Directors’ duty to promote the success of the company

Directors’ duty to promote the success of the company: do the ends always justify the means?

In this article, we look back at the Court of Appeal (CoA) decision in Saxon Woods Investments Limited v Francesco Costa and in particular, the test to be applied when considering whether a director has complied with their duty under section 172 of the Companies Act 2006 (CA 2006), to promote the success of the company.

It is not just a matter of assessing the director’s own subjective belief. The duty imports an obligation to act honestly, which is to be assessed objectively.

This means that a director who disregards an obligation under a shareholders agreement, even if they genuinely believe that to be in the best interests of the company as a whole, may, unless they have also acted honestly, find themselves in breach of duty and looking down the barrel of an unfair prejudice petition.

Background

This dispute arose out of a shareholders agreement between Spring Media Investments Limited (the Company) and its shareholders (the SHA).

Under the terms of the SHA, the parties had agreed to work together in good faith to achieve a sale of the Company by the end of 2019 and fairly consider any offers received prior to that date.

In the event that a sale had not been achieved by that date, it was agreed that the Company would instruct an investment bank to pursue an “Exit”. This never occurred and after a number of years the company remained unsold.

This resulted in one of the shareholders, Saxon Woods Investments Ltd (the Petitioner), petitioning under section 994 of the CA 2006 for an order for sale on the basis of unfair prejudice.

The Petitioner argued that Mr Costa (the Respondent), in his position as chairman of the Company and a shareholder with a controlling interest, had deliberately taken action to frustrate the sale process. This, it was alleged, constituted a breach of his directors’ duties owed under the CA 2006.

The Respondent denied that there had been a breach of the SHA. But even if there had been a breach, the board of the Company did not consider that a sale based on the timetable set out in the SHA would maximise value for the shareholders and against that background, the decision not to sell did not constitute a breach of duty.

The matter first came before the High Court, which found that although there had been a breach of the SHA, the Respondent had not breached his directors’ duties.

The matter was then appealed to the Court of Appeal. First, by the Respondent on the basis that the High Court was wrong to find that there had been a breach of the SHA and secondly, by the Petitioner, on the basis that the High Court had been incorrect to conclude that the Respondent was not in breach of his statutory duties.

Relevant statutory provisions

The High Court decision primarily turned on two sections of the CA 2006: sections 172(1) and 174.

Section 172(1) of the CA 2006: The duty to act in good faith

This section provides that:

[a] director of a company must act in the way he considers, 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 […] (f) the need to act fairly as between members of the company.

Section 174 of the CA 2006: The duty to exercise reasonable care and skill

This section states that:

“(1) A director of a company must exercise reasonable care, skill and diligence.

(2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with-

(a) the general knowledge, skill and experience that may be reasonably expected of a person carrying out the functions carried out by a director in relation to the company; and

(b) the general knowledge, skill and experience the director has.”

Decision of the High Court

Breach of section 172(1)

The first issue to be decided by the High Court was whether the duty under section 172(1) was subjective or objective in nature. The Judge concluded that it was subjective based on the reasoning in Regentcrest plc (in liquidation) v Cohen[1]:

The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the court; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind.

Having reached that view, the High Court had to consider whether the Respondent’s subjective belief was reasonable.

It was the Respondent’s position that he firmly believed that it was best interests of the shareholders not to comply with the SHA within the specified timetable. This was grounded in the belief that a considerably higher value might be obtained if the process were to be delayed.

The High Court found that it was not the Respondent’s deliberate intention to “injure either the [Company] or any investor” and that his state of mind might best be described as “they wouldn’t like it now if they knew, but they will thank me in the long run.”

The Judge concluded that, on the facts, the Respondent genuinely believed that he was acting in the best interests of the Company and its investors and as a result, applying the test set out in Regentcrest, he was not in breach of his duty under section 172(1).

Breach of section 174

A potential defence to an allegation that a director has failed to exercise reasonable care and skill is whether or not professional advice was sought as part of the decision making process.

The Respondent claimed the Company had at all times taken and acted upon professional advice and therefore section 174 was not engaged.

The High Court confirmed that while taking advice does go some way towards a defence, it is not absolute. In forming that view, the Judge relied on the earlier decision in Sharp v Blank:

In general, a director who takes and then acts upon expert evidence has gone a long way to performing his duties with reasonable skill and care. But the taking and acceptance of advice is not a substitute for the exercise of reasonable skill and care: it is only part of the discharge of that duty.

The issue here was that the professional advisors engaged by the Company had not been instructed to advise on the question of whether what the Respondent was doing or proposing to do was in line with the Company’s contractual obligations under the SHA.

As a result, he could rely on the fact that advice had been sought as evidence of the fact that he believed what he was doing was in line with the SHA.

The question which the High Court had to decide was whether the Respondent had been negligent by not complying with the SHA. The Judge concluded that he had not been negligent on the basis that:

[he] sincerely believed that he was engaging in a course of action which would ultimately be for the benefit of the Company and its shareholders, and applied himself energetically to pursuing this course of action. He took the view that the Company’s breach of its obligation was a price worth paying in order to achieve this aim. I cannot see how this can be described as negligence in the way the term is described in s. 174.

Decision of the Court of Appeal

The CoA disagreed with the approach taken in the High Court.

The CoA found that Regentcrest was not authority for the proposition that the obligation on a director under section 172 CA 2006 to act in the best interests of the company was purely a subjective one.

Instead, it was principally intended to explain that in a company it is the directors and not the court, who decide what is in the best interests of the company and the court will “not find a breach of fiduciary duty […] simply because the court (or anyone else) might have taken a different commercial view.”

The CoA stated the obligation to act in good faith, when deciding what was in the best interests of the company, included, as its core, a requirement to act honestly.

The CoA referred to the fact that, at the time Regentcrest had been decided, the law had been in something of a muddle as to whether honesty and dishonesty were simply subjective concepts. However, post-Regentcrest, it had been:

authoritatively decided that the test as to whether a person had acted honestly or dishonestly requires an objective assessment of the conduct of the relevant person, in the light of the facts as they believed them to be when they embarked on their course of conduct.

The CoA found that the High Court had focused entirely on the Respondent’s subjective belief without going on to consider whether the Respondent’s reliance on his belief was, objectively, honest by the standards of ordinary decent people.

The CoA stated that the High Court was plainly wrong because, if its decision was followed through to its logical conclusion, it would mean that a director could do anything provided he believed, subjectively, that his actions were most likely to promote the success of the company.

This would allow a director to be the “sole arbiter of the best course of conduct to achieve that aim, and also of what constituted “success” for the company at that time.”

The CoA concluded that it was not the position of English law that the ends always justified the means. Section 172 requires a director, in all that he does, to act in good faith towards the company, in the way he considers would be most likely to promote the success of the company; and the “requirement that the director acts in good faith includes, as a core fiduciary, a requirement that the director acts honestly towards the company.”

The CoA concluded that in light of the fact the Respondent had been found to have misled the Board and had concealed the fact that he was not working towards achieving a sale by the December 2019 deadline, lead to the inevitable conclusion that he had behaved dishonestly and was therefore in breach of his duty under section 172.

The CoA stated that “[d]eliberately deceiving the board of a company must, either always or almost always, be inconsistent with a director’s duty under section 172.”

The CoA did not consider it necessary to consider the question of whether the Respondent had also breached his duty under section 174.

In light of that conclusion, the CoA ordered that the appropriate remedy was an order that the Respondent buy-out the Petitioner’s minority shareholding.

The key takeaways from the Court of Appeal’s decision are:

The duty under section 172 of the CA 2006 includes an obligation to act honestly, which is to be determined on an objective basis. It is not enough that the director subjectively believes that they were acting in a way that promotes the best interests of the company as a whole. If they have acted dishonestly, a breach of duty is likely to have occurred.
If the shareholders have contractually provided for a particular outcome and a director engages in a course of conduct that deliberately frustrates that outcome, then they are likely to be found to be in breach of fiduciary duty under section 172.
In those circumstances, a breach of contract is likely to form a proper basis for an unfair prejudice petition under section 994 CA 2006 for an order that the majority shareholder buy out the shares of the prejudiced minority shareholder.

Directors’ duty to promote the success of the company

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