UK Supreme Court directors ruling shows need for ‘good faith’ behaviour

The court ruled (21-page/ 299 KB PDF) that directors have a duty to act in good faith and show loyalty to the company under section 172 of the Companies Act 2006, after dismissing an appeal over a company director’s efforts to delay the sale of their company – with the court warning that failure to behave in good faith could lead to “chaos and paralysis” for companies.

James McBurney, a high value disputes expert with Pinsent Masons, said the court’s decision would have important implications for other directors going forward.

“Interestingly, the main focus of the Supreme Court when deciding whether Costa, the director, had breached s172 was whether he had acted in good faith, rather than whether he had acted dishonestly,” he explained.

“This suggests that a director's behaviour can fall short of dishonesty while still breaching s172.”

The ruling came after fashion and beauty creative firm Spring Media Investments and its investors entered into a shareholders’ agreement to work towards selling the company by 31 December 2019.

The sale process had been delegated entirely to Mr Costa, one of the directors, but the process was not carried out in accordance with the agreement as Costa felt a sale after 31 December 2019 would likely produce a better financial return for both company and investors.

While successfully delaying the sale past that date, the Covid-19 pandemic significantly impacted the company’s business the following year. Saxon Woods Investments, one of the company’s shareholders, presented a petition against Costa for relief from unfair prejudice under s994 - 996 of the Companies Act 2006, arguing that he had been personally responsible for the failure to complete the sale and as such should be required to buy out Saxon Woods’ stakeholding at a suitable value, that being the pre-pandemic value of the shares.

A previous trial judge found Costa had sought to delay a sale, including limiting any knowledge of the process; misleading the board to give the other directors the impression he was fulfilling the obligations under the shareholder agreement; and failing to disclose to the board his instructions to company advisors in connection with the sale, that did not encompass achieving a sale by the expected date.

The first instance hearing had ruled that although Saxon Woods had been unfairly prejudiced, Costa had not breached his fiduciary duty under s172. The court ordered a conditional buy-out order of the shares’ value at the end of 2019 – the condition being that, had the company complied with the exit strategy agreed in the shareholders agreement, a final offer of more than US$75 million net of debt would have been received for the company by the end of 2019. Both Costa and Saxon Woods appealed.

The Court of Appeal ruled that Costa’s behaviour was dishonest and therefore not in good faith, and so in breach of s172 of the Companies Act 2006. The Court of Appeal dismissed his appeal and allowed Saxon Woods’ appeal, ordering an unconditional buyout of the shares. Costa appealed to the Supreme Court.

Lord Briggs delivered the Supreme Court ruling, which upheld the Court of Appeal’s decision that Costa’s conduct “fell short” of the requirements of his fiduciary duty, even if he believed he was acting in good faith. In his judgment, he said: “That essentially objective approach to the determination of the extent of a fiduciary duty, and of an allegation of breach of it, continues unabated to this day.”

He added that allowing directors to merely think they were behaving in good faith, rather than acting as such, would be a “a recipe for chaos and paralysis in corporate governance”.

Chris Dryland, a litigation expert with Pinsent Masons, added: “Although the Supreme Court did not consider whether not complying with the agreed exit strategy in the shareholder agreement in itself meant that the director had breached s172, this point was considered by the Court of Appeal, which held that it was a breach, which provides useful guidance to directors and practitioners as to what type of conduct may or may not breach s172” .