No director can verify everything personally. Section 116 of the Companies Act 1997 makes reasonable reliance safe — on defined terms.
Section 116(1) — the three permitted sources
(a) an employee of the company whom the director believes on reasonable grounds to be reliable and competent in relation to the matters concerned;
(b) a professional adviser or expert in relation to matters which the director believes on reasonable grounds to be within the person’s professional or expert competence;
(c) any other director or committee of directors upon which the director did not serve, in relation to matters within the director’s or committee’s designated authority.
| Source | The qualification | What it means in practice |
|---|---|---|
| (a) Employee | Believed on reasonable grounds to be reliable and competent in relation to the matters concerned | The belief must be reasonable and subject-specific. A capable operations manager is not a reasonable source on tax |
| (b) Professional adviser or expert | The matters believed on reasonable grounds to be within that person’s professional or expert competence | Lawyers on law, accountants on accounts, valuers on value — not on each other’s fields |
| (c) Another director or a committee | A committee on which the director did not serve, and matters within its designated authority | A director on the audit committee cannot rely on the audit committee — and the committee’s authority must be designated, which means recorded |
Paragraph (c) protects reliance only on matters within the other director’s or the committee’s designated authority. That points directly to section 111: a delegation should be recorded by board resolution, identifying the power and its limits. Without a recorded scope, there is nothing against which to test whether the matter was within it.
Section 116(2) — the conditions
(a) acts in good faith; and
(b) makes proper inquiry where the need for inquiry is indicated by the circumstances; and
(c) has no knowledge that such reliance is unwarranted.
Reliance is protected until something puts the director on notice. Warning signs that indicate a need for inquiry include: figures that do not reconcile with what the director knows of the business; a qualified auditor’s report; creditors pressing for payment; the resignation of an adviser or officer; a report that is internally inconsistent; or a transaction that seems too favourable to be explicable.
Where such a sign appears, the director must ask. Continuing to rely on the report without inquiry loses the protection, and leaves the director exposed under section 115.
How section 116 fits with the other duties
| Provision | Relationship |
|---|---|
| s 115(1) | Section 116 is how a director discharges the care and diligence standard on matters outside their own knowledge |
| s 115(2)(c) | The business judgment rule requires a director to inform themselves to the extent they reasonably believe appropriate — reliance under s 116 is a principal way of doing so |
| s 4(2)(b) | In applying the solvency test, directors may rely on valuations of assets or estimates of liabilities that are reasonable in the circumstances |
| s 110(2A)(b) | In valuing a contingent liability for a major transaction, directors may rely on reasonable estimates |
| s 111(2) | Governs the board’s responsibility for a delegate; s 116 governs an individual director’s reliance on information |
| s 54(2) | A director is liable where reasonable grounds did not exist for the solvency belief — proper reliance under s 116 is the answer |
A director may rely on information and advice. The decision remains the director’s. An adviser can say what a transaction means; only the board can decide whether to enter it, and only the directors can form the opinion the Act requires them to certify — solvency under section 50(2), fairness and reasonableness under section 47, and the best interests of the company under section 57(2).
That is also why those powers appear in Schedule 3 as non-delegable.
Using section 116 well
- Identify the source and the scope. Record in the minutes who provided the report or advice and on what question.
- Check competence. For paragraph (b), satisfy yourself that the matter is within the adviser’s field — and that the adviser has been given the right facts.
- Record the inquiry. Where a question arose, minute the question and the answer. That is the evidence for paragraph (b).
- Do not rely on a committee you sit on. Paragraph (c) excludes it.
- Keep committee terms of reference current, so “designated authority” can be established.
- Reassess when circumstances change. Reliance that was reasonable last quarter may not be reasonable after a warning sign.
- Do not rely on the interested party. Where a director has an interest, the safe harbour in section 115(2) is unavailable to them, and the board should take independent advice — see sections 117 to 122.
Sources
- Companies Act 1997 — ss 4, 47, 50, 54, 57, 110, 111, 112–117, 122, 188; Schedule 3
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.