Podcast: the Good
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 Good
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 common law position set out 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) Identifying that directors owe ‘general’ duties and these are owed to the company alone.
In Percival v Wright (1902), the directors of a company were privy to confidential information which, once released, was likely to increase the value of the company’s shares. P, a shareholder, offered to sell his shares to the directors, who accepted his offer. When the confidential information was released, P sought to have the contract of sale set aside and to recover the shares, on the ground that the lack of disclosure was a breach of fiduciary duty by the directors. Swinfen-Eady J, in rejecting P’s claim, held that the directors did not, simply by being directors, owe a fiduciary duty to an individual shareholder; they did owe such a duty to the company but they had not broken it. In Peskin v Anderson (2001), the directors were held not to owe a duty to former shareholders to inform them of the disposal of a company asset, which resulted in existing members each receiving a windfall of £34,000, as there was no special factual relationship generating a fiduciary obligation such as a duty of disclosure. (2) Summarises the cases both accurately and succinctly. These codified, fiduciary duties are based on the equitable principle that a director is required to exercise his powers in a way that has regard to the interests of the person to whom the duties are owed and not to abuse his position of trust and influence within the company, so that, for instance, in common with a trustee, a director cannot, without authorisation or ratification, derive any benefit from the use of corporate property.
From the problem, there are two possible breaches of the no-conflict rule that can be indentified - each of these will be examined in turn (3) The answer will set out the work in two parts so that the examiner can be confident that the student knows the difference between the different aspects of the no-conflict rule.
1 The ‘bonus’ from Fix (F) Ltd
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 (for example, article 14 of the model articles and s 178 CA 2006). Further, s 182 CA 2006 provides for disclosure to the company but the penalty for failing to comply with s 182 CA 2006 is a criminal one, not a civil one. For the civil consequences of non-disclosure, there is a need to turn to the general equitable rules, as provided for by s 180 CA 2006, which state (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 Fix Ltd, the contract becomes voidable, although whether Q&B Ltd can rescind the contract depends on whether the right of rescission has not been lost. It would appear that the company cannot elect to exercise its right to rescind the contract, as restoration of the parties' property (a condition of rescission) would not be possible, the power tools having being sold to various, and presumably, innocent trade and non-trade 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 Privy council in this case ruled that the company must elect between account of profit and damages. In the problem, it would appear that the loss suffered by the company of £50,000 is greater than the secret profit made by L and that given the quick nature of the sale of the power tools, market conditions have had little effect on the original price paid by Q&B. The reduction of the value of the goods has occurred over a three week period and the loss suffered by Q&B Ltd of £50,000 is recoverable from L. This amount is greater than the amount L received in the form of the gift. In Attorney-General for Hong Kong v Reid (1994), the Privy Council recognised a proprietary remedy by way of a constructive trust in favour of the company against the director or other agent in respect of a bribe, so that the company would be able to claim any profit the director made from his use of the bribe.
As Lord Porter stated in Regal (Hastings) Ltd v Gulliver (1942), ‘Directors, no doubt, are not trustees, but they occupy a fiduciary position towards the company whose board they form.’ (4) Good use of a quote from a judgment to support the point made. 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 which 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 which they had formed. The directors were held liable to hold the benefit of the contract as constructive trustees for X. (5) The work includes a summary of the cases – this theme is continued throughout the work.
Neither, in this case, 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, that did not entitle the director to register the company’s mark in his own name and deprive the company of the use of its property. (6) Makes a excellent distinction between that information that can be regarded as ‘corporate property’ and that information that can be regarded as ‘personal’.
Judging by the cases in this area, it would appear that L has breached the no-conflict rule by appropriating an opportunity belonging to the company. The information does not appear to be in the ‘public domain’ and the fact that Q&B Ltd might not be interested in the opportunity may not absolve L from liability, as the information might be considered to be ‘worthwhile and commercially attractive’ to the company (Bhullar v Bhullar Bros Ltd (2003)), or of a type that the director is under a duty to pass on to the company (Industrial Developments Consultants Ltd v Cooley (1972); Bhullar v Bhullar Bros Ltd (2003)). If, however, 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. (7) Looks at remedies available to the company, not simply analysing the question in terms of breach alone. However, 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 (Royal Brunei Airlines Sdn Bhd v Tan (1995); Twinsectra Ltd v Yardley (2002); Barlow Clowes International Ltd v Eurotrust International Ltd (2006)). In Twinsectra, the House of Lords held that in order to show that defendant has been dishonest for purpose of liability as an accessory it must be shown that his conduct was dishonest by the ordinary standards of reasonable and honest people and that the defendant realised that by those standards his conduct was dishonest. It is not necessary to show dishonesty on the part of the third party in respect of knowing receipt, for which, see Bank of Credit and Commerce International (Overseas) Ltd v Akindele (2001). It does appear from the facts of the question, that C Ltd can be held liable as a constructive trustee but that H Ltd has appeared to have acted innocently. (8) The answer considers the liability of third parties that may have assisted in a director’s breach of duty.
Finally, it should be noted, albeit briefly, 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 3 of the model articles (2008)) but it can lie with the general meeting, either by passing of a special resolution instructing the directors to take action (art 4 of the model articles (2008)) 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). (9) There is no need to consider this matter further, as the question does not invite the student to analyse the forms of corporate action.