Conflicts of Interest and Corporate Opportunities

Following on from my previous post about my publication on conflicts of interest...

This publication was aimed at addressing some of the uncertainty in company law concerning the director's duty under section 175 to avoid a conflict of interest. From my perspective the courts and academics have, in places, whilst in most cases reaching the correct conclusions, have done so through unorthodox means by trying to assess whether there has been a breach of duty by looking at the issue from the company's perspective. By this I mean that they analyse whether a breach has occurred by asking if the company was interested in the opportunity. This is not akin to the traditional orthodox approach where the issue, in other cases of fiduciary jurisdiction, is analysed by looking at what the individual took responsibility for. Thus, one must approach the question from the director's perspective and ask what interests of the principal did the director take responsibility for? Therefore, looking at it from the director's perspective.

I was critical of attempts by others to characterise this in the form of implied terms, competing companies and scope of business tests. All rather vague terms and still looking at it from the company's perspective since what the company's scope of business is, for example, may say little about the director's responsibility to the company's interests. Requiring a director to suspend self-interest where they had no responsibility for the interest complained of would be highly unjust and beyond the purpose of the duty.

It was the purpose of my article to assert that position rather than primarily critique the work of others. During the writing up of this piece, Lim's work on the same topic, claiming a 'new analytical framework' in 2013, was published and offered a different approach to the one I proposed. Here I plan to go through some of this work and offer some views on the supposed 'new analytical framework'.

Setting the Scene
To set the scene for his new framework, Lim juxtaposed the supposed strict and flexible positions of fiduciary jurisdiction. The strict approach is well known: fiduciaries must not allow personal interests to conflict with the principal's. Currently, I am working on a collaborative piece on how liability may be avoided for those in a fiduciary position but the strict approach is clear that there simply must not be a conflict. Honesty, good faith, knowledge, ownership and the like are no excuse for a breach.

Lim then notes the flexible approach, and arguably simply what his argument is. That the courts will undergo a fact finding mission to decide 'holistically' if the director has breached their duty. There is not one UK case that has adopted this approach and so his citations here are misguided in respect of the primary sources. The cases cited all concerned resigned directors where a fact sensitive approach is taken to determine if the director was prompted or influenced to resign because of the opportunity, but the assessment of a conflict is still strict. He cites Lowry and Edmunds' work as evidence for this flexible approach and his arguments therein are similar to those put forward there.

This sets the scene for Lim's analysis in trying to consider, under s.175(4)(a), in what situations can a situation not reasonably be regarded as likely to give rise to a conflict'. To my mind the answer is straightforward. Those interests not taken responsibility for. The Act was a partial codification and looking at the old common law, and even the new cases post 2008, liability is avoided when it is demonstrated they did not have responsibility for the particular interest complained of and thus cannot reasonably be regarded as a conflict. Lim's error is to forget the nature of the codification as partial and tried to adopt normal rules of statutory interpretation despite this. Phrases such as 'reasonably give rise to a conflict' and 'real sensible possibility of a conflict' only serve to obscure the matter in favour of the fiduciary, something the courts have never been too keen on.

To support his analysis in assessing reasonableness under s.175(4)(a), he puts forward three different situations: 1) where the company has considered and rejected the opportunity in question on a bona fide basis. Anyone who knows anything about conflicts of interest, will already know this argument is well rehearsed after the decision in Peso Silver Mines and has never been adopted in England. Lim offers no new analysis here; 2) the situation concerning the company's scope of business if the opportunity is discovered pre-resignation. As mentioned above, I asserted in my own piece why the scope of business test is wrong in the context of directors, but the argument for a scope of business test was put forward much more coherently by Kershaw in his article where he tried to assert ownership type rights over opportunities that fell within the company's scope of business, albeit this view has been rejected by the Supreme Court in FHR European Ventures. It is this second category in Lim's article that is most troublesome; 3) the situation where directors have resigned where he tried to assert a 'maturing business opportunity' test, again something not adopted in England and is used only as one factor in determining why the director resigned and not whether there was a conflict.

First I will consider Lim's assessment of s.175(4)(a) before looking at some of these situations. I do not plan to make this an in-depth analysis, but only to point to some serious flaws in the analysis from Lim that should be addressed.

S.175(4)(a)

The argument suggesting a more permissive standard of liability comes from an interpretation of the 2006 Act. Lim’s submission that the omission of the word “would" from the Companies Act 2006, s. 175(2), where it states ‘This [the duty] 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)’ (emphasis added), means that upon a literal interpretation a company that is unwilling (would) to pursue an opportunity, rather than incapable (could), would mean a director can pursue it personally is unlikely. This is because first and foremost the duties in Part 10 of the Companies Act 2006 are a general statement. The general statement was adopted, inter alia, to allow the courts to develop duties that are not “well-settled”. It is not a precise definition of when the duty will be breached. The omission of the word “would” then does not mean such circumstances of unwillingness, where the company would not pursue the opportunity, are precluded. This can be supported by Lord Goldsmith’s approval of Lord Upjohn’s judgment in Boardman that ‘rules of equity have to be applied to such a great diversity of circumstances that they can be stated only in the most general terms and applied with particular attention to the exact circumstances of each case’. Therefore cases such as Boardman and Regal, which are examples of when a principal has been unwilling rather than incapable of pursuing an opportunity, are still to be followed. A director cannot defend a claim by arguing unwillingness on the part of the company, as it would permit the director to act with self-regard ahead of their undertaking and thus not fulfil the purpose of the duty. 

Scope of business
The arguments for a scope of business test put forward by Lim needed greater consideration and support. Lim makes no attempt to define scope of business, makes analogies with partners, which it is well known you do not do in fiduciary analysis, makes practical assertions with no support for them, and asserts implied terms without acknowledging the case law in full.

The basics for scope of business come from partnership law, not company law. The idea is that a conflict can be avoided by a director if the opportunity falls outside the company's scope of business. As the argument goes in my article an analogy cannot be drawn with partnership law since a partner's fiduciary duty is circumscribed by the partnership agreement or any responsibility beyond that determined by fact. A director's duty is not circumscribed by the company's constitution since it is open to any business. This is the argument put forward in the case of O'Donnell v Shanahan. Lim and I agree that the duty is fact sensitive and not determined solely by constitution or partnership agreement. Thus in partnership law the partners' responsibility can be ascertained by looking at the partnership agreement but it is by no means comprehensive. A company's constitution is of little help since a company is open to any business and thus one must simply look to the facts to determine responsibility. However, Lim asserts that the scope of business can be determined by the circumstances. Yet this is not clear, that he is saying that the fiduciary's liability is determined by the circumstances i.e. their responsibility, but then says it can be determined by the company's scope of business but makes no attempt to say why the company's scope of business is the limit of their responsibility beyond drawing a very thin comparison with partners. He argues that the scope of business can be determined by looking at the corporate documents and this is his main practical argument failing. He assumes everything a company does, can do, or is planning on doing is published in corporate documents. He ignores a glaring issue of commercially sensitive information. He makes no attempt to define scope of business. He ignores the fact the board do not know everything the company is doing, thus not everything it does will be in its corporate documents. He makes no attempt to say which corporate documents he is talking about. 

I use a couple of practical examples in my article in relation to Apple and Tesco. The basics being that if a conflict can be avoided if the opportunity cannot be said to fall within the company's scope of business as determined by corporate documents then does this mean Apple directors can pursue smart watch technology before they announce it in corporate documents? Does it mean Tesco directors can pursue opportunities in designer fashionwear since the company only produced retail fashion clothes. Does this then mean a director can postpone publication of corporate documents until they pursue the opportunity? What about companies looking to purchase raw materials for production? Are they in competition if one director looking to buy wood for furniture for their company diverts an opportunity to buy wood for paper manufacture? These points clearly show how impractical Lim's arguments are. Legally, they are also flawed since it is asserting liability on the basis of the company's interests and not the interests the director took responsibility for. The prophylactic concerns would arise if a scope of business test is adopted for directors since they can try and manipulate their stronger position to make it appear as if they were not conflicted with their responsibility if a strict approach is not adopted.

What the director takes responsibility for may be wider or narrower than the company's scope of business and should not be used for directors. It is used for partners since the partnership agreement is generally what they take responsibility for.

Lim tries to assert that, failing this, the scope of business test could be an implied term in to the agreement and thus asserting a contract first approach, which removes loyalty for interests outside the scope of business. I have cited several cases in my article that show this is a very narrow exception that would not apply in this context. I have also noted that the impact a wide interpretation of the duty would not impact greatly on multiple directorships, which Lim seems to think will happen.

Maturing Business Opportunity
This argument is in respect of resigned directors but Lim ignores the fact the assessment of whether the opportunity is maturing is done to ascertain the director's state of mind as to whether they were prompted or influenced to resign and not to determine if there was a conflict. The assessment of facts in cases where a director has resigned often obscures this underlying premise and leads to these erroneous analyses. Thus Lim asserting the maturing business opportunity test has been adopted by many cases is wrong. They have done no such thing. When assessing a conflict for resigned directors it is still strict. If they had the responsibility to do it then they must be free from self-interest. They cannot learn of an opportunity and then resign to try and obtain the opportunity on the basis it was not 'maturing' as it would go against the prophylactic concerns of the duty. Lionel Smith probably said it best when he noted in 'motive not the deed' that the status as a resigned director was a 'red herring'.

One could again pick up Lim's vague terminology. What exactly is a 'maturing business opportunity'? It is odd to me that for directors there has been this adoption of strange and vague terms to obscure what should be a straightforward analysis as it is in other types of fiduciary relationships.

The term fiduciary and what it means has become bogged down in vague terminology much like the corporate veil was before Prest v Petrodel. The new analytical framework has done little to remove that obscurity and, if anything, has added to it. I hope my ongoing work will highlight this unnecessary obscurity and assert some more straightforward analyses.