Court of Appeal upholds strict interpretation of the "Duomatic" principle, which allows informal shareholder approval of company decisions

In a recent decision, the Court of Appeal reconfirmed that the Duomatic principle can only apply where all shareholders have approved the relevant act of the company. It is not enough that a relevant individual would have approved the act had they known about it: Dickinson v NAL Realisations (Staffordshire) Ltd [2019] EWCA CIV 2146.

The strict application of the Duomatic principle in this case led to a property transaction entered into by the company with one of its directors being avoided and the director being ordered to restore the property to the company.

The director sought to rely on s.1157 of the Companies Act 2006 (the "Act"), under which a director's breach may be excused where it appears to the court that the director has acted honestly and reasonably and ought fairly to be excused. While the court confirmed that s.1157 could relieve a director from a proprietary liability, it was not appropriate for the court to vary the first instance judge's decision that the director should not be excused.

The decision will serve as a reminder to company directors that, particularly in transactions to which both they and the company are party, the directors may face questions not only about compliance with their duties, but also about their ability to bind the company if proper procedures are not followed. Transactions entered into without authority can be unwound many years after they occurred (here, the Court of Appeal gave judgment 14 years after the relevant transaction), including where the company subsequently enters an insolvency process, and even if there was no issue as to the company's solvency at the time of the transaction.

Natasha Johnson and Andrew Cooke, a partner and senior associate in our contentious restructuring and insolvency team, consider the decision below.

Background

Mr Dickinson was the majority shareholder of NAL Realisations (Staffordshire) Ltd (the "Company"). The second largest shareholder was a discretionary trust on behalf of which Mr Dickinson had authority to act. The final shareholder was a pension scheme, of which Mr Dickinson was one of the trustees alongside his wife and a professional trustee. Mr and Mrs Dickinson were the only current members of the scheme.

In 2005, the Company sold its foundry premises to Mr Dickinson.

Five years later, the Company bought back almost all of its shares, with the purchase contract providing that the nominal value of the shares would be paid to the shareholders upon completion of the buyback. In fact, the price was never paid. Instead, cash representing the price was left in the Company and, around one month after the buyback had been completed, recorded as a loan to the Company from Mr Dickinson. The loan was secured by a debenture in favour of Mr Dickinson.

The Company entered administration in 2012 as a result of a judgment debt. It then entered liquidation in 2013.

First instance decision

Mr Dickinson commenced proceedings seeking to enforce the terms of the debenture. Acting by its liquidators, the Company counterclaimed that: (1) the transfer of property to Mr Dickinson in 2005 had been made without authority and should therefore be unwound; (2) the 2010 share buyback was void as a result of non-compliance with the Act; and (3) even if the buyback was valid, it should be set aside as a transaction defrauding creditors under s.423 of the Insolvency Act 1986.

HHJ David Cooke held that the property transfer should be set aside. On the evidence, Mr Dickinson had not sought the approval of the Company's board to enter into the property transaction and, had he done so, he would not have been entitled to vote on any board resolution as a result of his conflict of interest and the relevant provisions of the Company's articles of association.

The property transaction had therefore been entered into without authority. Mr Dickinson, as purchaser of the property, was not a third party who could rely on the presumption under the Act that a director has the authority to bind his Company. The judge refused to exercise his jurisdiction under s.1157 of the Act to relieve Mr Dickinson of liability.

The judge separately found that the buyback was void because, contrary to s.691(2) of the Act, the Company had not in fact paid any price for the shares, book entries instead having been made under which the payment of the price was effectively deferred via the extension of a loan by Mr Dickinson.

Court of Appeal decision

Both issues were appealed to the Court of Appeal, where Newey LJ gave the leading judgment with which Baker and Dingemans LJJ agreed.

Property transfer

Mr Dickinson accepted that the property transaction had not been approved at a board meeting. However, he contended that the property transaction had been entered into with the unanimous approval of the Company's shareholders so that it had been approved under the Duomatic principle.

It was obvious that Mr Dickinson and, through him, the discretionary trust had approved the transaction. The issue therefore turned on whether the Company's final shareholder, the pension scheme of which Mr Dickinson was one of three trustees and one of two current scheme members, had also approved the transaction.

The court assumed, without deciding, that the assent of the beneficial owners of a share can meet Duomatic requirements. This issue has been the subject of uncertainty in previous High Court authorities. It was unnecessary to decide the point in this case because, as the court held, it had not been shown that the beneficiaries had approved the transaction.

Mrs Dickinson's evidence was that she could not recall whether the property transaction was ever mentioned to her. It was irrelevant whether she would have approved the transaction had she known of it. For the Duomatic principle to apply, actual and unqualified approval is required.

Even had Mrs Dickinson approved the transaction, Mr and Mrs Dickinson were not the only beneficiaries of the scheme. Though they were its only current members, the scheme rules permitted payments to certain eligible recipients including the family of scheme members.

Even if Mr and Mrs Dickinson had been the only beneficiaries, they did not have the power to cause the scheme to approve the transaction even if they acted together and therefore unanimously. That is because the beneficiaries of a trust do not, absent specific provision in the trust instrument, have the power to instruct the trustees how to discharge their functions. The beneficiaries can, acting unanimously, terminate the trust but not cause it to be administered in a particular way.

In relation to the scheme trustees, Mr Dickinson sought to argue that as one of the trustees he would have been entitled to attend a shareholder meeting of the Company and vote the scheme's shares. The court rejected that argument. While Mr Dickinson would have been entitled to represent the scheme at a shareholder meeting, and to vote its shares, he could not have done so without the approval of the other trustees. There was no evidence that the professional trustee or the trustees acting together had approved the property transaction entered into between the Company and Mr Dickinson.

Accordingly, Mr Dickinson had not had authority to cause the Company to enter into the property transaction with himself. It was liable to be set aside.

Application under s.1157

Mr Dickinson sought relief from the liability to restore the property to the Company under s.1157 of the Act, which permits the court to excuse a director who is or may be liable in proceedings for negligence, default, breach of duty or breach of trust, if it appears to the court that the director acted honestly and reasonably and that, having regard to all the circumstances, ought fairly to be excused.

The Company argued that Mr Dickinson could not rely on s.1157 because these were proceedings for the restoration of property, not for negligence, default or breach of duty or trust. The court rejected that argument. Mr Dickinson's transfer of Company property without authorisation was necessarily a default or breach of duty. It would lead to inconsistent results if s.1157 could only be invoked where a company sought a personal remedy against its director, but not where a proprietary remedy was sought, particularly because certain breaches of duty can give rise to both personal and proprietary remedies.

However, the court held that HHJ David Cooke had been correct to refuse the director relief under s.1157. This was an exercise of judicial discretion, and so the Court of Appeal should interfere only if the judge had regard to the wrong factors. The judge had not ignored the factors on which Mr Dickinson relied (for example, that the Company was solvent at the time of the transfer and that the majority of shareholders had approved the transaction). The judge had simply found that those factors did not justify excusing Mr Dickinson from his liability, particularly when balanced against the fact that Mr Dickinson had not given any thought to the interests of the Company as distinct from his own interests when transferring the property. The judge also noted that at least one other director had voiced concerns that the price for which the property was transferred was too low and that, if Mr Dickinson were relieved of liability, that would have the effect of permitting Mr Dickinson to deprive the Company of its property without any recourse.

The court therefore upheld the judge's order that Mr Dickinson restore the property to the Company.

Share buyback

In relation to the buyback, the court also found in favour of the Company. Under s.691(2) of the Act, shares which are bought back by a company "must be paid for on purchase". The Company had not made any payment to Mr Dickinson or the other shareholders when buying back the shares. Instead, it had entered into a loan arrangement and a debenture.

The court held that the statutory wording had not been complied with for two reasons. First, the loan and debenture were not entered into at the time of the purchase of the shares, but one month later. The Company had not made any payment for the shares "on purchase".

Second, while the court recognised that the form of payment was flexible (and could include, for example, the transfer of assets to the shareholders in place of cash), the entry into a loan arrangement did not constitute payment. Even had the loan arrangement been entered into at the same time as the purchase, it would not have provided for any payment upon purchase but, instead, repayments at a later date. This could not satisfy the statutory wording.