The High Court has recently delivered a significant judgement clarifying the stringent requirements of a director's duty to promote the success of the company in good faith, emphasising the objective standard of honesty and the binding nature of shareholder agreements on directorial conduct.
Background:
The company is the holding company for a group of companies that provide creative services to existing brands in the fashion, beauty and luxury brand sectors. The business operated by the group was founded in 1996 by Mr. Loy, who was the CEO until 2017, at which juncture he sought to negotiate the sale of his shares. The business of the group grew rapidly, and by 2012 it had a turnover of £23 million.
At that point, Mr. Loy decided to expand the business into New York. This required raising external investment, and Mr. Loy was introduced to Mr. Costa, who was appointed to the board. A shareholders' agreement was entered into on 27 February 2013, which was later amended on 20 May 2016.
Further rounds of financing followed in 2014 and 2016. In conjunction with the 2014 financing, Mr Loy's shares were transferred, indirectly, to Saxon Woods (SW).
A board meeting was held on 20 November 2018, at which it was resolved that the company would hire Jefferies LLC as the company's investment bank, to commence the exit process, with Mr. Costa leading the discussions.
SW alleges that Mr. Costa caused the company to breach its obligations under Article 6.2 of the shareholders’ agreement by failing to achieve an exit by 31 December 2019. At first instance, the High Court found that the company acted in breach of its requirement to work in good faith towards an exit by 31 December 2019 and that Mr. Costa was responsible. The Judge also ruled that he misled the board of directors by giving them the impression that steps were being taken when they were not, but refused to make an unconditional order despite concluding that Mr. Loy suffered an unfair prejudice. Both parties appealed.
Decision:
The Court of Appeal (CoA) dismissed Mr. Costa’s appeal, set aside the Judge’s order, and made an unconditional order that Mr. Costa buy SW's shares in the company on the terms indicated. The CoA, however, fundamentally disagreed with the Judge's approach to Section 172 of the Companies Act 2006 and the resulting remedy.
The Court emphatically states that the Judge's approach to Section 172, which focused solely on Mr. Costa's subjective belief that he was acting in the company's best interests ("sincerely believed"), was incorrect. This approach "deprives the phrase 'in good faith' of all content and meaning," effectively deleting it from the statute. The Court explicitly concludes that the requirement for a director to act "in good faith" under Section 172 includes, as a core fiduciary duty, “a requirement that the director acts honestly towards the company”.
The Court strongly asserts that "Deliberately deceiving the board of a company must, either always or almost always, be inconsistent with a director's duty under Section 172".
The Court finds that the Judge's exercise of discretion regarding the remedy was "flawed and must be set aside" because it was premised on the incorrect assumption that Mr. Costa had acted in good faith regarding his fiduciary duties.
Implications:
This case clarifies the extent to which a director in defending a claim for breach of duty under Section 172 of the Companies Act 2006 can rely upon their subjective opinion of what the best interests of the company would be. This judgement clarifies that the "good faith" requirement in Section 172 now incorporates an objective assessment of honesty based on the Ivey test, meaning a director's conduct can be deemed a breach of duty if, by objective standards, it is dishonest, regardless of the director's personal belief about long-term benefit. This significantly raises the bar for directorial conduct.
Directors cannot simply claim they "sincerely believed" their actions were for the company's benefit if, by objective standards, their conduct (given their knowledge of the facts) would be considered dishonest by "ordinary decent people". Moreover, deliberately misleading the board is almost always a breach of Section 172.
This case also highlights that the valuation date for the buy-out can be set before adverse market events if the director's breach of duty led to the company being exposed to those risks against the wishes of the affected shareholders.