CULLEN INVESTMENTS V BROWN – RELIEF FROM LIABILITY PURSUANT TO SECTION 1157 OF THE COMPANIES ACT 2006

The recent case of Cullen Investments Ltd v Brown [2017] EWHC 2793 (Ch) serves as a reminder of the rigorous approach that the court adopts when dealing with directors who have breached their duty to avoid conflicts of interests.

The director in question (D2) had been found liable at an earlier trial (Cullen Investments Ltd v Brown [2017] EWHC 1586 (Ch)) for breach of the duty under section 175 of the Companies Act 2006 to avoid conflicts of interests on the grounds that he had allowed himself to be placed in a position where there was a potential conflict between his personal interests and the interests of the company. The conflict arose by virtue of his having accepted a promise from his brother (D1) to give him part of any profit that he, D1, might obtain through the pursuit of a business opportunity. At the trial it was held that D1, also a director, had wrongfully diverted that business opportunity from the company.

A further hearing was convened before the trial judge, Barling J, to deal with matters relating to relief. At that hearing, Edward Davies QC acted for D2 who applied under section 1157 of the Companies Act 2006 for an order that he be relieved from liability for his breach of duty.

In cases where the court considers that a director is, or may be, liable for breach of duty, the court has the power under section 1157 to relieve the director from liability if it considers that he acted honestly and reasonably, and that, having regard to all the circumstances of the case, he ought fairly to be excused. It is established on the authorities that the question whether the director acted honestly is to be answered subjectively and the test of reasonableness is to be answered objectively by reference to the knowledge, skill and experience which might reasonably be expected of a person carrying out his functions: see Coleman Taymar Ltd v Oakes [2001] 2 BCLC 749 at [83].

D2’s application under section 1157 was dismissed on the basis that D2’s failure to obtain separate authorisation for his interest in the proceeds of the business opportunity, although not dishonest, could not be characterised as reasonable.

The Cullen case concerned the affairs of Kauri Investments Limited (“KIL”), which was the vehicle for a joint venture between D1 and a wealthy acquaintance of his, and fellow New Zealander, Mr Eric Watson. D1 was in a position to source investment opportunities in the property business; Mr Watson was interested in opportunities for his investment vehicle, Cullen Investments Limited (“Cullen”). KIL was established as the vehicle by which Cullen and D1, as the 50/50 owners of KIL, would exploit opportunities in UK and European property. A shareholders’ agreement was entered into under which D1 agreed to introduce investment opportunities to KIL, and Cullen had a first right of refusal in respect of any initial equity investment. In any case where the chance to participate in an investment opportunity was offered by D1 to KIL, and KIL declined to take it up, then D1 was entitled to pursue that opportunity in his personal capacity, provided that no conflict arose with the interests of KIL.

The dispute arose in relation to an opportunity to invest in residential properties in Berlin (“the German Opportunity”). Over a period of several months, D1 engaged with Cullen and Mr Watson with a view to persuading them to commit to making an equity investment in the German Opportunity. Although there was some discussion of terms, at no point did Cullen commit to making an investment. As discussions regarding the prospect of Cullen making an equity investment petered out, it was left that D1 would nonetheless seek to involve KIL in the German Opportunity as a provider of management services. D1 then proceeded to invest in the German Opportunity in a personal capacity, and subsequently promised to D2 that he would give D2 a share of any profits that he, D1, might make out of the German Opportunity. Neither D1’s personal interest in the German Opportunity, nor the promise of a profit share for D2 were disclosed to Cullen or authorised by KIL.

Cullen subsequently discovered that D1 had taken a personal interest in the German Opportunity and brought proceedings in its own capacity against D1 for breach of the shareholders’ agreement and by way of a derivative claim against D1 and D2 for breaches of their directors’ duties. D1 and D2 also faced claims for conspiracy by unlawful means.

The key issue was whether Cullen’s refusal to commit to making an equity investment in the German Opportunity, having been offered the chance to do so by D1, meant that, for the purposes of the shareholders’ agreement, KIL could be said to have declined the opportunity to participate in the German Opportunity. Barling J held that it did not; on the contrary, the upshot of the various communications between D1 and Cullen was that it was accepted that KIL would participate in the German Opportunity, albeit only as a provider of services.  In those circumstances, and notwithstanding that Cullen had failed to commit to making an equity investment, D1 was not free to pursue the German Opportunity himself, and by secretly doing so he had breached the shareholders’ agreement and the duties that he owed KIL as a director.

D2, on the other hand, was not a party to the shareholders’ agreement and was only found liable on the grounds of his failure to obtain separate authorisation for the interest that he had in the German Opportunity by virtue of D1’s promise to give him a share of any profits. The main thrust of the case against D2, to the effect that he had dishonestly conspired with D1 to divert the German Opportunity away from KIL and Cullen, was dismissed. It was found that D2 had been told by D1, and genuinely believed, that Cullen had consented to D1 taking a personal interest in the German Opportunity, and that D2 had not been consciously party to any attempt to conceal D1’s involvement in the German Opportunity.

In those circumstances, there was reason to think that D2 was a suitable candidate for relief under section 1157; he not acted dishonestly, the profit that he had gained, in the sum of €64,000, was relatively modest, and he had various excuses for his failure to have disclosed his own interest. In particular, he had thought that D1’s promise to give him a share of profits was only an understanding between brothers, and was not legally binding, he had believed that D1’s interest, from which his own interest derived, had been authorised by Cullen, and he had little or no interaction with Mr Watson, who, as the only other director of KIL, was the person to whom his interest should have been disclosed. Finally, it was D2’s case that, but for the promise of a share in the profits of the German Opportunity, he would not have continued to work for KIL (which work, D2 contended, was to KIL’s benefit).

Barling J accepted that relief under section 1157 was, in principle, available in a case where the relief sought was an account of profits. In addition, the Judge accepted that, in assessing the reasonableness of D2’s conduct, D2 would be entitled to the benefit of his finding that D2 had believed that D1’s investment in the German Opportunity had been duly authorised even though, in fact, no such authorisation had been given.

Nonetheless, D2’s application under section 1157 was dismissed. In finding that D2’s failure to disclose and obtain separate authorisation for his interest in the German Opportunity was not reasonable, Barling J held that D2 must have been aware that he was in a position of conflict. The Judge referred to that fact that D2 was a qualified lawyer, well-versed in the workings of companies; as such he should have been aware that he was under a legal obligation to obtain authorisation for his conflict of interest.

The jurisdiction under section 1157 is of long standing, and the Cullen case, unsurprisingly, does not materially depart from established principles. That said, the acknowledgement that section 1157 may afford relief from an account of profits is welcome, and the Judge’s preparedness to assess the reasonableness of the director’s conduct according to the director’s reasonable understanding of the facts, even if that understanding is subsequently shown to have been wrong, may be helpful in future cases.

Above all, the case illustrates that the application of the power to grant relief under section 1157 is highly dependent upon the facts of the particular case, and that the criteria for the grant of relief allow a Judge considerable latitude to reach whatever conclusion is considered to meet the justice of the case. In a case where a director has put himself in a position of conflict of interest, the Cullen case shows that the Court may well adopt a very strict approach.

Barristers
Edward Davies QC