Corporate Law Update
- The court clarifies the extent to which a director’s duties continue after they resign
- The Government creates a new working group to develop a new UK “green taxonomy"
- The SustainAbility Institute publishes a report on climate change in private equity
- The Law Commission is consulting on the future of corporate criminal liability
Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.
The High Court has held that a former director of a company breached his duty to avoid a conflict of interest by using information that he had acquired while he was a director to the company’s detriment.
In doing so, the court usefully commented on when and to what extent the duty to avoid a conflict of interest continues after a person has resigned as a director.
Burnell v Trans-Tag Ltd  EWHC 1457 (Ch) concerned two companies: Trans-Tag Limited (“TTL”) (a UK company) and Trans-Tag Systems Oü (“TTS”) (an Estonian company). The two companies entered into an arrangement under which TTS would design hardware and software for remote vehicle-tracking devices, and TTL would manufacture, distribute and sell those products. TTS would licence TTL to use the intellectual property in the products and TTL would pay TTS a royalty.
At a particular point, Mr Burnell joined TTL as a financial investor. The facts are complicated, but, in essence, Mr Burnell would acquire shares in the company giving him a stake equal to that of the company’s founder, Mr Aird, and he would inject further funds into the company by way of loans. In the event, TTL never issued any shares to Mr Burnell.
Mr Burnell was also appointed as TTL’s chief executive officer (CEO), although he was never formally appointed as a director on TTL’s board.
In short, although the business managed to design some products and achieve a certain level of certification for military use, it was unable to make the progress Messrs Aird and Burnell had hoped for. Over time, the relationship between Mr Burnell and Mr Aird, as well as relationships with TTS’ contractors, began to deteriorate. In particular, TTL refused to make payments to TTS under the licence arrangement, eventually resulting in legal proceedings between TTL and TTS.
Eventually, Mr Burnell decided to resign as TTL’s CEO and (believing he had been appointed) as a director and to recoup his financial investment from the venture.
Following his resignation, Mr Burnell was presented with the opportunity to invest directly in TTS to continue to develop marketable products. He did so by acquiring shares in TTS. Following that acquisition, Mr Burnell became the sole director of TTS and promptly proceeded to terminate the licence arrangement with TTL and to cause TTS to pursue legal proceedings against TTL.
What was the dispute?
In due course, Mr Burnell brought legal proceedings directly against TTL to recover the loan he had made to it and against Mr Aird for failing to ensure that TTL issued the shares he had been promised.
In response, TTL brought a counterclaim against Mr Burnell. It claimed that, by assuming control of TTS, terminating the licence and pursuing litigation against TTL, Mr Burnell had breached several of his statutory duties to TTL. These included his duties to promote the success of TTL and to exercise reasonable care, skill and diligence.
However, the allegation of most interest was that Mr Burnell had breached his duty to avoid a conflict of interest in section 175 of the Companies Act 2006. Under section 175(1), a director must “avoid a situation in which [they have], or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”. Under section 175(2), this applies in particular to “the exploitation of any property, information or opportunity”, whether or not the company could take advantage of that property, information or opportunity.
The general duties of directors in the Companies Act 2006 replace the previously uncodified fiduciary duties that directors owed to a company under common law and in equity (section 170(3)). However, the courts must interpret the statutory duties in the same way as the previous duties (section 170(4)).
As a general rule, when a person ceases to be a director of a company, they cease to owe any duties to the company. However, section 170(2) states that certain duties continue to apply after a person ceases to be a director. These include the duty to avoid a conflict of interest in section 175, but only “as regards the exploitation of any property, information or opportunity of which [the person] became aware at a time when [they were] a director”.
In this case, TTL alleged that the duty in section 175 had continued to apply to Mr Burnell after he resigned, and that he had breached that duty by:
- resigning and acquiring shares in TTS, rather than presenting that opportunity to TTL; and
- having acquired control of TTS, using the information he had acquired while a director of TTL to TTL’s detriment, in particular by terminating the licence arrangements and causing TTS to continue legal proceedings against TTL.
A key issue for the court, therefore, was the precise effect of section 170(2) and the extent to which the duty in section 175 continues after a director resigns. To date, there has been little or no case law on this precise provision.
What did the court say?
The court found that, in most respects, Mr Burnell had not breached his duties to TTL. However, the judge did feel that, by using his control of TTS to terminate the licence and continue litigation against TTL, Mr Burnell had breached a continuing duty to avoid a conflict of interest.
The court began by recalling the position for a director before the statutory duties in the Companies Act 2006 came into force. The judge noted that, historically, the courts had had to balance the need to prevent “the emasculation of fiduciary duties” (by allowing a director to resign so as to exploit opportunities that arose during their directorship) with the right for a director to use the body of skills and experience they have acquired to pursue their future interests.
As a result, to date the courts had held that a director would not ordinarily be in breach of duty by resigning to set up a competing business, provided that, before resigning, the director was not exploiting business opportunity that should be treated as the company’s property. The courts have historically used the term "maturing business opportunity" to describe this kind of opportunity.
Should a director resign and subsequently exploit a maturing business opportunity, a company may still have a claim for breach of duty, but it would be based on the director’s pre-resignation actions, rather than anything they did after resigning. In this sense, the duty to avoid a conflict of interest would not continue after a director resigned.
However, section 170(2) had changed that. The plain meaning of the words of that provision was that, so far as it relates to the exploitation of property, information or opportunity of which a director becomes aware before resigning, the duty to avoid a conflict of interest does continue after someone ceases to be a director.
However, that continuing duty still needs to be interpreted in line with historic case law. The upshot of this is that, when deciding whether a former director has breached their continuing duty to avoid a conflict, the court can take into account the director’s conduct both before and after they resigned as part of a “merits-based assessment”.
In particular, as in this case, the court can examine whether a director resigned in order to exploit an opportunity or information that rightfully belonged to the company (which would be a breach of duty), or whether they simply availed themselves of an opportunity that arose after their resignation but happened to be informed by information they had acquired while a director (which would not be a breach of duty).
In this case, the judge found that Mr Burnell had not breached his duty by acquiring the shares in TTS, because that had never been an opportunity available to TTL and he had not made use of any information acquired specifically as a director of TTL to acquire those shares. However, he had breached his duty by using information he had obtained as a director of TTL to end the license arrangements and to pursue litigation against TTL.
What does this mean for me?
For legal practitioners, this is a useful judgment. The codification of directors’ duties in the Companies Act 2006 has generally been regarded as a useful development. However, the requirement to interpret the duties in accordance with historic case law, whilst well-intentioned in its design to preserve existing jurisprudence, can make it difficult to decide whether to interpret the codified duties fairly literally (based on principles of statutory interpretation) or effectively as an extension of the previous common law and equitable duties.
The decision in this case shows that the duties are to be regarded, in some respects, as a “fresh start” and a break from the previous law. In particular, section 170(2) now imposes certain duties post-resignation that previously would have ended once a person ceased to be a director. However, the requirement to take into account historic case law means that that break may not be a stark as it might at first appear.
For directors, the critical aspect of this case is that it will not necessarily be a breach of duty to exploit a competing opportunity after the director resigns. The courts will look at all the surrounding context to decide whether, in reality, a director is effectively abusing the trust the company has placed in them by exploiting property or information that really belongs to the company.
If a person, while acting as a company director, identifies a lucrative opportunity which the company itself can exploit but instead resigns and exploits that opportunity personally, this will strongly point towards a breach of duty.
The Government has announced the creation of a new body – the Green Technical Advisory Group (GTAG) – whose primary role will be to provide independent, non-binding advice on developing and implementing a new “Green Taxonomy” in the UK for both financial and non-financial firms.
The taxonomy will look to define clearly which economic activities qualify as “environmentally sustainable”. This is aimed in part at tackling the problem of so-called “greenwashing”, where organisations make unsubstantiated or exaggerated claims as to the environmental credentials of an investment as a means of attracting investment.
According to the GATG’s terms of reference, the Group will also be responsible for advising on (among other things) any deviations from existing international frameworks or taxonomies, how the taxonomy can be used to support the UK’s transition to “Net Zero” and to accelerate other Government policies, such as the Green Finance Strategy and the 25-Year Environment Plan.
The GTAG is to be chaired by the Green Finance Institute and will comprise financial and business stakeholders, taxonomy and data experts, as well as subject matter experts drawn from academia, non-governmental organisations, the Environment Agency and the Committee on Climate Change.
The announcement comes after the European Union published its new law creating an EU-wide sustainability taxonomy. For more information on that, see our previous Corporate Law Update.
Also this week…
- SustainAbility Institute publishes report on climate change in private equity. The SustainAbility Institute by ERM, together with sustainability non-profit Ceres, has published a report designed to assist the private equity industry with navigating the systemic risk of climate change. The report (which is derived in part from interviews with 27 top PE actors with collective AUM of $3.2 trillion) seeks to understand how deeply climate-related expertise is embedded within PE firms and what climate performance expectations those firms impose on the companies in which they invest. It also sets out five “actions” for the PE sector as a whole, as well as specific recommendations for limited partners and general partners.
- Law Commission launches discussion on corporate criminal liability. The Law Commission has published a discussion paper on the criminal liability of corporations under English law. The purpose of the paper is to gauge the merits of changes to the current law so as to improve how corporations can be held liable for the misconduct of their employees and agents. In particular, it seeks views on whether, for criminal offences that require a particular mental state, the current “identification principle” approach, which attributes a corporation’s mental state to that of a senior person who represents its “directing mind and will”, should be retained or instead give way to further “failure to prevent” offences (such as those in the Bribery Act 2010 and the Criminal Finances Act 2017). The Commission has asked for responses by 31 August 2021.