office.
3.0 KEY LESSONS
Having established the fact that directors are personally liable for preparing financial statements, it also projects the corporate governance practices of such organisation which invariable leads to corporate reputational damage, loss of shareholders’ capital which could plummet into insolvency and the eventual job losses.
Despite the passage of Nigerian Code of Corporate Governance 2018 and the Companies and Allied Matters Act 2020, multinational and indigenous companies’ board and management are still found wanting when exercising their corporate responsibilities in this regard. In 2021, the World Bank refrained from executing any contract with nine Nigerian individuals and firms due to bad corporate governance practices, extending to fraud, and collusive practices. This implies that there is a huge demand for recruiting reputable and competent directors where the goal is not only to build profitable organisations but enduring ones. Statutes and judicial decisions are also consistent in qualifying the standards required by directors in discharging their corporate responsibilities when preparing financial statements: that they should act professionally at all times, possess the requisite knowledge of accounting practice and concepts in assessing financial books and preparing accurate statements, develop the right disciplines for their roles, balance the need for sufficient information from management, whilst carefully and diligently reviewing all of the financial information presented in annual reports including asking management and the auditors the right questions.
Ultimately, shareholders are also statutorily empowered to exercise their powers at general meetings to remove a director liable for making misleading statements to protect the company from further financial and/or reputational loss.
Author: Adeola Osifeko
Bio: Adeola is an IP lawyer, transactional and corporate governance practitioner with local expertise and global outlook. She curates corporate commercial contents on legal advisory and regulatory compliance needs for start-ups, SMEs and corporate entities seeking to establish, run and scale their businesses in Nigeria. She can be reached by sending an email to adeola@aeolawpractice.com