Directors of informally run companies may have a lower threshold for disclosing conflicts

Directors of smaller, informally run, companies may have less onerous obligations for disclosing conflicts of interest than directors of larger or formally run companies, following a Court of Appeal judgment in Humphrey v Bennett [2023] EWCA Civ 1433.

Background

The case concerned a small property development company (“Esprit Land”) and an opportunity to develop residential houses on land it had purchased (the “Opportunity”). The land to which the Opportunity related was purchased for £107,500 in June 2018 but it was both land locked and did not have planning permission (the “Development Land”).

After the Development Land was purchased but before February 2019, the First Defendant applied for and secured planning permission to build 12 houses: ten on the Development Land and two on land that connected the Development Land to the road (the “Adjoining Land”).

In February 2019, the First Defendant negotiated a purchase price for the Adjoining Land with its owner on behalf of Esprit Land, but the purchase never took place.

The Claimants were the minority shareholders (49%) of Esprit Land. The Defendants were the majority shareholders. Both Claimants and Defendants were directors of Esprit Land.

The Claimants allege that the Opportunity was diverted away from Esprit Land on 21 January 2020 when the Development Land was sold for £107,500 to a separate company, Esprit Homes Construction Limited (“EHC”) in which the First Defendant was sole shareholder and both Defendants were directors.

The Claimants allege that the sale of the Development Land to EHC for £107,500, so that EHC could pursue the Opportunity, ultimately went against their interests as minority shareholders of Esprit Land. The First Defendant asserted that the Claimants had made clear their intention not to invest the monies required to pursue the Opportunity and knew that the Defendants intended to do so.

The Adjoining Land was later purchased by the First Defendant’s nephew on the open market.

Relevant provisions of the Companies Act 2006 (the “Act”)

The provisions relevant to the Claimants’ claim are as follows:

• a director must disclose potential conflicts of interest between them and the company and avoid conflicts (s.175 of the Act). A majority of the other directors must authorise a director’s actions if there is a potential conflict.
• a director must declare any interest they have in a proposed transaction or arrangement with the company and where there is a conflict, a majority of the other directors must authorise the conflicted activity proceeding (s.177 of the Act).
• the court may relieve a director of liability for negligence, default, breach of duty or breach of trust if it appears that the director acted honestly or reasonably in the circumstances (s.1157 of the Act).

What did the Court decide at first instance?

The Claimants were originally awarded summary judgment against the First Defendant.  The Court decided:

• there was insufficient evidence of disclosures under ss.175 and 177 of the Act to give rise to a defence that those sections had been complied with and that the sale of the Development Land to the First Defendant’s other company, EHC, was authorised by Esprit Land.
• it was inappropriate to award the First Defendant relief under s.1157 of the Act in the circumstances of the case.
• the value of the Development Land had likely increased due to planning permission having been granted before it was sold to EHC. By selling that land for the original purchase price (1) Esprit Land was denied the true sale value of the Development Land at the time it was sold and (2) the First Defendant had retained a profit made as a result of having breached his fiduciary duties to Esprit Land (and to the Claimants) and would profit further upon completion of the planned development.

The decision of the Court of Appeal

The Defendants appealed the Court’s decision to the Court of Appeal which unanimously overturned the summary judgment, sending the claim back to the High Court for trial. In doing so the Court of Appeal made the following comments:

s.175 point

All parties accepted that Esprit Land was run informally and that all involved simultaneously pursued their own separate property businesses and interests.

If the Claimants did not have an interest in pursuing the Opportunity, they ought to have appreciated that the Development Land would potentially be sold to the Defendants (or an entity controlled by them) who did. A trial judge would have to decide whether the parties had come to an understanding on this.

There was a “realistic argument” that if the Claimants agreed that the Defendants (or a company controlled by them) could pursue the Opportunity, the Claimants ought to have appreciated that the Defendants would need to buy the Development Land from Esprit Land “at an appropriate (full) value”.

The First Defendant was entitled to argue that the potential conflict had been disclosed to the Claimants (s.175).

s.177 point

The First Defendant should also be entitled to raise a defence of compliance with s.177 of the Act at trial. The Court had seen no evidence that planning permission had increased the value of the Development Land and therefore it had no evidence that EHC had purchased it at an undervalue by paying £107,500 for it.

S.1157

The First Defendant should be allowed to seek relief / assert a defence under s.1157 of the Act. Whilst a trial judge might decide that the First Defendant breached duties under s.175 or 177 of the Act, it cannot be ruled out that the First Defendant’s genuine perception of what he had been authorised to do was reasonable, thereby entitling him to a defence under s.1157 of the Act.

Why might this be of interest?

This judgment of the Court of Appeal, although dealing with a summary judgment of the lower court, shows that directors of small and/or informally run limited companies may have a lower threshold for complying with ss.175, 177 and s.1157 of the Act.

In this instance the Defendants are not necessarily out of the woods because the matter has been returned to the High Court for trial unless it is otherwise resolved, but they have overturned the summary judgment and now have the opportunity to attempt to demonstrate on the evidence why their defences should succeed or relief should apply.

If you would like to discuss shareholder disputes, please contact either Nick Roberts (Senior Associate) or Marie-Louise King (Partner).

This article is for general information only and does not, and is not intended to, amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.