Fiduciary Duties of Non-Executive Directors and Capacity

It has been a while since I focused on this topic. Today I returned to it reading an article on the topic by Witney, 'Corporate Opportunities Law on the Non-Executive Director (2016) 16(1) JCLS 145.

The work cites my piece in the Company Lawyer that seeks to explain that a fiduciary duty of a director is often misunderstood because people struggle to grasp that an executive director generally takes responsibility for all interests of the company, which are broadly defined because a company cannot act by itself. It is completely reliant on its directors. But people look to narrow the interests of the company and focus on defining its interests rather than what the director takes responsibility for, which is the orthodox for fiduciaries. Thus, they seek to change the fiduciary jurisdiction and apply it differently to all directors than they would to other types of fiduciaries because they look to focus on the interests of the principal rather than what interests the director is responsible for.

Whilst it is possible to vary when it is owed, as the article explains by focusing on the scope, it is not possible to change the application of the duty once it is owed. Duties, including fiduciary ones, are monolithic. They cannot be varied once owed. They are inflexible, not flexible as Witney claims. Only when they apply is flexible because, as my article shows, it depends on what the fiduciary has responsibility for to the principal's interests.

The argued changes to application of fiduciary duties for directors, as a result of that confusion, comes in many different forms, that this article tries to advance with little plausible justification for it. For one, there is no such thing as corporate opportunities law. There is no such doctrine in the UK. He tries to use this to explain that the capacity you are acting in can affect whether you can avoid the application of fiduciary duties. That is also not possible. It shows a complete disregard for the meaning of loyalty. The purpose of the duty of loyalty is to regulate self-interest within the scope of the undertaking to the principal's interests. It bans self-interest to fulfil this purpose and demands loyalty to the principal's interests that you are responsible for. This is because the director stands in the stronger position, capable of manipulating information to prefer their own interests ahead of the ones they undertook to act for. It is therefore complete fiction that the capacity you are acting in affects the fiduciary duty. The idea that we can simply argue we were acting in a personal capacity to avoid acting for the interests you undertook to protect is a complete disregard for the duty. His example given, that it is none of the company's business to be offered investment opportunities that the director invests in personally, is just one way the duty could be abused and undermine that purpose. Witney offers no justification as to why it would not be a breach other than 'capacity' (I note he cites a couple of cases where there has been no breach of duty such as CMS Dolphin, Plus Group v Pyke, and West Coast Capital but all have been misapplied as to why there was no breach in those instances, I return to one example below). On that ground I could argue any conflicting investment was not conflicting simply because I was acting in a personal capacity. The duty of loyalty is strict in its application. Is there a risk of conflict i.e. did your personal interest conflict with the interests of the company you undertook to protect? If yes, there is a breach. Capacity is not an excuse and never has been. The flexibility Witney refers to is misapplied to fit his thesis. The flexibility is when the duty is owed, not how it is applied.

To return to the cases he cites, mentioned above: He says these cases show that it is clear that a director is not bound by their duties all the time. Is it? But consider Plus Group v Pyke and CMS Dolphin that are glossed over to advance his thesis. Of course a director can resign even though it would be harmful to the business. But there is clearly no conflict of interest in resigning. What interest is he acting in conflict with by resigning? None. But take the example further. The director resigns to take an opportunity personally. If the director has responsibility for the interest that is a conflict of interests. He is still well within his right to resign but his motivation makes it a breach because he is doing it due to a conflict of interests. It has nothing to do with his capacity.

Thus Witney misunderstands what I said when I advance that a court needs to consider what the director has responsibility for. He says this is only one relevant factor in determining whether the duty was owed as a director cannot unilaterally determine the scope of their duty. No, it is the only factor in determining the scope initially, because there are no constructive fiduciaries and yes, they cannot unilaterally determine the scope of duty as much as the principal cannot unilaterally determine it. The scope is set based on what the parties mutually agreed the fiduciary's responsibility would be. If the director did not take responsibility for the matter then they cannot be required to owe a duty of loyalty. If the director does take responsibility, whether it be unilaterally, voluntarily, or contractually then the duty is owed.

I agree with the premise of Witney's article though, that the broad application of fiduciary duties can make it difficult for non-executives to practically take on multiple roles, which they often do. However, that is not the company's problem. The House of Lords have long shown little sympathy for an individual who puts themselves in a position of conflicting duties. A non-executive does not have to take on multiple roles to fulfil their function to one principal. The Court of Appeal made it clear that the court will only permit self-interest where acting for multiple principals is inherent to the business. If non-execs want to take on conflicting opportunities then get authorisation from the principal. The conservative line is not a problem. Flagrant disregard for the duty is, however.

Now to apply this to non-executives, as my paper briefly did, they do not necessarily take responsibility for all the interests of the company. Executive directors generally do as a presumption because the company simply cannot act without them. Therefore, there is some flexibility in when the duty is owed for non-executives to accommodate their multiple appointments, but that is not the same as advocating a change in the way the duty is applied. The added benefit of this approach compared to the capacity approach is certainty. We can say with certainty what the director's (non-exec or exec's) responsibility was. Saying what capacity they were acting in is riddled with uncertainty.

So finally, to return to Plus Group v Pyke, the director in that case avoided liability because the facts demonstrated he no longer had responsibility for the interests of the company as they had been effectively forced out of the company in all but name. It had nothing to do with capacity. Capacity has never been inherent in common law or equity.

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.

New Publication

My recent article has now been published in the Company Lawyer. The full reference is:

D Gibbs, 'The absolute limit of directors' fiduciary liability for conflicts of interest: the director's perspective' (2015) 36(8) Company Lawyer 231-244

More to follow...

Forthcoming Publication

In the coming months I will have a publication released on the director's duty to avoid a conflict of interest. It is titled 'The absolute limit of directors' fiduciary liability for conflicts of interest: The director's perspective'. I shall provide the citation when I have one.

The abstract is below and the analysis incorporates new authorities on the issue from the last 6 years including: FHR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45; Halcyon House v Baines [2014] EWHC 2216; The Northampton Regional Livestock Centre Company Ltd v Cowling [2014] EWHC 30 (QB); Ross River Ltd v Waveley Commercial Ltd [2013] EWCA Civ 910; Ranson v Customer Systems [2012] EWCA Civ 841; Rossetti Marketing Ltd v Diamond Sofa Company Ltd [2012] EWCA Civ 1021; Cambridge v Makin [2011] EWHC 12 (QB); JD Wetherspoons plc v Van de Berg & Co Ltd [2009] EWHC 639; and Re Allied Business [2009] EWCA 751.

Abstract

The absolute limits of fiduciary loyalty are misunderstood in the context of directors as analyses focus on the interests of the principal alone. This article will demonstrate that such an approach is inconsistent with traditional fiduciary analysis and that it is the specific undertaking to the principal’s interests that determine the limits of loyalty in a fiduciary relationship.

New publication

I have recently had published my book review of two key textbooks on company law. The review can be found via the following citation:

D Gibbs, 'David Kershaw, Company Law in Context: Text and Materials' (2013) 47(3) The Law Teacher 433

The review covers Kershaw's textbook as well as the 29th Edition of Mayson French and Ryan's (links to 30th edition) textbook on company law.

Publication in ICCLR

I have a new publication in the International Company and Commercial Law Review. It is just a short case note due to the slightly limited time I have available at the moment. Christmas was not long enough this year...

Anyway, the note was on the recent Court of Appeal decision in Chandler v Cape [2012] EWCA Civ 525 see here for an earlier blog post. The publication can be found under D Gibbs 'Company Law: Corporate Groups' [2013] 24(1) ICCLR N8.

I will be uploading a blog post next week on a recent presentation I gave at the Teaching and Learning module I have been on as part of my continuing professional development.