The statutory directors’ duties, set out in the Companies Act 2006 (‘the Act’), form the basis of the responsibilities which directors owe to a company. They shape how directors conduct themselves, make decisions and can have a very real impact, given that any breach of these duties has the potential to result in a civil claim being brought against a director in a personal capacity. Section 172 of the Act requires directors to act in a way which they “consider in good faith” to be most likely to promote the success of the company for the benefit of its shareholders as a whole. It is often referred to as the overarching duty. Whilst directors will have a sense of what this duty means, a recent Supreme Court judgment has provided some welcome clarification.
In Saxon Woods Investments Limited v Francesco Costa, the Supreme Court heard an appeal from the Court of Appeal’s decision which we originally wrote about here. In the case, the company entered into a shareholders’ agreement which provided for an investor exit by 31st December 2016. In breach of this, Mr Costa, a director, covertly delayed the sale of the company beyond this date. In contrast to many directors’ duties cases, he was not acting purely to benefit himself personally - he purported to do so in the genuine belief that the delay would increase the sale proceeds of the shares, which would ultimately be in the best interests of the company.
An objective test?
One of the key points of the case turned on the standard required by directors in discharging their duty under section 172 of the Act. Mr Costa appealed the Court of Appeal’s decision to use an objective test to establish a breach of duty on the basis that the director had done what he personally believed to be in the company’s best interests. He contended that it was primarily up to directors to decide how to discharge their duty and that there should be limited involvement from the court in deciding this. There was some substance to this argument, given that courts have long been reticent to involve themselves in purely commercial decisions of companies, largely because of the ‘hindsight rule’. This rule emphasises that director conduct should be judged according to the context at the time decisions were made.
In its analysis of section 172 of the Act, the Supreme Court chose not to apply a literal interpretation of the statute, which would have suggested that the duty was to be discharged according to a standard that a director themselves considered to be in good faith. Instead, a purposive approach was preferred on the basis that an objective good faith assessment was more aligned with the pre-existing common law, which the court emphasised had been codified by the statutory duties rather than having been replaced in their entirety.
The court used this context to explain the practical risks of embracing a subjective standard of good faith: for a corporate entity with no consciousness of its own to function properly, there must be mutual understanding between those who give the entity animus - in other words, between its directors. The court explained that corporate governance would be prone to “paralysis” if directors were only required to think and not simultaneously to act in good faith. A purely subjective interpretation would be “destructive of the collegiality of the board of directors.” It was accepted that the starting point would usually be the business judgment of directors, but that this did not give directors “carte blanche” to implement dissenting views in a “covert or disloyal” way. It was primarily for these reasons that the Supreme Court held that the requirement of good faith governed both the subjective thinking of the director and their objective conduct.
What this interpretation of section 172 could mean for directors
Every director is responsible for the commercial success of the company but, amongst a board of several directors, there may be conflicting interpretations of how best to achieve such success. The Supreme Court’s interpretation of section 172 of the Act is important as it brings the board as a whole into the forefront. It suggests that the way in which directors should promote the company’s interests and implement their own delegated responsibilities does not exist in a vacuum, involving only the director in question and the company. Instead, it is predicated on the board’s collective will. Individual directors cannot therefore act in a way that is contrary to the decisions of the board, even where they themselves believe that this action will benefit the company. This interpretation of section 172 of the Act is important to bear in mind in a practical sense when considering the composition of the board and any mechanisms for decision-making by the board provided for in the articles, for instance, through the existence of a chairman’s casting vote.
Legal implications
From a dispute resolution perspective, the Supreme Court’s endorsement of an objective standard of good faith under section 172 of the Act has important practical consequences for directors. Until now, claims for breach of section 172 of the Act were often difficult to establish because the test was largely subjective. A director could argue that they genuinely believed they were acting in the company’s best interests, and that belief could be hard to challenge. The objective element means that courts will now look not only at what the director believed, but also at what they did. That includes whether they followed proper board processes, acted consistently with board decisions and communicated openly with fellow directors. This may make it easier for companies, liquidators or shareholders to bring breach of duty claims under the Act. Directors should therefore review whether their directors’ and officers’ insurance cover remains adequate in light of this wider potential exposure.
The decision may also affect shareholder remedies, particularly unfair prejudice petitions under section 994 of the Act. In those cases, a minority shareholder must show that the company’s affairs have been conducted in a way that is unfairly prejudicial to their interests. If the complaint is that a director acted alone and departed from a decision previously approved by the board, the Supreme Court’s focus on collective governance and objective good faith may help the shareholder’s case. A court may be more willing to treat a hidden departure from a board decision as unfairly prejudicial, even where the director says they acted with good intentions. The same reasoning may also be relevant to derivative claims under Part 11 of the Act, where a shareholder seeks to bring a claim on behalf of the company for breach of directors’ duties.
Impact
Following the Supreme Court’s decision, directors should be aware of the effects that this interpretation could have when discharging their statutory duty owed to the company under section 172 of the Act. While the court has historically shown restraint in judging the commercial decisions of directors, this case marks a clear change as it highlights both a subjective and objective assessment of this duty. It clarifies that the objective part of this test is linked to the decisions made by the board and directors must therefore always bear this in mind when considering the company’s best interests.
Brodies' Corporate and Corporate Disputes teams are well placed to assist on any corporate matters and regularly act for companies, directors and shareholders. For any more information, please contact the authors or one of the members of the Corporate team or Corporate Disputes Team.
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