Directors' Duties to Disclose Interests In Proposed Transactions: Not a one-size-fits-all approach?

The Court of Appeal has recently grappled with the contentious issue of when directors will be considered to have acted in breach of their fiduciary duties for having pursued a business opportunity for their own benefit.

The Facts of the Case

In the case of Humphrey & Anor v Bennett [2023] EWCA Civ 1433, the Defendants were the directors and the majority shareholders of a property development SME company (the Company). The Claimants were former directors and minority shareholders of the Company.  The Claimants' claim against the Defendants was brought derivatively in the name of the Company (with the permission of the Court) under section 260 of the Companies Act 2006 (CA06). 

The Company purchased a piece of land in 2019 with a view to developing the land, however, due to insufficient funds, the development of this property was left on standby. The Defendants subsequently sold the property to one of their other associated companies in which the Defendants were the only directors and one of the Defendants was the sole shareholder.

When the Claimants complained of this sale, the Defendants used their majority shareholding to remove the Claimants as directors from the Company. 

In their Particulars of Claim, the Claimants alleged that as directors, the Defendants owed the full range of statutory duties to the Company as set out in sections 172-177, CA06, together with equivalent fiduciary duties and duties of care at common law. It was alleged that the Defendants had breached these duties by causing the Company to dispose of the property and diverting (away from the Company) an opportunity to profit from developing and selling the land for the benefit of the Company.

The Defendants' defence was that the Claimants had made clear that they were unwilling to provide any investment monies to the Company to meet the costs of the development project. It was argued that the refusal amounted to an agreement that the Defendants could develop the property on their own account which resulted in the Defendants ultimately selling the property to one of their associated companies.

The High Court Decision

On 28 June 2022, summary judgment was entered against the First Defendant who was the sole shareholder of the company that purchased the development. The Judge held that there was a failure by the First Defendant to disclose sufficient information to the Claimants regarding his interest within the company that subsequently purchased the property from the Company. This meant that the First Defendant could not rely on the defences contained in Sections 175 or 177(6), CA06, which set out circumstances when a conflict of interest will not arise and when a director need not declare an interest in a proposed transaction.

Furthermore, the judge refused the First Defendant relief under Section 1157 CA06, which allows the Court to relieve directors in claims of breach of duty where they acted honestly and reasonably.

The Court of Appeal Decision

The Court of Appeal unanimously allowed the First Defendant's appeal, concluded that, when due regard was had to the informal manner in which the Company was run (including in relation to the dealing by the directors with the assets of the company for their own personal benefit), there was a realistically triable case that the Claimants had agreed to the relevant land being sold at market value to the First Defendant's company, or that they were aware that this would happen.  According to the Court of Appeal, this was relevant as "… a director is under no duty to disclose matters of which his fellow directors were already aware or of which they ought to have been aware…" It was held, therefore, that the First Defendant would be allowed to run that defence to trial. 

The Court also ruled that even if a director falls short of the specific relief mechanisms relating to declaring interests in proposed transactions (as per sections 175 and 177 CA06) this does not, without more, mean a director is not entitled to relief under section 1157, CA06, on the basis that they have, overall, acted honestly and reasonably. In this regard, Snowden LJ said "it may be that a director who has failed to use, or has insufficiently used, the mechanisms provided by the 2006 Act to avoid a breach of duty under sections 175 and 177 might nevertheless be found to have acted reasonably for the purposes of section 1157."  In similar vein, Lewison LJ noted "whether a director can make out a defence under section 1157 in the case of an informally run company like the present is (or at least may be) highly fact-sensitive"; he therefore considered "a fuller investigation into the facts of the case might well alter the outcome". The section 1157 defence was therefore allowed, also, to proceed to trial. 

Comment

Directors should still consider being explicit about their interests with other companies in proposed transactions and document this in writing to prevent disputes such as arose in this case regardless of the size of the company, even if, doing so, feels like stating the obvious.

The Court of Appeal's comment that the relief provision in section 1157, CA06, is not unavailable merely because there has been a breach of duty under sections 175 and 177, is very welcome. 

The case confirms that directors are likely to be able to plead a section 1157 defence even if their actions could be said to fall short of the disclosure requirements as set out in sections 175 and 177 of the Companies Act. However, this is very much a backstop defence, and, as the Court of Appeal noted, directors will still need to "plead the specific facts and matters upon which [they] intend to rely in order to demonstrate that there is a realistic prospect of a court granting [them] relief under that section at trial."