Podcast: the Fair
Q&B Ltd was incorporated in 1980. The business of the company is the retailing of building material for the trade and DIY market. Leslie is the managing director of the company. There are also five other directors sitting on the board of directors. The company’s articles are based on Schedule 1 of the Company’s (Model Articles) Regulations 2008.
Recently, it has been discovered that Leslie was engaged in activities that might have amounted to a breach of the ‘no-conflict’ rule. These are as follows:
1 Three months ago, Leslie bought a consignment of power tools on the company’s behalf for £500,000 from Fix Ltd for which, unknown to Q&B Ltd, he received a ‘thank you’ present of £10,000 from Fix Ltd. Last week, the tools were sold to various trade and retail customers, causing Q&B to suffer a loss of £50,000.
2 A year ago, Leslie was approached by Basil, a director of Hulti plc, a customer of Q&B Ltd, with a view to Q&B developing a chain of smaller DIY stores for the commuting market, called ‘Q&B Local’. A week later, Leslie told Basil in an email that Q&B Ltd was not interested in developing high street stores as a result of the difficulty in finding financial support from the UK banks following the ‘credit crunch’. However, Leslie informed Basil two days later by ‘phone that another company, Cranebag Ltd, was interested in developing and financing the project together. Unknown to Basil and Q&B Ltd, Leslie owns the majority of the shares of Cranebag Ltd and is Cranebag’s sole director. Following successful negotiations between Cranebag Ltd and Basil, Cranebag Ltd made a reported profit of £5m on the deal between Cranebag and Hulti plc.
In the light of these activities, consider whether Leslie has breached the no-conflict rule and the remedies available, if any, for breach of duty.
Podcast: the Fair
Directors of companies owe duties to the company they serve. The codified, fiduciary (and common law) duties that directors owe are owed to the company, that is, the company’s current and future shareholders as a body, and not to any individual shareholder. This is the effect of s 170(1) of the Companies Act (CA) 2006, which codifies the decision (of the Court of Appeal) in Percival v Wright (1902) and Peskin v Anderson (2001). However, it is possible for a director to owe a duty to a shareholder, as in Allen v Hyatt (1914), where the court held that a director may voluntarily undertake a fiduciary duty towards a single shareholder by acting as his agent. (1) Although the work identifies the principle that directors owe ‘general’ duties to the company, the work fails to summarise the cases in support of the propositions made.
A director is under a duty to avoid a conflict of interest arising as between his duty to the company and his own personal interest. The House of Lords in Aberdeen Rly Co v Blaikie Bros (1854) ruled that a director could not benefit directly or indirectly from a contract made by his company, for example, where he enters into a service contract, or where a director benefits indirectly from a contract between his company and a third party (such as being in receipt of a bonus or commission) without making adequate disclosure of his own interest in that contract. Disclosure should be to the shareholders, unless the articles allow disclosure to the board. Further, s 182 CA 2006 provides rules for the nature of the disclosure to the board, but the penalty for failing to comply with s 182 is a criminal one, not a civil one. For the civil consequences of non-disclosure, we need to turn to general equitable rules, which provide (i) that the contract is voidable at the option of the company (Aberdeen Rly Co v Blaikie Bros (1854)) and (ii) the director can be held accountable for any secret profit made (Boston Deep Sea Fishing Ice Co v Ansell (1888)). Given that L did not disclose his interest in the contract between Q&B Ltd and F Ltd, the contract becomes voidable, although whether Q&B Ltd can rescind the contract depends on whether the right to elect rescission has not been lost. (2) Attempts some application of the rules to the facts of the problem but the application is incomplete, for instance, it would appear the company cannot elect its right to rescind the contract, as restoration of the parties' property (a condition of rescission) would not be possible, the goods having being sold to apparent innocent purchasers.
However, whether the contract is avoided or not, it leaves it open for the company to compel the director to account for any secret profit he made from breaching the no-conflict rule. Alternatively, a director could be sued in damages (equitable compensation) where, in breaching the no conflict rule, he causes the company to suffer a loss. In Mahesan v Malaysia Government Officers' Co-operative Housing Society (1978) a housing society company claimed from the manager of the society the difference between the amount the society paid for the land and what it was later sold for, the original price not being its market value. However, the company must choose between the two remedies. (3) Correctly identifies the relevant legal principle and supporting authority, but fails to apply the rule or the case to the facts of the problem.
The ‘general’ duty to put corporate interest above private profit is augmented in respect of corporate property; in common with a trustee, a director cannot appropriate corporate property. If he does so appropriate, he is liable as a constructive trustee (JJ Harrison (Property) Ltd (2003)). The duty is set out in s 175 CA 2006, the duty being that a director should not benefit from his position as director, an obligation that applies after the ending of the directorship (s 170(2)(a) CA 2006). It is obvious that, if a director appropriates the company’s tangible property, he will be liable to return the property to the company. The same is true of appropriation of intangible corporate assets, for example, the benefit of a contract possessed by the company. This liability for misappropriation is extended to commercial opportunities that are within the company’s grasp. In Cook v Deeks (1916), a company, X, was about to sign a contract to build a railway when X was persuaded by three of the four directors of X to award the contract to a new company that they had formed. The directors were held liable to hold the benefit of the contract as constructive trustees for X. Neither could the directors be excused by the subsequent shareholder ratification of their actions (the three directors held 75 per cent of the shares in X), for misappropriation of corporate assets is an unratifiable breach of a director’s duty (s 239(7) CA 2006 – the statutory procedure on ratification is subject to any common law rendering certain acts as being incapable of ratification). The duty in s 175 CA 2006 provides, but this is not an absolute prohibition, as the duty is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest (s 175(4) CA 2006) - comments to this effect can be found in the judgments of their lordships in Regal (Hastings) Ltd v Gulliver (1942). In Industrial Developments Consultants Ltd v Cooley (1972), C, the managing director of the company, was party to negotiations by the company for the design and construction of a gas terminal. It became clear that the company was unlikely to obtain the contract and C feigned illness, resigned his directorship and successfully tendered for the contract on his own account. The judge held C liable to account for the profit he had made on the contract. Although the company was unlikely to get the contract, C was not entitled to use information concerning it and obtained in corporate service, for his own benefit. In contrast, in Island Export Finance Ltd v Umunna (1986), a former director who successfully tendered for a contract with the Cameroon postal authorities was not in breach of his fiduciary duty despite the fact that he had gained useful information and contacts with the authority while negotiating a contract with it on the company’s behalf some two years ago. The court noted that there was a lack of a ‘maturing business opportunity’ for the director to exploit. In LC Services Ltd v Brown (2003), a director, in breach of duty delivered a copy of a company database to a rival company for whom he worked and removed company documents and company maintenance procedures. The court held that this amounted to a misuse of confidential information. In Ball v Eden Project Ltd (2004),the court held that, despite B’s claim for compensation in respect of a dispute with the company over remuneration, the director was not entitled to register the company’s mark in his own name and deprive the company of the use of its property. (4) The work does attempt to summarise the leading cases, but fails to draw any firm conclusions in the light of the facts of the question.
If L had obtained authorisation by the directors (s 175(5) CA 2006) or approval from the shareholders (s 239 CA 2006), he may have escaped liability (Regal (Hastings) Ltd v Regal (1942)). In respect of authorisation under s 175(5) CA 2006, where the company is a private company, authorisation is permitted as long as it is not invalidated by anything in the articles; where a public company, the articles must provide for authorisation. For misuse of corporate property, L would be liable to account for any profit made. (5) Although the work refers correctly to the need to consider remedies for breach and the means by which a company can excuse a director for breach, it fails to either provide sufficient authority or make a clear or clearer connection to any breach, as identified in the previous key point. Here, the profit that has been made has been made by Cranebag (C) Ltd, a company controlled by L. In these circumstances, in order for Q&B Ltd to recover the profit, the court may be prepared either to lift the veil of incorporation (Trustor AB v Smallbone (1999)), or to hold the third party liable as a constructive trustee. Liability can be imposed on third parties who have been involved in a director’s breach of duty, as in Selangor v Cradock (1968), where the third party was held liable as a constructive trustee. Whether such third party liability exists depends on whether C Ltd had knowingly participated in a breach of duty or trust by the director on the basis of ‘knowing receipt’ or ‘knowing (or dishonest) assistance’; the appropriate remedy is either restoration of property misapplied and held by the third party or damages representing the value of the misapplied assets (as in Royal Brunei Airlines Sdn Bhd v Tan (1995) and Twinsectra Ltd v Yardley (2002)). (6) Identifies the relevant law and cases but does not provide any analysis of the facts of the problem.
It should be noted that the proper claimant to address a wrong done to the company is the company itself – this represents the rule in Foss v Harbottle (1843). The power to sue on the company’s behalf normally resides with the directors (as provided for by art 70 of Table A) but it can lie with the general meeting, either by passing of a special resolution instructing the directors to take action (art 70 of Table A) (7) Fails to recognise that Table A has been replaced by the model articles, 2008, or to explain that Table A may still form the basis of a company’s articles, or by taking action under a default power where the directors have committed the wrong to be suffered by the company. Alternatively, a shareholder, under s 260 CA 2006, can bring a derivative claim on behalf of the company against a director for breach of duty, but the shareholder would have to show a prima facie case in accordance with s 261 CA 2006 and to obtain the permission of the court to continue with the claim (s 263 CA 2006). Section 260 provides that the shareholder must establish that the directors are in breach of duty and the company has a cause of action arising from such a breach. Assuming in this case, that provision was satisfied, the shareholder must establish a prima facie case. If the court is satisfied that there is a prima facie case, it has the power inter alia to give directions as the evidence to be provided by the company and, on hearing the application, to give or refuse permission to continue the claim (s 261 CA 2006). Under s 263 CA 2006, the court must refuse to give permission where it is satisfied that a person acting in accordance with s 172 CA 2006 (duty to promote the success of the company) would not seek to continue with the claim, or where the act has been authorised or ratified by the company (s 263(2) CA 2006). Where this is not the case, factors the court can take into account in deciding whether to allow the claim to proceed include whether the shareholder is acting in good faith, the importance a person acting in accordance with s 172 CA 2006 would attach to continuing the claim, whether the act in the circumstances would be likely to be authorised or ratified by the company, whether the company has decided not to pursue the claim, whether the member could pursue an action in his own right, and the views of other members who have no personal interest (s 263(3)(4) CA 2006). Any decision by the company to ratify the conduct of the directors amounting to a breach of duty must be taken by the members, the votes of the directors as shareholder not counting (s 239 CA 2006), unless consent is unanimous (s 239(6) CA 2006). The common law and equitable rules on acts that are incapable of ratification are preserved by s 239 (7) CA 2006. For example, a derivative claim did not lie at common law where the shareholder participated in the fraud or had benefited from it (Nurcombe v Nurcombe (1985)), or was seeking to sue for an ulterior motive (Barrett v Duckett (1995)), or had failed to establish that it was the fraudsters who were blocking litigation by the company (Smith v Croft (No 2) (1987)). In Franbar Holdings Ltd v Patel (2008), the court refused to grant permission to a minority shareholder to continue with a derivative claim, on the basis that the allegation relied on by the shareholder gave rise to causes of action already subject to a personal remedy in the form of breach of shareholder agreement and a petition for relief under s 994 CA 2006. Further, a director acting in accordance with his duty to act bona fide in a way likely to promote the success of the company (s 172 CA 2006) would have attached little importance to continuing the derivative claim (s 263(2)(a)&(b)). In contrast, in Kiani v Cooper (2010), which was the first reported decision in which the court agreed to allow an application under the new statutory, derivative procedure to proceed further. The court held that the director had failed to adduce any evidence to rebut the allegations made against him and that the claimant was acting in good faith. A notional director, acting in accordance with his duty under s 172 CA 2006, would wish to continue with the claim against the defendant, where the defendant had failed to adduce any corrobative evidence in support of his denial of the allegations made against him. (8) Although the work is accurate, it is not entirely relevant to the question, which invites the student to consider breach of duty and applicable remedies and not forms of shareholder or corporate action. Even if that was ‘permitted’, the work as found elsewhere in this answer fails to draw any firm conclusions in terms of applying the principles to the facts of the question.