Director good faith: UK Supreme Court draws a clear line on covert conduct

Background

Spring Media Investments Limited (the Company) and its investors, including Saxon Woods Investments Limited (Saxon Woods), which held 22.33% of the shares, agreed under a shareholders' agreement to work in good faith towards a sale of the Company by 31 December 2019. Mr Costa, the Company's chairman, was given sole conduct of that sale process. Mr Costa believed a sale later than December 2019 would achieve a better price for the Company and accordingly, but covertly, delayed the sale process. He kept the Company’s board in the dark about the process and misled fellow directors into believing the agreed timetable was on track, withholding his true instructions to the Company's advisers. The delay succeeded but the Covid pandemic then destroyed the prospect of a profitable sale.

Saxon Woods petitioned for unfair prejudice under Sections 994 to 996 of the Companies Act 2006 (CA06). The trial Judge found unfair prejudice but found no breach of Mr Costa's good faith duty under Section 172 CA06 (s172) on the basis he had genuinely believed he was acting in the Company's best interests. The Judge therefore made only a conditional buy-out order. The Court of Appeal disagreed on the s172 point, finding Mr Costa's conduct objectively dishonest and made the buy-out unconditional. Mr Costa appealed to the Supreme Court.

Supreme Court decision

The key question for the Supreme Court was whether the good faith requirement in s172 is subject only to a director's subjective state of mind in taking action in what they believe is the best course for the company.

Mr Costa argued that s172 turns only on what a director genuinely believes and not on the methods used to act on that belief. Saxon Woods submitted that good faith must also be judged objectively, once a director's conduct is put in issue and is not satisfied by belief alone.

The Supreme Court unanimously dismissed Mr Costa's appeal, holding that the long-standing principle that courts will not second-guess directors' genuine business judgement, does not extend to a director covertly pursuing a strategy that directly conflicts with the course already resolved upon by the board. Confining good faith to a director's thoughts alone and not their conduct, would be “a recipe for chaos and paralysis” in corporate governance, undermining the collegiality of the board, which all stakeholders in a company are entitled to expect.

Rather than relying on the Court of Appeal's finding that Mr Costa had acted dishonestly by reference to the objective test in Ivey v Genting Casinos (UK) Ltd, the Supreme Court held that where a fiduciary duty of loyalty is owed, the only question is whether that duty has been breached. Dishonesty may be evidence of a breach, but the fiduciary duty itself supplies the framework and there is no need to import the Ivey test. The ultimate outcome was, however, the same, with the unconditional buy-out order being upheld.

The Supreme Court left open the question of whether a director acting in breach of contract equated to a breach of s172, that ground of appeal not having had permission actually granted and was not deemed necessary given its findings that Mr Costa’s conduct was a breach of s172. The Supreme Court did however note that it is open for a director to revisit a previously agreed strategy, to the point of breaching a contract, where circumstances have changed. 

What this means in practice

A director's duty of good faith under s172 is not satisfied merely by a sincere, subjective belief that a particular course serves the company's interests. A director who disagrees with the board's agreed strategy and pursues an alternative course covertly or conceals material facts from fellow directors, can be held to be in breach of s172 regardless of how genuinely they believe their own view and actions are the right ones, without needing to amount to dishonesty.

The decision is particularly relevant to distressed and insolvent companies, and to insolvency officeholders in considering legal claims, though this will always depend on the specific facts involved.

For more insight and guidance or to discuss specific circumstances get in touch with Christopher Jones or Russ Parkin.

Christopher Jones is Director and licensed Insolvency Practitioner and qualified accountant based in the firm's Manchester office. His practice sees him investigating, formulating and managing fraud and civil claims in an insolvency context.

Russ Parkin is a Partner and licensed Insolvency Practitioner and qualified accountant, leading Grant Thornton UK's insolvency and asset recovery team across Leeds and Manchester, and with more than two decades of experience, Russ specialises in complex corporate and personal insolvencies, fraud investigations, pursuing legal claims, asset tracing, and enforcement of judgments and awards.