Directors’ duties – the dishonesty trap

In Saxon Woods Investments Ltd v Francesco Costa, a minority shareholder (Saxon Woods) brought a petition alleging it had suffered unfair prejudice in relation to the affairs of Spring Media Investments Limited (the Company). The Company and Saxon Woods had entered into a shareholders’ agreement (SHA) under which the Company agreed to work in good faith towards an exit by means of the sale of the Company or its assets by the end of 2019. That had not occurred, despite Saxon Woods seeking to make introductions to potential buyers to assist the process. As a result, no exit had been achieved by 2020 and when COVID hit, the business was badly affected and the value of Saxon Woods’ shareholding in the Company severely impacted.

A director, Mr Costa, had effectively controlled the proposed sale process, working with a financial adviser, Jefferies LLC. The judge at first instance found that, in the event, Mr Costa deliberately slowed the process of seeking a buyer for the business. He did not inform Jefferies LLC of the contractual deadline for a sale and they were working on a longer timescale. Mr Costa decided that a better price could be obtained for the Company in 2020 or beyond and he deliberately kept information from the board and from shareholders, while purporting to aim for the 2019 deadline.

“ …in good faith …”

When it came to the question of whether Mr Costa was in breach of his duties under section 172 of the Companies Act 2006, the judge in the High Court held that he was not, because he reasonably believed that he was acting in the best interests of the Company i.e. a wholly subjective test was applied. The Court of Appeal overturned this finding. Section 172 states that a director of a company “must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”. The requirement of good faith requires honesty and the test for whether someone has acted honestly or dishonestly was set out in the key Supreme Court case of Ivey & Genting Casinos in 2017. Its two fold approach comprises a subjective test of what the actual state of the individual’s knowledge or belief was followed by a test of applying the, objective, standards of ordinary decent people. Although a criminal law case, this approach applies equally in civil law cases where honesty is in question.

The Court of Appeal held that the judge at first instance had applied the wrong test by looking solely at Mr Costa’s subjective state of mind rather than applying the two fold test set out above. If the judge at first instance was correct, it would mean that the words “in good faith” in section 172 could simply be deleted as they would have no meaning. Applying the two stage test, the Court found that Mr Costa had acted dishonestly. This dishonesty meant that he was not acting in good faith and was therefore in breach of his fiduciary duties as a director, as set out in section 172.

The wider picture

Dishonesty

Reputationally, a finding of dishonesty against a director will be extremely damaging. Where, as here, the director said he believed he was acting in the best interests of the company and its shareholders, there might be some sympathy for his position. However, the introduction on 1 September 2025 of the new Failure to Prevent Fraud offence will increase the impact of any finding of dishonesty. From that date, under the Economic Crime and Transparency Act 2023, certain organisations may be held criminally liable where an employee, agent, subsidiary, or other “associated person”, commits a fraud intending to benefit the organisation unless the organisation can show that it had reasonable procedures to prevent such a fraud.

As part of the guidance issued by the Home Office on how to implement reasonable anti-fraud procedures, organisations are recommended to conduct due diligence on anyone who might be representing the organisation or performing services on its behalf. A company which employed someone against whom a finding of fraud had been made or appointed that person as a director of the company is likely to struggle to show that it had reasonable anti-fraud procedures in place. Personal integrity on the part of directors, and indeed all staff, has never been more important.

For more on the Failure to Prevent Fraud offence, see here.

Exit arrangements

The case is a helpful reminder for investors that they should play close attention to exit arrangements in shareholders’ agreements, both when negotiating new provisions, and in respect of existing exit provisions. It is important that they fully understand the nature and extent of any obligations created for shareholders and directors and what they may or may not be required to do. In this instance Mr Costa was required to give good faith consideration to exit opportunities as they arose and in failing to engage with expressions of interest he had breached the good faith obligation.

Each director should ensure that they are conscious of how their director duties and the provisions of any shareholders’ agreement interact, including when it comes to exit arrangements. In this case, the Court reasoned that the SHA was an agreement by which the company and its members had identified their objectives and therefore identified what “success for the benefit of its members as a whole” meant (being the achievement of an exit on the best terms available). Therefore if exit provisions are agreed by the shareholders and the directors knowingly fail to act in accordance with these then that is likely (based on these findings) to amount to a breach of section 172. In such circumstances, a prejudiced shareholder may be in a better position as it opens up an action for breach of duty (in addition to a breach of contract claim).

Key Takeaways

• Both a subjective and objective test will apply when determining whether a director is acting in good faith for the purpose of section 172.
• Any finding of dishonesty against a director may have implications for the new offence of failure to prevent fraud introduced by the ECCTA 2023.
• Directors should ensure that they are fully aware of provisions in a shareholders’ agreement relating to exit arrangements.
• Directors knowingly failing to act in accordance with exit arrangements are likely to be in breach of section 172.