The Court of Appeal has handed down judgment in the case of Humphrey v Bennett, providing some useful guidance on the nature and scope of a director’s duty to avoid conflicts of interest. The case was an appeal against summary judgment of the High Court following a derivative claim brought on behalf of a company by minority shareholders. The case will be of particular interest to directors of smaller companies whose management structures very often operate on a more informal footing.
The full judgment can be accessed here.
Background
Mr Bennett and Miss Murphy were the owners and directors of a property development company (the company). In 2015, Mr and Mrs Humphrey acquired 49 per cent of the company’s share capital and were each appointed directors in addition to Mr Bennett and Miss Murphy.
The company purchased a piece of land in Coventry in 2018 with the intention of obtaining planning permission and developing it (the development land). The site was landlocked and therefore an adjoining piece of land would need to also be acquired in order to provide access to the development land (the adjoining land). The company obtained planning permission for the development land and the adjoining land and agreed a price with the owner of the adjoining land for its acquisition for the purposes of the proposed development.
Significant further capital was required by the company in order to purchase the adjoining land and proceed with the planned development. However, when approached in relation to this, Mr and Mrs Humphrey declined to invest further funds, prompting Mr Bennett and Miss Murphy to cause the company to sell the development land to a company which was solely owned by Mr Bennett (and whose directors were Mr Bennett and Miss Murphy). When Mr and Mrs Humphrey complained about the sale of the development land, on the basis that the opportunity had been diverted away from the company to another company in which Mr Bennett was the sole shareholder, they were removed as directors of the company by Mr Bennett and Miss Murphy (in their capacity as majority shareholders).
Conflicts of interest – Companies Act 2006
Section 175(1) of the CA 2006 requires a director to avoid a situation in which they have a direct or indirect interest that conflicts (or may possibly conflict) with the interests of the company in respect of which they are appointed. This duty is not breached in circumstances where the matter has been proposed to, and authorised by, the directors at a meeting which is quorate, without counting the “interested” director (sections 175(5) and (6)).
Section 177(1) CA 2006 provides that a director must declare the nature and extent of any interest they may have in relation to a proposed transaction or arrangement with the company to the other directors. Section 177(2) confirms that any such declarations may be made during the course of board meetings (but do not have to be), while section 177(6)(b) provides that a director need not declare any such interest if other directors are already aware of the conflict (for this purpose directors are treated as being aware of anything of which they ought reasonably to be aware).
Section 1157 CA 2006 provides the court with the power to grant relief from liability to a director who has breached their duties if it considers that the director acted honestly and reasonably and in the circumstances ought fairly to be excused.
As duties are owed by the director to the company to which they are appointed, rather than to shareholders, Mr and Mrs Humphrey brought an action on behalf of the company (a derivative action) against Mr Bennett for breach of duty.
First instance decision
At first instance, summary judgment was entered against Mr Bennett on the basis that he had failed to provide sufficient disclosure of his interests in relation to the sale of the development land by the company to a company in which he was the sole shareholder. The court therefore held that he was unable to rely on the statutory defences provided under sections 175 and 177 CA 2006. The court also held that Mr Bennett was unable to seek relief pursuant to section 1157 CA 2006 given that he had retained the benefit of the transaction – noting that to hold otherwise would require an “extremely powerful case”.
Court of Appeal decision
The Court of Appeal allowed Mr Bennett’s appeal. In doing so, it reversed the High Court’s decision that Mr Bennett’s defence to the claim for breach of duty had no prospect of succeeding at trial. The court considered that it was at least arguable that Mr and Mrs Humphrey would have understood that their refusal to provide additional financing for the proposed development would have resulted in the company selling the development land. Historically, the company had been run in an informal manner with the directors each pursuing their own business interests outside of the company, and so it was not inconceivable that Mr and Mrs Humphrey’s refusal to provide funding, coupled with the understanding that the opportunity for the proposed development would be pursued by Mr Bennett via his corporate vehicle if not pursued by the company, could be construed as authorisation for the purposes of section 175 and approval for the purpose of section 177 CA 2006.
The court also confirmed that whether a director had retained the benefit of the transaction in question was only one of a number of factors that it would need to assess when considering whether to grant relief under section 1157 CA 2006, and that it was not the determinative factor. The court considered that a director who had benefitted from a transaction in relation to which he was alleged to have breached his duties would potentially still be capable of obtaining relief under section 1157 CA 2006. Further, the mere fact a director had been unable to avail himself of the statutory relief mechanisms in sections 175 and 177 CA 2006 would similarly not, as a matter of principle, prevent relief being granted pursuant to section 1157 CA 2006.
Comment
David Steinberg, co-head of the restructuring and insolvency team comments that:
"The decision in this case does not finally determine the issue of whether there was a breach of duty by the director in question, but it does demonstrate the court’s willingness to adopt a “common sense” approach to the application of directors’ duties. While the court’s recognition that the management structures and processes adopted in small, informally run businesses are often vastly different to those in place in much larger companies arguably only reflects the commercial reality, it will be welcomed by directors of smaller companies nonetheless. The rejection of the High Court’s rigid interpretation of directors’ duties will provide comfort to directors that their actions will not be scrutinised in a vacuum and that a court’s analysis in this regard will take account of the relevant factual context specific to the companies in respect of which they are appointed".
David Steinberg
Louise Corcoran