Directors’ duties – To what extent is a person who has resigned as a director still subject to a duty to avoid conflicts of interest with his former company? Edward Davies QC considers a recent High Court decision extending the scope of the duty.

In Burnell v Trans-Tag Ltd [2021] EWHC 1457 (Ch), the High Court considered the scope of a director’s duty to avoid conflicts of interest under s 175 CA 2006 as it continues to apply to a former director by virtue of s 170(2) CA 2006. The issue arose in a counterclaim that was brought as part of a dispute about the circumstances surrounding the collapse of Trans-Tag Ltd (TTL).

Allowing both the claimant’s claims and the counterclaim, the judge decided that for the purpose of establishing a breach of the duty under s 175 to avoid conflicts of interest in relation to a former director, it was not necessary to be able to point to some conduct of the director before or at the time he ceased to hold office. Instead, the breach could be based entirely upon acts that took place after the director’s resignation. In reaching this conclusion, the judge recognised that this was contrary to the reasoning in some of the case law relating to the common law rules and equitable principles on which the general duty in s 175 is based (and which remain relevant to the construction of s 175 under s 170(3) and (4)).

Edward Davies QC acted for the claimant.

Background

The first defendant, TTL, was in the business of designing, manufacturing and selling a range of devices which allowed for the remote tracking, monitoring and analysis of goods, equipment and people. The majority shareholder in TTL was a company which was controlled by the second defendant, Mr Robert Aird (Mr Aird).

The claimant, Mr Alan Burnell (Mr Burnell), became an investor in, and the Chief Executive Officer of, TTL after being introduced to the business by Mr Aird in 2016. It was alleged by the defendants that Mr Burnell also became a director of TTL. After resigning in 2017, Mr Burnell subsequently took up an opportunity to acquire shares in a counterparty (TTS) to an intellectual property licence agreement with TTL. At the time of Mr Burnell’s acquisition, TTS was engaged in defending ongoing proceedings brought by TTL in the Chancery Division, in which TTL sought a declaration that TTS was not entitled to terminate its licence agreement with TTL.

In 2018, Mr Burnell brought a claim against TTL for repayment of a loan of £250,000 which he had made to TTL in two tranches in July 2016 and February 2017. Mr Burnell also claimed for breach of contract against Mr Aird, alleging that the loan was made as part of an arrangement negotiated with Mr Aird under which Mr Burnell was to receive shares in TTL, and that Mr Aird had breached the agreement by failing to procure the issue or transfer of shares. Mr Burnell claimed that his loss was the sum of £250,000 that he had loaned to TTL.

In response, TTL brought a counterclaim against Mr Burnell alleging that he had sought to gain control of TTL’s valuable rights to manufacture and sell its devices for his own benefit in breach of his duties as a director of TTL. This claim was based on the circumstances in which Mr Burnell acquired the shares in TTS and his subsequent actions to terminate TTS’s licence agreement with TTL. TTL also argued that Mr Burnell’s actions were in breach of his equitable duty of confidence to TTL.

The claim

Ashley Greenbank (sitting as a deputy High Court judge) first considered Mr Burnell’s claim against TTL. He found that Mr Aird had been acting on behalf of TTL in negotiations with Mr Burnell, and that there was a binding agreement between Mr Burnell and TTL in respect of the loan and the transfer of shares. He accepted that TTL had acted in breach of that agreement and that Mr Burnell was entitled to repayment of the loan by way of restitution.

The judge then considered Mr Burnell’s claim against Mr Aird. Mr Burnell’s claim was that it was an implied term of the loan agreement that Mr Aird had personally undertaken to procure the transfer or issue of shares in TTL to Mr Burnell and that, by failing to do so, Mr Aird was in breach of contract. The judge agreed with Mr Burnell and found that, in principle, Mr Burnell was entitled to recover damages for breach of contract against Mr Aird. The measure of damages would be subject to the outcome of the counterclaim.

The counterclaim

The counterclaim raised a number of issues for the court to determine:

    1. whether Mr Burnell was a de jure or de facto director of TTL and as such owed duties to TTL during and, given the terms of s 170(2), after the termination of his directorship;
    2. whether Mr Burnell had engaged in various acts aimed at destabilising TTL so that he could obtain control of the right to develop, manufacture and sell its devices which were in breach of those duties; and/or
    3. whether the acquisition of TTS also involved a breach of his equitable duty of confidence.

TTL claimed that Mr Burnell’s actions had damaged its business and resulted in a loss to the value of its assets of up to £9,895,000. It claimed damages in respect of this loss and an account of profits.

The judge considered each issue in turn.

Was Mr Burnell a director of TTL?

It was TTL’s case that Mr Burnell became a director of TTL either on 1 July 2016 or at some point between 28 February and 7 March 2017 on the basis that:

    1. he was properly appointed as a director;
    2. the members of the company gave their unanimous informal consent to his appointment so that he should be regarded as duly appointed in accordance with the Duomatic principle; or
    3. he was a de facto director.

 

The judge rejected the claim that Mr Burnell had been validly appointed by a decision of the directors. The relevant provision in TTL’s articles of association provided that a director either had to be appointed by ordinary resolution or by a decision of the directors. It was common ground that there was no ordinary resolution of the members to appoint Mr Burnell, and the judge found that no formal decision had been made by the directors to appoint Mr Burnell as a director.

The judge also rejected the proposition that Mr Burnell had been appointed as a director as a result of an informal decision by TTL’s members in accordance with the Duomatic principle. Under this principle, shareholders may take decisions informally by unanimous consent in certain circumstances. However, for the principle to apply, a shareholder must act with full knowledge and consent and, in this case, the shareholders “were not at any stage requested to give their consent to the appointment and remained unaware that their assent may have been necessary”.

Finally, the judge considered whether Mr Burnell was a de facto director of TTL. The appropriate test was: (a) whether Mr Burnell was part of the corporate governance system of the company; and (b) whether he assumed the status and function of a director so as to make himself responsible as if he was a director (Smithton Limited v Naggar [2014] EWCA Civ 939). The judge noted that: (i) from February 2017, Mr Burnell had started to exercise authority without the control or approval of Mr Aird; (ii) he had asked Mr Aird to arrange his appointment as a director; (iii) he was treated by all the other directors as if he was a director; (iv) he had represented to third parties that he was a director; and (v) he had instructed the company’s solicitors to provide advice in his assumed capacity as a director. On the basis of these observations, the judge decided that Mr Burnell did assume the position of director from February 2017 because he had “acted as a director, was treated by others as a director and sought to exercise his powers as a purported director”. In the judge’s view, Mr Burnell ceased to be director from 29 March 2017.

Continuing duty under s 170(2)

Having established that Mr Burnell was a de facto director of TTL, the judge turned to the question of the scope of his duties to the company.

It was common ground that, as a de facto director, Mr Burnell owed the same fiduciary duties to TTL (as set out in Chapter 2 Part 10 CA 2006) that he would have owed if he had been validly appointed as a director (McKillen v Misland (Cyrpus) Investments Limited [2012] EWHC 521). While the general rule is that a director, de facto or de jure, is no longer subject to these general duties when ceasing to be a director of the company, s 170(2) provides that a person who ceases to be a director remains subject to the duty to avoid conflicts of interest under s 175 in relation to ‘the exploitation of any property, information or opportunity of which he became aware at a time when he was a director’ (s 170(2)(a)). TTL argued that Mr Burnell had acted in breach of this duty because, after he had ceased to be a director of TTL, he had exploited opportunities and confidential information for his own benefit in acquiring the shares in TTS, causing TTS to seek to terminate its licence agreement with TTL, and in enabling TTS to defend the court proceedings brought by TTL.

Although the relevant duties have been codified by Chapter 2 Part 10 CA 2006, the judge started his analysis of the scope of s 170(2) by considering the pre-CA 2006 case law, including the judgments of Rix LJ in Foster Bryant Surveying Limited v Bryant [2007] EWCA Civ 200 and Cockerill J in Recovery Partners GP Limited v Rukhadze [2018] EWHC 2918 (Comm). On the basis of his review of the authorities, the judge noted that the “classic” case involving the diversion of a corporate opportunity was where a former director had obtained for himself a profit from the exploitation of a maturing business opportunity of the company where his resignation was prompted or influenced by a wish to acquire that opportunity for himself. Under the common law, the analysis in such a case is not that the fiduciary duty survived the termination of the directorship, but that a breach of fiduciary duty prior to or at the termination of the directorship resulted in a liability to account for a profit which was realised after the termination of the relationship but causally connected to the breach. On this basis, the judge concluded that the better view of the common law was that a claim of a breach of duty had to be based on actions of the director before or at the time of resignation.

The judge then considered the position under CA 2006 and concluded that, in contrast to the position as a matter of common law, it was not necessary for the purpose of establishing a breach of s 175 as extended to former directors under s 170(2) to be able to point to some conduct of the director before or at the time he ceased to hold office. Instead, a breach of duty could be founded solely on post-resignation acts and so, for example, without a requirement to show that the resignation of the director was prompted or influenced by the director’s desire to exploit a business opportunity for his or her own benefit.

The judge indicated that he was driven to this conclusion by the express words of s 170(2), which provide that the duty in s 175 ‘continues’ after the person ceases to be a director. The judge considered that this implied that the conduct of a director post-resignation could give rise to a breach of that duty. On this basis, it could not be an absolute requirement for a breach of the continuing duty under s 170(2) that the director’s resignation must have been prompted or influenced by his or her wish to acquire a business opportunity of the company.

The judge acknowledged that this conclusion was contrary to the reasoning in some of the case law considering the relevant common law rules and equitable principles on which the general duty in s 175 is based (as described above) and potentially extended the scope of the obligation imposed upon former directors. However, he did not think that his interpretation would, in practice, threaten the delicate balance which the courts had (in the pre-CA 2006 case law) sought to maintain between the protection of the fiduciary relationship and avoiding a regime which acted as a restraint on trade.

On the facts, the judge held that the opportunity for Mr Burnell to acquire shares in TTS only arose after his resignation, and so it was not something of which Mr Burnell could have been aware when he was a director, which is an express requirement under s 170(2). Accordingly, the claim that Mr Burnell had breached his duty under s 175 by acquiring the shares in TTS was rejected. The judge also rejected the allegations to the effect that Mr Burnell had breached his duty to avoid conflicts of interest by pursuing a plan to destabilise and take over TTL’s business.

However, one aspect of the conflict of interest claim was upheld. This was the claim that Mr Burnell had exploited information of which he had become aware in his capacity as a director of TTL for the purposes of his acquisition of the shares in TTL. This happened after Mr Burnell had ceased to be a director, but given the judge’s conclusion that the duty continued after the point when the director resigned, it was not necessary for TTL to show that Mr Burnell’s resignation as a director of TTL had been prompted or influenced by a desire to acquire the company’s information or exploit it for himself. The judge considered that there was “no doubt” that Mr Burnell was aware of commercially sensitive information relating to the relationship between TTL and TTS, including the terms of the licence agreement between them, legal advice given to TTL concerning the efficacy of the licence agreement and details of the dispute between TTS and TTL concerning payments due under the licence agreement. Therefore, by acquiring shares in TTS and then (through his control of TTS) taking action to terminate the licence agreement (whether pursuant to the court proceedings or otherwise), the judge concluded that Mr Burnell “put himself in a position in which his personal interests conflicted with the interests of TTL as regards the exploitation of property of TTL – its rights under the Licence Agreement – of which he was aware when he was a director”. The judge held that the loss caused to TTL as a result of this breach was limited to the loss of the rights under the licence agreement, which he valued at £200,000 (to be set off against Mr Burnell’s award against TTL in respect of his loan).

The judge also found that Mr Burnell had breached his duty of confidence to TTL by using TTL’s confidential information for his own benefit, although no additional loss was ascribed to this breach, which was simply treated as an alternative to the breach of fiduciary duty claim.

Comment

This is a notable case because the judge’s analysis avowedly extended the scope of the duty to avoid conflicts of interest beyond the position that pertained as a matter of common law. This was notwithstanding the requirement under s 170(4) that the general duties of directors under Chapter 2 Part 10 CA 2006 are to be ‘interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties’.

On the basis of the judge’s reasoning, a person who has resigned as a director may be found liable for breaching the duty under s 175 to avoid conflicts of interest on the basis of things done entirely after the director left office and without the need to establish that the resignation was in any way prompted or influenced by a desire to exploit any property, information or opportunity belonging to the company.

This is an inherently problematic outcome. In simple terms, given that the basic function of fiduciary duties is to regulate the conduct of persons who are in a fiduciary position, it is at the very least incongruous that a person who has ceased to be a fiduciary could nonetheless be subject to continuing fiduciary duties.

Of course, in relation to the duty to avoid conflicts of interest, it has long been recognised that a director should not be able to get round his obligations through the simple expedient of resigning from office before taking steps to exploit the company’s information or opportunities. However, the analysis in such cases is not that the fiduciary duty continued after the resignation, but that a breach of fiduciary duty prior to or at the termination of the relationship resulted in a liability to account for a profit which was realised after the termination of the relationship but causally connected to the breach (Rix LJ in Foster Bryant at para 69; Cockerill J in Recovery Partners at paras 75 and 76). That is why, as a matter of common law, it was important to establish that the director’s resignation was prompted or influenced by the wish to acquire the opportunity for himself.

The reason why the judge felt unable to adopt the same approach was the terms of s 170(2) itself. In dealing with the application of the conflict of interests doctrine to former directors, s 170(2) states: ‘A person who ceases to be a director continues to be subject’ to s 175. The judge considered that the use of the word ‘continues’ meant that he was constrained to depart from the reasoning that applied as a matter of common law and to conclude instead that a breach of the no conflict rule could be founded on acts which took place after a director had resigned his directorship.

The ramifications of this construction are significant. In short, the need to link the profit that the company is seeking to claim from its former director with some conduct of that former director when he was in office no longer applies; all that is required under the express terms of s 170(2) is that the former director became ‘aware’ of the property, information or opportunity in question at a time when he was a director.

The judge recognised that his interpretation might be said to threaten “the delicate balance” between, on the one hand, upholding fiduciary duties, and, on the other, avoiding a regime which acts as a restraint on trade. However, he expressed confidence that this would not be the case for two reasons:

 

In relation to business opportunities, it is obviously correct that the restriction of the application of the duty to opportunities that were “maturing” at the time of the former director’s resignation would still operate as a limit on the scope of the duty, if, as the judge held, the duty continued after resignation. However, for the judge to have found otherwise would have represented an even more significant extension of the scope of the duty to avoid conflicts of interests as it applies to former directors. Moreover, as a matter of policy, the question remains as to why a former director should not be allowed to pursue an opportunity, even one that was “maturing” during his directorship, if it is the case that his resignation was not in any way influenced by a desire to do so. In such a case, it is reasonable to contend that the regulation of the ability to exploit opportunities should be within the realm of contract, and restrictive covenants, as opposed to being a matter of the law of directors’ duties.

The other key point is that it is much more difficult to understand how the existing case law could operate to limit the ramifications of the judge’s decision when dealing purely with information. Thus, whilst the notion of a maturing business opportunity is reasonably well-developed as a means of defining the kind of opportunity which would be covered by the duty to avoid conflicts of interest as a matter of common law, it is much more difficult to discern in the case law any equivalent limiting factor that might apply when dealing just with information. On the judge’s analysis, it is entirely uncertain where the line is to be drawn between information that a former director is allowed to exploit after his resignation and information which he is duty-bound not to exploit. It would seem that this is where the “merits-based assessment” referred to by the judge would be called in aid, but that is inherently vague.

In the result, considerable uncertainty has been introduced into the scope of the duty to avoid conflicts of interest as it applies to former directors, particularly in relation to the exploitation of information. Again, it may reasonably be argued that these are matters more properly to be regulated by contract or under the established principles concerning the equitable duty of confidence. Indeed, in the present case, the same facts as gave rise to a breach by Mr Burnell of the extended duty that he continued to owe as a former director under s 175 also were held to have put him in breach of a duty of confidence.

Ultimately, it is questionable whether the judge needed to find as he did regarding the construction of s 170(2). As indicated above, he considered that his finding that a former director remained under a continuing duty under s 175, so that a breach could be established on the basis of post-resignation conduct alone, was “an inevitable result of the codification”. However, given the ramifications referred to above and the requirement under s 170(4) to have regard to the corresponding common law rules and equitable principles, and absent any indication of any legislative intention to extend the scope of the duty in relation to former directors, it is suggested that a more nuanced interpretation of the provision would have been permissible. Specifically, the words ‘continues to be subject’ could have been taken merely to encapsulate the concept, established under common law, that the duty to avoid conflicts of interests cannot be circumvented by resigning from office.