High Court affirms orthodox application of directors’ no conflict duty in insolvency

The High Court has ruled that directors breached their duties by taking up the company’s business opportunity for their own benefit, even if the company was unable to take up that opportunity by reason of its financial position: Davies v Ford & Ors [2020] EWHC 686.

The decision confirms the strict nature of directors’ duties in relation to conflicts of interest and re-confirms the orthodox approach in corporate opportunities cases, where the fact that a company is unable to take up an opportunity does not give the directors a defence if they pursue the opportunity themselves.

The defendants had sought to argue that, where the directors would have been at risk of exposing themselves to wrongful trading liability had the company continued to trade, such that in practice the company could no longer trade or take advantage of the corporate opportunity, there was no credible risk of a conflict between the interests of the directors and the company. That argument was rejected. For directors of companies in distress as a result of the COVID-19 pandemic, this argument is unlikely to be available anyway given the Government’s proposed disapplication of the wrongful trading regime (as explained here).

While the decision does not make new law, it is nevertheless interesting in confirming that a company’s inability to take up an opportunity provides no defence to directors who have taken up that opportunity themselves – even if that inability arises from insolvency, near insolvency or the directors’ duties in the context of approaching insolvency to stop the company from continuing to trade.

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

Background

The claimant, Mr Davies, incorporated GBR in 2010. GBR took over a recycling business from an existing company and operated that business from a site in Ashford until GBR was dissolved in 2011. GBR was subsequently restored to the register and placed into liquidation. GBR’s liquidators assigned its potential claims to Mr Davies.

The first two defendants, Mr Ford and Mr Monks, were directors of GBR in the period leading to its dissolution. In 2011, they incorporated GBRK. GBRK operated a recycling business from the Ashford site that had been used by GBR. For the benefit of GBRK, Mr Monks:

• caused the Ashford site to be cleared, charging at least part of the cost of clearance to GBR even though GBR would not have use of the premises once cleared;
• caused an environmental licence required to operate the site as a waste management facility to be transferred to GBRK;
• acquired a lease, via GBRK and later directly in his own name, in respect of the Ashford site;
• caused GBRK, not GBR, to enter into hire purchase and lease agreements of the equipment used at the Ashford site; and
• caused GBRK to take over a traffic licence application which had originally been made in the name of GBR, eventually procuring the issue of a licence for GBRK not GBR.

Mr Davies claimed that, by taking each of these steps, Mr Monks had acted in breach of his duties as a director of GBR. Mr Davies sought relief against Mr Monks, Mr Ford and GBRK. Only Mr Monks actively defended the proceedings. A trial on liability took place in November 2019.

Decision

One of the key issues at the trial, and the sole focus of this blog post, was whether Mr Monks had breached his duties to GBR by taking steps via GBRK to set up and operate a recycling business from the Ashford site. Mr Monks argued that he was not in breach of duty because GBR was not ever in a position to take this opportunity itself since: (1) GBR was a bad credit risk so could not obtain financing; (2) Mr Davies had relocated abroad; (3) GBR faced potential difficulties obtaining certain of the licences required to operate a recycling business; and (4) GBR was insolvent or close to insolvency.

In those circumstances, Mr Monks said that there was no reasonable prospect of a conflict of interest so that he was not in breach of his duty under section 175 of the Companies Act 2006.

The deputy judge held that Mr Monks was in breach of his duty to avoid a conflict of interest. His starting position was section 175 of the Act, which provides that:

(1) A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company.

(2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity.) …

(4)  The duty is not infringed –

a. If the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or

b. If the matter has been authorised by the directors.

The deputy judge held that each of the steps taken by Mr Monks as noted above gave rise to an obvious conflict of interest for the purposes of section 175. Both GBR and GBRK were looking to develop exactly the same trading business from the same Ashford site. Mr Monks was a director of both companies and their interests directly competed. Mr Monks could not promote the interests of GBR and GBRK simultaneously.

It was no answer for Mr Monks to say that GBR could not have pursued the opportunity itself.  That followed from equitable principles dating back almost three centuries to the famous case of Keech v Sandford and had been codified in s.175(2), which made plain that “it is immaterial whether [GBR] could take advantage of the… opportunity.”

This appeared to be a complete answer to all of Mr Monks’ arguments. However, the deputy judge was required to consider Mr Monks’ novel argument that the position may differ where a company was insolvent or approaching insolvency. Mr Monks argued that, in these circumstances, a director owes a duty to act in the interests of creditors, not shareholders. Further, the directors have a duty not to trade a company when it has no reasonable prospect of avoiding insolvent liquidation. If the director continues to cause the company to trade beyond this point, the director is potentially liable for wrongful trading under s.214 of the Insolvency Act 1986. It was, argued Mr Monks, not in the interests of creditors for GBR to continue to trade. Accordingly, the interests of GBR could not  reasonably be regarded as in conflict with those of GBRK – GBR’s interests were served by ceasing to trade whereas GBRK’s interests were in continuing pursuit of the business at the Ashford site. Put another way, Mr Monks argued that the directors of GBR could not be subject to a duty requiring them to cause GBR to take an opportunity when it was insolvent.

The deputy judge dismissed that argument. It did not matter why GBR itself was unable to take the opportunity. As s.175 of the Companies Act made clear, it was immaterial even whether GBR was able to take the opportunity.

Even if the directors of GBR were obliged to take certain steps as a result of its insolvency or near insolvency, the situation was still one which could reasonably be regarded as likely to give rise to a conflict of interest. This conflict arose simply from Mr Monks’ status as director of both GBR and GBRK. If Mr Monks’ argument had been right, it would cut across the nearly 300 years of authority and the Companies Act in circumstances – insolvency or near insolvency – where arguably the need to protect the interests of the company via the duties imposed on directors were greater.

Having considered, and discounted, two New Zealand cases which Mr Monks relied on in support of his argument, the deputy judge considered Re Welfab Engineers Ltd [1990] BCLC 833, a first instance decision of Hoffmann J.  There, the directors of a company in financial difficulty had to make a decision between two offers to purchase the company’s business. The higher offer was for the company’s premises alone. The directors chose to accept the lower offer, which was for the premises, equipment and work in progress, on the basis that it had the effect of preserving the employees’ jobs (including the directors’ jobs, in which they had an obvious self-interest). Hoffmann J held that the directors had not breached their duties in doing so because the lower offer was still higher than the company could have achieved in a formal insolvency process.

The deputy judge concluded that Welfab did not assist Mr Monks because it did not say anything about whether the directors, by taking the offer which had preserved their employment in their own interests, had breached their no conflicts duty or whether that duty could be commuted when a company approached insolvency.

For these reasons, Mr Monks had breached his duty. A further trial may be required in order to determine the remedy against Mr Monks.