When a business partnership collapses, it is common for the founders to believe that their legal obligations to the company evaporate the moment they stop working together. A recent watershed judgement from the Court of Appeal (CoA) clarifies that while an informal joint venture agreement (JVA) can be terminated by conduct, the underlying statutory duties of a director remain very much alive. For business owners, this ruling serves as a vital reminder that corporate divorces are governed by strict statutory rules and not personal grievances.
Background:
The petitioners, Mr. & Mrs. Zhao, and the respondents, Mr. & Mrs. Smith, held equal shares in Kestral Group Ltd. (KGL), a holding company operating as a quasi-partnership for the acquisition, development, and sale of property. Mr. Song provided funding while Mr. Smith managed the construction work. The professional and personal relationship between the parties had irretrievably broken down by July 2022, after which Mr. Song withdrew his funding from the business and ceased his participation entirely. Following this separation, Mr. Smith established new companies under his own control and used them to secure two lucrative refurbishment contracts for properties located at Holton Road and Albany Road.
In response, Mr. & Mrs. Zhao brought an unfair prejudice petition under Section 994 of the Companies Act 2006, alleging that Mr. Smith had misappropriated funds from the group companies prior to the split and had wrongfully diverted the Holton Road and Albany Road business opportunities to his personal companies in breach of his fiduciary duties as a director of KGL. At first instance, HHJ Jarman KC dismissed the petition in its entirety, completely rejecting both the misappropriation allegations and the diversion of opportunities claims. The petitioners appealed the decision.
Decision:
The CoA, however, overturned the Trial Judge's core reasoning on the diverted business, providing a definitive statement on the strict nature of the fiduciary "profit rule". Under Section 175 of the Companies Act 2006, a director is under an absolute statutory obligation to avoid any situations where their personal interests conflict with those of the company. Crucially, Section 175(2) explicitly mandates that it is legally immaterial whether the company could actually have taken advantage of the property, information, or opportunity.
Drawing on the Supreme Court authority in Recovery Partners GP Ltd v Rukhadze, the Court held that a director cannot use a company's financial inability, insolvency, or internal deadlock to excuse self-dealing. Even if a company is bordering on insolvency—which, under BTI 2014 LLC v Sequana, shifts a director's primary duty toward protecting the creditors as a whole—the director still owes an unyielding duty of loyalty to that specific corporate entity.
However, the Court drew a sharp factual distinction between the two diverted projects. One property had already been purchased by the group before the breakdown, making it a "maturing opportunity" that belonged to the company. Diverting that contract constituted a clear breach of duty that could cause unfair prejudice. However, the other property was never owned by the group and was only pursued months after the split. As the funding partner had walked away and ceased all capital provision, the Court ruled it was not unfairly prejudicial for the remaining partner to pursue that pure "future opportunity" independently.
Finally, the Court upheld the contention of unequal salaries, ruling that, because the joint venture had ended, it was entirely fair for the board to award increased remuneration to the partner doing all the active physical labour.
Implications:
The most critical takeaway for commercial partners is that corporate deadlock or financial distress is never a legitimate pretext to divert business opportunities toward a new entity. If you are a registered director, then you owe an unyielding duty of single-minded loyalty to that specific company. You cannot argue that, because your shareholding partner stopped funding the business, resigned as a director, or left insufficient capital to bid on a contract, you are then free to capture that target for yourself. If the opportunity came to you by virtue of your role or sector presence within that company, any profits generated belong strictly to the original business unless your co-shareholders provide fully informed, formal consent.
Moreover, there is a dangerous and common misconception that, when business partners verbally agree to split up, their legal obligations to one another end at that juncture. While an informal JVA can be terminated by words or conduct, any underlying statutory duties under the Companies Act 2006 remain unbroken, as a corporate entity retains a distinct legal persona. Until a director formally resigns his or her duties, or a company is properly wound up (in the event of discord through a court-sanctioned clean break), the strict rules governing conflicts of interest continue to apply with full force.
Crucially, this judgement establishes that proving a legal wrong does not automatically entitle a shareholder to an economic remedy. Under Section 994, a shareholder must prove that a director's wrongdoing caused them real and substantial prejudice in their capacity as a member. If a company is deeply insolvent, then its shares are mathematically valueless. Thus, if any profits from a wrongfully diverted project are insufficient to clear the company's debts and thereby create a surplus, then the shares remain valueless, and the lawsuit will be dismissed.
Before embarking on a ruinously expensive lawsuit over a diverted asset, business owners must ensure that they can clear a strict case-management hurdle in proving that the clawed-back profits will actually exceed any outstanding directors' loans and fully restore the company to solvency. Without such concrete financial proof, legal action may only lead to a pyrrhic victory.
