Director’s fiduciary duty of good faith

The law pertaining to a director’s duties and interests seem to be plagued with ambiguity. Often, the interests of the company, its directors and members are not aligned and this leads to conflicts
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Introduction

The United Kingdom’s Insolvency Act of 1986 lays down a statutory mechanism for liquidators and trustees in bankruptcy for the reversal of transactions. Section 423 deals with transactions defrauding creditors. The general statutory duty of a director to promote the success of the company and its members is subject to the creditors’ interests. Directors of a company constitute the mind and will of the company, and also control what it does. A company is a mere legal entity that exists in the eyes of the law alone. Corporate law seeks to place a check on the powers that directors possess by imposing duties. These duties are attached to a corresponding right of enforcement possessed by the company’s stakeholders. Duties are of two kinds:

  • The dutyof care and skill and;
  • The fiduciary duty of loyalty and good faith.

While the former deals with the common law tort of negligence, the latter has equitable connotations pertaining to corporate stakeholders. The United Kingdom case of Regentcrest Plc. v. Cohen[1]revolved around a claim by a company in liquidation through its liquidators against a director of thecompany stating thathe had acted in breach of his fiduciary duty to the company by voting to allow thecompany to waive the clawback of sums that the company was entitled to from other directors at a time whenthe company was insolvent and was therefore, liable in damages to the company.

Factual Background

The claimant company, Regentcrest, was a property development company. In the year 1988, the company agreed to purchase the shares in another company, Greenground, which owned a development site. The vendors of the Greenground shares were two directors of Regentcrest, including a former shareholder and director.[2] The clawback provision of the agreement stated that additional remuneration was be payable if the value of the site had increased by the date of deemed practical completion of the development in 1990, but if the value had fallen, the vendors were liable to repay any shortfall. Regentcrest had two other directors, Roy and Don Richardson.[3]In 1990,Regentcrestfaced financial difficulties following which the Richardsons injected £5m of their own resources into the company. The development of the site had not taken place and the value of the site had fallen leading to a shortfall of £1.5m, for which the vendors were liable under the clawback claim to repay Regentcrest.[4]

In September 1990,Regentcrest agreed to waive any claim against its vendors under the clawback provision in return for the vendors’ future free services as directors. Subsequently, Regentcrest was compulsorily wound up inNovember. The liquidators of Regentcrest claimed damages against Don Richardson for breach of fiduciary duty asa director in voting in favour of the resolution to waive the clawback claim on the basis that he did not act inthe best interests of the company and with the knowledge that liquidation was inevitable, consented tothe waiver of the clawback provision to protect the vendors of the Greenground shares alone.

Issues

  1. Whether Don Richardson was in breach of his fiduciary duty as a director of the company?[5]
  2. Whether the vendors had the ability to meet a judgment on the clawback claim?[6]

Arguments

Arguments of the Appellants

As a director of Regentcrest, Don Richardson owed the company a fiduciary duty to acthonestly and with utmost good faith in addition to a duty to act in the interests of Regentcrest at all times. It was contended that the resolutions for the waiver of the clawback claim as well as the confirmatory resolution was passed to his knowledge and not in the best interests of Regentcrest.[7] By voting in favour of the resolutions, the appellants argued that he breached his fiduciary duty to Regentcrest and this move led to the loss of the opportunity to recover the clawback amount.

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At the time of the passing of the resolution, the directors of the company knew that Regentcrest was insolvent and unable to continue its operations.[8] They were aware of the fact that there was no real prospect of the vendors or any of them carrying out duties for Regentcrest for three years and that the value of any such services could not possibly have amounted to adequateconsideration for the waiver. Moreover, they knew that the vendors had no claims against Regentcrest under the agreement and that the waiver had no commerciality from Regentcrest’s point of view, being calculatedto benefit the vendors and incapable of benefiting Regentcrest. Concerning the second resolution,reliance wasplaced on the fact that by 27th September1990, Herring Son & Daw had presented a winding-up petition, and the board of Regentcrest had decided not to resist that petition or to put further funds into Regentcrest.

Arguments of the Defendants

The defence admitted that as a director of Regentcrest, he owed fiduciary duties toRegentcrest to act honestly and in good faith, and in what he considered was Regentcrest’s best interests, but he does not admit any higher duty of utmost good faith. Richardson believed that the resolution was passed in the best interests of Regentcrest. He argued that at the time of the resolution, the directors believed that the company would continue trading.[9]Moreover, the defendants denied that the company was insolvent on 5th September1990. However, since then the Regentcrest was technically insolvent. According to Don Richardson, the waiver of the clawback provision was for commercial reasons in favour of the company. Furthermore, to prove that the directors had the company’s best interests in mind, it was alleged that the Richardsonbrothers had injected£5m into Regentcrest and that every effort was beingmade to enhance the financial position of Regentcrest. Due to the minimal prospects of recovery under the claim and keeping in mind the financial pressures on the vendors, the resolution was passed.[10]

Summary of the decision and judgment

With good reason, the court normally would not interfere with a director’s good faith judgment in the best interests of the company. Under common law, if there is, prima facie, no reason to believe that a director had acted mala fide, even where this results in consequences which are not in the company’s favour, the court does not dictate how he should have acted. Thus, the law recognizes that the decision of what is the best interest of the company is best left to the director.

The evidence shows that even after 5th September, the Richardson brothers were still prepared to support Regentcrest and were genuinely striving for its survival. Roy Richardson’s conduct in continuing thereafter to negotiate with the banks as well as procuringthe delisting of Regentcrest’s shares are indicative of the same. The argument that he was acting out a charade inorder to mask his true motives was not credible.

It was concluded that in September1990, the possibility of recovering more than 20% of the clawback claim, keeping in mind the associated risks and the vendors’ intention to contest the claim, was minimal. Moreover, the total sum recovered under a judgment would not have covered the costs of obtaining it. The value of the clawback claim was assessed at £50,000.

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Analysis

The duty imposed on directors to act in good faith and in the interests of the company is subjective. When analyzing the actions of a director juxtaposed with his duties and interests, the question is not whether he would have acted differently if viewed objectively, rather, it considers the belief that the director had that his act or omission was in the best interests of his company. The Honourable Judge relied on the caseof Re Smith and Fawcett Ltd[11]where it was established that the duty to act bona fide was subjective.A director must exercise his discretion in utmost good faithaccording to his standards and not what a court may consider is in the interests of his company. To prove disloyalty and infidelity, mere incompetence would not suffice.[12]

The state of mind of the director is the indicator of good faith. Whether or not the act or omission results in substantial detriment to the company, the director has to establish that he genuinely believed his actions to be in the best interests of the company. In this case, we can observe the director’s state of mind by observing the actions and decisions he made after the resolution. The law concedes to the director to act according to what he believes and the parameters for this are not decided by the court. The commerciality of his decisions is measured according to subjective standards. However, the court mandates a director to always have the best interests of his company in mind while discharging his duties.

Conclusion

The law pertaining to a director’s duties and interests seem to be plagued with ambiguity. Often, the interests of the company, its directors, and members are not aligned and this leads to conflicts. Interests of employees and members are subjected to the director’s consideration, without any possible means of enforcement for employees. The director represents the decision-making organ of the company and the fiduciary duty entrusted to him is subjected to the duty of care he owes. Therefore, a director must act in good faith and promote the best interests of not only the company but its members as well. Corporate stakeholders’ interests are not adequately included under the law. A holistic approach has to be adopted to protect the interests of the company as well as its stakeholders and promote commercial well-being and harmony. This view was observed in Pantiles Investments Ltd.[13], where the Court took a more stringent approach with respect to the standards to be applied while analyzing the actions taken by a director.


[1]Regentcrest Plc. v. Cohen&Anr., [2001] BCC 494.

[2]Id. at 494.

[3]Id. at 495.

[4]Id. at 496.

[5]Id. at 494.

[6]Id. at 495.

[7]Id. at 510.

[8]Regentcrest Plc. v. Cohen&Anr., [2001] BCC 494, 511.

[9]Id. at 511.

[10]Id. at 512.

[11] Re Smith and Fawcett Ltd.,[1942] Ch 304.

[12]Regentcrest Plc. v. Cohen&Anr., [2001] BCC 494, 514.

[13] Re Pantiles Investments Ltd. (In Liquidation), [2019] EWHC 1298 (Ch).

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