- within Corporate/Commercial Law, Criminal Law and Energy and Natural Resources topic(s)
- in United States
In Saxon Woods Investments Ltd v Costa, the Court of Appeal has clarified the scope of a core directors' duty.
s.172 of the Companies Act 2006 requires directors always to act in the way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.
This duty is a core plank of the legal regime imposed on UK company directors, which disgruntled shareholders will often point to and seek to establish a breach of if they are unhappy with the way in which a company is being run.
The question before the court was whether a director who had acted dishonestly towards their company, while simultaneously believing that what they were doing was in the company's best interests, had breached this duty.
The answer was a resounding "yes".
The facts
The court's decision arose from an unfair prejudice petition brought by the minority shareholder in a company against the company's indirect majority shareholder, Mr. Costa.
The company and its shareholders had signed a shareholders' agreement which required them to work together in good faith towards either a sale of the company's shares, or a sale of its business and assets, by the end of 2019.
The minority shareholder alleged that Mr. Costa, as the director/shareholder charged with running the sale process, caused the company to breach this obligation, both by pursuing a policy of delaying any sale beyond the end of 2019, and by keeping from his fellow directors and shareholders that that was what he was doing. This amounted to a breach of Mr. Costa's s.172 duty.
Mr. Costa contended that he had taken these steps in the (ultimately mistaken) belief that the delay would result in a better sale price and therefore a better overall outcome for both the company and its shareholders – and that as a result, his duty had not been breached.
The decision
The Court of Appeal clarified that the s.172 duty requires a director, in all that they do, to act honestly towards a company.
Where a director's honesty is in question, the first step is to establish what their subjective state of mind was at the relevant time. The second step is to consider on an objective basis whether their conduct was honest, by reference to how an ordinary decent person would view it. An individual can subjectively consider that they are being honest, or doing the right thing, but still fall foul of this second limb if an ordinary decent person would consider what they are doing to be dishonest.
Here, while Mr. Costa subjectively believed he was doing the right thing for the company, his conduct was objectively dishonest. It therefore amounted to a breach of his s.172 duty.
Key takeaways
This decision will be relevant to any director defending a breach of duty claim where their honesty is in issue. It will no longer be enough for directors to point to their subjective state of mind as an answer to a claim (i.e. to run an "I honestly believed that I was doing the right thing for the company" defence). There will also need objective assessment of whether, by the standards of an ordinary decent person, what they have done is dishonest.
This represents a tightening of standards and may encourage more frequent breach of duty claims.
As ever, directors seeking to ward off such claims will be assisted if they have documented the basis for their decisions. If a director believe obligations in a shareholders' agreement are no longer in a company's best interests, they should not unilaterally cause the company to breach those obligations, or conceal the fact that they are doing so. Instead, advice should be sought as to how those obligations can be amended or removed.
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