Corporate Law Update
We also look at a decision by the FCA to fine a bond trader for market abuse, and a report by the FRC’s Financial Reporting Lab on viability statements and risk reporting.
In Cullen Investments Limited and others v Brown and others  EWHC 2793 (Ch), the High Court refused to grant relief to a director for breaching his duty to disclose his interest in a transaction.
The decision follows the High Court’s original judgment in July, in which it found that two brothers and directors of a company – Julian and Quentin – had breached their statutory duties by taking part in an opportunity which they ought to have offered to the company. Julian had played the greater role in the venture, whilst Quentin had merely agreed with Julian to receive a share in the venture.
The court found that Quentin had breached his duties under sections 175, 176 and 177, Companies Act 2006 (the “Act”). These require a director not to put himself in a position of conflict of interest or to accept benefits from third parties, and to declare his interest in transactions concerning the company.
Quentin applied for relief under section 1157 of the Act. This allows the court (among other things) to relieve a director wholly or partly from liability for breach of duty if it believes the director acted honestly and reasonably. Quentin argued that he should be relieved from liability because:
- he did not think he had an interest in the competing opportunity, as the promise from his brother was not legally binding;
- he believed his brother’s interest in the opportunity had already been authorised and that, by virtue of that, any interest he had in the opportunity had also been authorised;
- his work on the opportunity did not cause any conflict because it aligned directly with the company’s own interests;
- Quentin’s breaches of duty did not in fact cause any harm to the company; and
- Quentin did not appreciate that he was required to obtain authorisation for his interest.
What did the court decide?
In short, the court accepted (as it had in the original judgment) that Quentin had honestly believed that his brother had disclosed his interest in the opportunity and received authorisation for it. However, it felt that Quentin had not acted reasonably in failing to disclose his own interest.
In particular, the court said:
- the fact that the promise from his brother was not legally binding did not preclude Quentin from being interested in the opportunity;
- whether or not the opportunity actually gave rise to a conflict, there was clearly the potential for it to do so and it was not reasonable to consider there would be no conflict of interest;
- although Quentin’s actions did not cause any specific loss to the company, they may well have caused wider harm to the company and gave rise to expensive legal proceedings; and
- whether or not Quentin was aware he was required to disclose his interest, he was an experienced lawyer versed in company law and should have been aware of this requirement.
The court therefore denied Quentin relief under section 1157.
This is a good illustration of how the court will interpret “honestly” and “reasonably”. The test of honesty is subjective; it is enough to show that the person seeking relief believed they were acting honestly. In this case, Quentin satisfied this test.
However, the test of “reasonableness” is objective. Although it can take specific circumstances into account, fundamentally it will be measured against the standards expected of a careful and circumspect company director. This can make it difficult (but not impossible) to establish that behaviour serious enough to amount to a breach of directors’ duties is reasonable.
In this case, the court felt that Quentin fell below this standard. This was exacerbated by the fact that Quentin, as a lawyer, was deemed to have additional knowledge relevant to his actions.
The case is a reminder to company directors to remain vigilant about actual and potential conflicts and to disclose these as early as possible to their company.
- The Financial Conduct Authority (FCA) has levied a fine of £60,090 on a former bond trader for market manipulation amounting to market abuse.
On eleven occasions, the trader entered a series of quotes to buy state bonds. This prompted other traders using algorithmic methods to raise their bids for the bonds, causing the bond price to rise. He then cancelled his quotes and instead sold bonds he already owned at the new price. (On one occasion, he did the opposite, putting in sell quotes to depress the price, then buying bonds.)
This kind of behaviour is known as “momentum ignition”. It is one of several activities specifically listed in EU market abuse legislation as likely to give false and misleading signals or secure the price of a security, which is in turn a form of market manipulation.
As the behaviour took place in 2014, the FCA brought proceedings under the old market abuse regime in the Financial Services and Markets Act 2000. However, the outcome would no doubt have been the same under the new regime under the EU Market Abuse Regulation.
- The Financial Reporting Council (FRC) Financial Reporting Lab has published a report on how companies can better inform investors of their viability and the risks they face.
The report notes that companies have made enhancements to risk reporting but could make further improvements. Risks reported should be specific to the company in question and should include risks to reputation. Finally, risk disclosures should tend towards more detailed disclosures of principal risks, rather than simply listing numerous risks, and any changes to the assessment of principal risks should be explained.
The report also encourages companies to be “bolder” in their viability report disclosures and not to put out viability statements that equate merely to longer-term going-concern statements.