Corporate Law Update: 2 - 8 December 2023

This week:

Court examines whether conflicted directors had complied with their duties

The High Court has found that two directors who had allegedly acted in conflict with their company’s interests may not have breached their duties.

What happened?

Humphrey v Bennett [2023] EWCA Civ 1433 concerned a property development company whose shareholders comprised four individuals: Mr and Mrs Humphrey, Mr Bennett and Ms Murphy.

The company acquired a plot of land for market value with a view to developing it. In due course, it obtained planning permission to build new houses on the land and an adjoining access strip, which the company had not yet acquired.

However, Mr and Mrs Humphrey declined to invest additional capital to acquire the access strip. In response, Mr Bennett and Ms Murphy caused the company to sell its property to a separate company whose sole shareholder was Mr Bennett and whose directors were Mr Bennett and Ms Murphy.

The property was sold at the same price as that at which the company had acquired it, with no uplift in value to reflect the fact that planning permission had been obtained.

Mr and Mrs Humphrey brought a derivative claim on behalf of the company against Mr Bennett and Ms Murphy, alleging breaches of duty under sections 175 and 177 of the Companies Act 2006.

How are director conflicts of interest regulated?

Directors of a UK company have long been obliged to avoid placing themselves in a position of conflict between their duties to the company and their personal interests.

This duty originated in the common law. However, now it is set out and codified in the Companies Act 2006, principally in two sections.

  • Situational conflicts. Section 175 requires a director of a company to avoid a situation in which they have, or can have, an interest that conflicts, or may conflict, with the interests of the company. This is often described as a “situational conflict”.

    Common examples of situational conflicts include sitting on the board of, or having a material ownership stake in, a supplier, customer or competitor.

    A director does not breach their duty in section 175 if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest.

    In addition, the company’s directors will normally be able to authorise a director’s situation conflict. The conflicted director is not entitled to vote on the resolution to authorise their own conflict, and the authorisation can be made subject to conditions or limited in time.
  • Transactional conflicts. Section 177 states that, if a director of a company is in any way interested in a proposed transaction or arrangement with the company, they must declare the nature and extent of that interest to the other directors before the company enters into the transaction or arrangement.

    Common examples of transactional conflicts include where a company is proposing to acquire property from, or sell property to, one of its directors, or to make a loan to one of its directors.

    A director does not breach their duty in section 177 if the transaction or arrangement cannot reasonably be regarded as likely to give rise to a conflict of interest.

    In addition, a director does not need to make a declaration under section 177 if the other directors are already aware, or ought reasonably to be aware, of the director’s interest.

Finally, in both cases (section 175 and section 177), the shareholders of a company can authorise a conflict in advance or, after the event, ratify any actions by a director that amount to a conflict of interest. In both cases, the shareholders must pass an ordinary resolution.

No board resolution was ever passed to authorise any situation conflict in which Mr Bennett and Ms Murphy found themselves. Similarly, neither Mr Bennett nor Ms Murphy ever made a formal declaration of interest in the sale of the property by the company to their own vehicle.

However, Mr Bennett and Ms Murphy argued that, when Mr and Mrs Humphrey declined to inject additional capital to purchase the access strip, it was clear that the company would no longer be able to pursue the development. They also claimed that Mr and Mrs Humphrey had understood that, in that circumstance, Mr Bennett and Ms Murphy would continue to pursue the development themselves.

As a result, they claimed that any situational conflict had, effectively, been authorised by the board, and that the other directors ought reasonably to have been aware of their interest in the sale.

This was an appeal against a summary judgment given by the High Court. As a result, the Court of Appeal did not need to determine whether Mr Bennett’s and Ms Murphy’s argument was legally or factually correct. Rather, the judges were merely required to decide whether there was a reasonable prospect of that argument succeeding at full trial.

They decided that there was. The court said there was a realistic prospect of showing that Mr and Mrs Humphrey had agreed that Mr Bennett and Ms Murphy would be able to pursue the development privately and that this would involve them acquiring the property from the company.

What does this mean for me?

The case will now proceed to a full trial (unless it is settled). For now, the judgment shows the importance of recognising potential conflicts of interest early and dealing with them appropriately.

Directors should err on the side of caution when it comes to potential conflicts. A director who feels they might be in a position of conflict should openly declare this to their fellow directors and seek approval to continue despite the conflict.

The board should check the company’s articles, which may require the conflicted director to recuse themselves from discussions and abstain from voting on matters touching on the conflict.

Conversely, non-conflicted directors should be vigilant against potential conflicts that other directors have not spotted. Directors will be deemed to know about any conflicts they ought reasonably to be aware of, and so boards should constantly remind directors of their duty to declare conflicts and challenge any potentially compromising circumstances.

If a director feels that one or more other directors may be in a position of conflict, they should raise the matter early, rather than sit on their hands, so that the matter can be dealt with properly.

Access the court’s decision on director conflicts in Humphrey and Humphrey v Bennett and Murphy [2023] EWCA Civ 1433

Takeover Panel rejects third-party attempt to intervene in public takeover

The Takeover Panel’s Hearings Committee has rejected a request by a third party to intervene in a public takeover by convening a hearing to review certain rulings by the Takeover Panel Executive.

The matter related to the proposed takeover of an online real estate portal. An individual, who was the sole managing partner of a private investment partnership, had publicly and vocally opposed the takeover. In November 2023, he formally requested that the Hearings Committee review certain rulings and anticipated rulings by the Panel Executive.

What are the various parts of the Takeover Panel?

Public takeovers in the UK are regulated by the City Code on Takeovers and Mergers, usually referred to as the Takeover Code. The Takeover Code is a quasi-statutory rulebook formulated, reviewed and implemented by the Takeover Panel.

The Takeover Panel is an independent and self-funding body. Because its role combines legislative, executive and judicial functions in relation to the Takeover Code, it is divided into various discrete organs with specific duties. These include:

  • The Panel Executive. This operates independently of the rest of the Panel and, in effect, applies the Takeover Code. This includes conducting investigations, monitoring dealings and giving rulings on the interpretation, application and effect of the Code. In effect, the Executive fulfils the Panel’s executive functions and certain initial judicial functions.
  • The Code Committee. This carries out the Panel’s rule-making (legislative) functions. It keeps the Takeover Code under review and proposes, consults on and implements amendments to it from time to time.
  • The Hearings Committee. This body reviews and hears appeals from rulings of the Panel Executive. It also hears disciplinary proceedings instituted by the Executive when the Executive considers that there has been a breach of the Takeover Code. In effect, the Hearings Committee is the first stage of an appeals process in relation to Code matters.

To ensure a proper separation of powers, no-one can sit on both the Code Committee and the Hearings Committee.

There is also a completely separate and independent Takeover Appeal Board, which is not part of the Takeover Panel. The Appeal Board hears appeals from rulings of the Hearings Committee.

Read more about the structure of the Takeover Panel

Under the Hearing Committee’s Rules of Procedure, a person is entitled to request a hearing only in certain circumstances. These include if that person is a party to the takeover in question, or is not a party but is “affected” by a ruling of the Executive and has a “sufficient interest” in the matter.

The Hearings Committee can refuse a request for a hearing if the person in question is not affected by the Executive’s ruling or does not have a sufficient interest in the matter, or if the matter has no reasonable prospect of success.

In this case, according to the Hearings Committee, although the individual in question had taken an interest in the proposed takeover and had spent “considerable time and energy” in opposing it, this did not mean he was affected by the proposed takeover, nor that he had a sufficient interest in it.

The individual was not a party to the proposed takeover and did not hold any shares in either the bidder or the target company. Rather, his interest in the takeover was rooted in the success of small business member-shareholders of the target company and the long-term development of the UK property development commerce category.

Again, however, this did not amount to his being affected by the takeover or give him a sufficient interest in it. According to the Hearings Committee, he had no greater claim to a sufficient interest than anyone else with the relevant expertise who has strong views on the merits of the takeover.

The decision shows the difficulty third parties face when looking to challenge a takeover in the UK. Any person who is not a party to the takeover itself will need to demonstrate to the Panel that the takeover would affect them in a way that does not affect persons generally.

Read the Takeover Panel’s decision to reject a hearing because the applicant did not have sufficient interest in the matter

New legislation would impose duties to prevent environmental and human rights harms

Legislation has been introduced into Parliament which, if passed, would impose duties on commercial organisations to investigate and prevent human rights and environmental (HR&E) harms.

The draft legislation has been put forward as a Private Members’ Bill, meaning that it has been proposed by an individual member of Parliament, rather than by the Government. Private Members’ Bills rarely become law, but they can indicate the mood of Parliament on certain issues.

The Bill would impose a duty on a commercial organisation to prevent HR&E harms, so far as is reasonably practicable, with respect to their own operations, products, and services, those of their subsidiaries, and throughout their value chains. This would include conducting HR&E due diligence on persons with whom the organisation enters into a business relationship.

Other obligations would include requiring a commercial organisation to mitigate HR&E harms before disengaging from a business relationship, as well as publishing an annual report on steps the organisation has taken and intends to take as part of its plan for HR&E due diligence.

The Bill would create civil liability for a commercial organisation for failing to prevent HR&E harms in its organisation and value chains, as well as criminal liability for the directors of a company that fails to implement HR&E due diligence.

Finally, on a separate note, the Bill would create a new failure to prevent offence, imposing criminal liability on a commercial organisation if a person associated with it commits any of a number of specified offences against the person, including kidnapping, false imprisonment, modern slavery, human trafficking and corporate homicide.

Some elements of the Bill are reminiscent of the European Union’s Corporate Sustainability Due Diligence Directive (CSDDD), which does not have effect in the UK but will affect UK businesses that conduct operations within the EU.

We will track the progress of the Bill and provide further updates if it progresses.

Read the Commercial Organisations and Public Authorities Duty (Human Rights and Environment) Bill

Read our previous Corporate Law Update for the latest position on the EU’s CSDDD