Directors’ duties – how to avoid chaos in the boardroom

The Supreme Court has issued its judgment in the case of Saxon Woods Investments Limited and Others v Francesco da Costa holding that a director’s conduct will be looked at objectively when considering whether they have complied with their duties under section 172 of the Companies Act 2006.

Background

The case relates to a company called Spring Media Investments Limited (the Company). The Company had entered into a shareholders’ agreement with various investors, including a minority shareholder Saxon Woods, 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.

Despite Saxon Woods seeking to make introductions to potential buyers to assist the process, 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 was severely impaired.

Saxon Woods brought an unfair prejudice claim against a director of the Company, Mr Costa who had effectively been leading on the proposed sale process. The judge at first instance found that Mr Costa deliberately slowed the process of seeking a buyer for the business. He did not inform the appointed financial adviser of the terms of the shareholder agreement and allowed them to work to a later target date. He also deliberately kept information regarding the process from the other board members and shareholders. While purporting to aim for the 2019 target, Mr Costa was of the view that a better price could be obtained for the Company in the future.

Section 172 of the Companies Act 2006 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 judge at first instance held that Mr Costa was not in breach of his duties under section 172, because he reasonably believed that he was acting in the best interests of the Company (i.e., a wholly subjective test was applied) by not pursuing an exit in 2019. The Court of Appeal then overturned this finding, holding that Mr Costa had acted dishonestly and therefore not in good faith. For that purpose, the Court applied the modern objective test for dishonesty.

Both parties then appealed to the Supreme Court.

The Supreme Court decision

After consideration of the background to the section 172 duty prior to its codification in the Companies Act 2006, the Supreme Court held that Mr Costa had breached section 172.

The Court held that whilst it will not seek to interfere with directors’ decision making when exercising their business judgment, the Court should apply an objective test as to whether a director’s action is in good faith. Here, given Mr Costa had not been transparent with his fellow directors and shareholders, or the financial adviser, the Court found a breach of the statutory directors’ duties.

Comment

The judgment is important because it is the first Supreme Court case which analyses how a director should apply section 172 in practice. Mr Costa’s view was that he believed that his course of action was in the best interests of the company and that it was entirely up to him as an individual to decide how to act, even where that course of action led to him actively misleading his fellow directors. Not surprisingly, the Supreme Court did not agree. The judgment makes clear that a court will look objectively at a director’s conduct and the decision should serve as a warning for directors tempted to act alone.

Key takeaways for boards and directors

• Boards are collective decision-making bodies - if a director disagrees with a course of action previously agreed to by the board, the correct approach is to discuss the difference of opinion with the rest of the board and then form a collective view as to the best way forward for the company
• Good intentions – even a well-intentioned director may be in breach of section 172 if their conduct does not meet an objective standard
• The well-run board - collegiality and openness is to be encouraged; going it alone is not