In a helpful judgment the Jersey Court of Appeal has upheld the decision of the Royal Court in Pirrwitz v AI Airports International Limited and PI Power International Limited [2013] JRC 017. In the process, the Court of Appeal has clarified the duty of a director under Article 74(1)(a) of the Companies (Jersey) Law 1991, which is to "act honestly and in good faith with a view to the best interests of the company". This, the Court confirmed, is a subjective duty: the best interests of the company is a matter for the directors to determine, not the Court. The Court noted, however, that directors are subject to other duties and, in particular, they must exercise their powers for the purposes for which they were conferred. In contrast to the duty under Article 74(1)(a), this is an objective duty – so that a director can be in breach of it notwithstanding his or her honest belief that what was done was in the company's best interest.

This Briefing considers the decision in relation to the duties of directors. The judgment is also of interest for its discussion of the remuneration of directors and in particular the scope of provisions in articles of association under which directors may be remunerated. That aspect of the case is considered in a separate Briefing.

Facts

Mr Pirrwitz was a director of two Jersey companies, AI Airports International Limited and PI Power International Limited, which held substantial investments in the airport and power sectors. Under his written terms of service he was entitled to certain payments in the event of his being removed from office or resigning on three months' notice. These exit payments were €600,000 and €700,000 respectively. The directors were expected by the hedge fund investors, who had procured their appointment, to realise the companies' investments and return cash to shareholders as soon as possible. The role was difficult and the board was unsupported by employees. Relations between the directors and the hedge fund investors became increasingly strained. Mr Pirrwitz was in due course removed by the investors as a director of both companies. As a result, he claimed the two lump sum payments. The companies resisted. They argued that the agreements were invalid and unenforceable because (a) neither company's articles of association contained power to agree to exit payments of this nature; the terms of the payments had not in fact been authorised by either board; and (c) the agreements to make the exit payments had not been in the best interests of the companies and were therefore unenforceable. The Royal Court rejected the companies' defence on each of these points and gave judgment in favour of Mr Pirrwitz.

The Court of Appeal's decision on directors' duties

The companies appealed. Christopher Nugee QC, sitting with the Hon. Michael Beloff QC and Robert Logan Martin QC, gave the Court of Appeal's judgment dismissing the appeal.

Article 74(1) of the Companies (Jersey) Law 1991 puts certain core duties of directors in statutory form:

"(1) A director, in exercising the director's powers and discharging the director's duties, shall:

  1. act honestly and in good faith with a view to the best interests of the company; and
  2. exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances."

It was contended by the companies that  the exit payments were not, in fact, in the best interests of the companies. The service contracts were therefore unenforceable in this respect by Mr Pirrwitz – and this was so, the companies argued, even though the directors at the time had honestly believed the agreements to have been in the companies' best interests.

The Royal Court found that the payments could properly be considered to be in best interests of the companies on the ground that they secured the loyalty and independence of the relevant directors. The Royal Court did not, however, specifically address the scope and meaning of a director's duty to act in the best interests of the company under Article 74(1)(a).

The Court of Appeal agreed with the Royal Court's conclusion but went on to consider the specific terms of Article 74(1)(a). On its plain wording, the Court said, a director is  not in breach of this Article if he acts in a way which he or she bona fide considers to be in the best interests of the company. Thus the exercise of a power by the directors, properly motivated in a subjective sense in accordance with Article 74(1)(a), could not amount to a breach of duty under Article 74(1)(a) simply because a court later concluded that the directors' acts were not, in its own view, in the best interests of the company. The Court did not doubt that, as fiduciaries, directors owed other duties going beyond Article 74; but this was not part of the case presented to it. The companies had not sought to argue that the directors had been acting otherwise than in good faith with a view to the best interests of the companies. It followed that the directors could not be said to be in breach of Article 74(1)(a).

Hogg v Cramphorn Ltd [1967] 1 Ch 254 and Howard Smith v Ampol Petroleum [1974] AC 821, cited by counsel for the companies, were authority for a rather different proposition: namely, that acts of directors are invalid if, however well-intentioned, they are carried out for a purpose which is not the purpose for which the power in question was conferred. It was trite law, the Court said, that any power must be exercised for the purpose for which it is given and not for some foreign or ulterior purpose. In the present case, securing the loyalty and independence of the directors was undoubtedly a proper purpose of the power of the board to fix remuneration.

The Court of Appeal also noted the Royal Court's endorsement of the board's position in resisting "instructions" from particular shareholders unless the action proposed was considered by them to be in the best interests of the company as a whole.

Comment

That directors must act with a view to the best interests of their company is, of course, a refrain very familiar to lawyers and directors alike. But until this case the Jersey courts had not had the opportunity to consider the meaning of this duty as it is set out in Article 74(1)(a) of the Companies (Jersey) Law 1991.

The Court of Appeal's comments are therefore most welcome. They confirm, in effect, that Article 74(1)(a) is a codification of the pre-existing common law position, inherited from English law. Thus the duty to act with a view to the best interests of the company is a subjective one. The words of Lord Greene MR in Re Smith and Fawcett  Ltd [1942] Ch 304 (though not cited in the judgment) are commonly regarded as the classic statement of this position. Directors, he said "must exercise their discretion bona fide in what they consider - not what a court may consider - is in the interests of the company, and not for any collateral purpose." Objective facts might be relevant, as a matter of evidence, to the credibility of a director's self-reported state of mind but the underlying question is still a subjective one of loyalty and motivation.

On the other hand, the Court of Appeal confirmed that directors, as fiduciaries, have separate non-statutory duties and that one of these is to exercise their powers for the purposes for which they are given and not, in Lord Greene's words, for a "collateral purpose". This is an objective duty in the sense that it does not matter if the director honestly believes that what is being proposed is in the best interests of the company. In both Hogg v Cramphorn Ltd and Howard Smith v Ampol Petroleum the power in question was the power to allot shares. The allotment of shares in Hogg in order to acquire voting control of the company and prevent outside control, was not in fulfilment of the proper purpose of this power, even if the directors genuinely thought that it was in the interests of the company for them and their supporters to obtain control. In Howard Smith the Privy Council similarly held that it was improper for directors to use their fiduciary powers to issue shares for the purpose of altering an existing shareholder majority. Again, it did not matter that the directors were acting honestly. An analogous issue, concerning the exercise of a director's power of veto over share transfers, arose in Jersey in Baker v Falle 1991 JLR 284; but in that case it was found that the director had not been motivated by the company's best interests but rather his own. The distinction between the objective "proper purposes" doctrine and the subjective requirement to act "with a view to best interests of the company" may not always be clear and it has been the subject of some conflicting Commonwealth judgments, which may be relevant in future cases.

The present case was argued in terms of whether the exit payments were in the best interests of the companies. However the case might have been seen as turning on the other duty in Article 74, namely the objective duty of care set out in Article 74(1)(b). This requires a director, "in exercising the director's powers and discharging the director's duties", to "exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances". Viewed from this perspective, the question would have been whether, in pursuing what they considered to be the best interests of the company, the directors had applied to this task the objective level of care, diligence and skill which is required by Article 74(1)(b). In the event, the arguments presented to the courts did not require this duty to be given detailed analysis. It is implicit, however, that neither the Royal Court nor the Court of Appeal would, on the particular facts, have found the directors to be in breach of the statutory duty of care; and it would certainly have been useful if the courts had taken the opportunity to consider the precise terms of Article 74(1)(b). Does this set a single, objective standard of care – the "reasonably prudent person" - regardless of the particular director's qualifications or experience? Or can a director's own qualifications and experience result in the bar being set higher? Do the relevant "comparable circumstances" include facts about the particular director or are they limited to the circumstances "in" which the director finds himself or herself? The wording of Article 74(1)(b) differs not only from English common law at the time it was drafted but also from subsequent developments in the common law (Re D'Jan of London Ltd [1994] 1 BCLC 561) which were then codified as s. 174 of the Companies Act 2006.

Directors of Jersey companies can take comfort from the Pirrwitz decision in that it makes it clear that the role of the court is   not to determine what the best interests of a company actually are: that is a matter for the directors. What the directors must do is ensure that they are properly motivated by what is, in their honest view, the company's best interests and apply to this task a level of care, diligence and skill which meets - at least - the standard required by Article 74(1)(b). The duty of care in Article 74(1)(b) thus sets an objective limit on the directors' margin of discretion. Directors must also ensure that particular powers, such as the power to issue further shares, are exercised for the purposes for which they can be seen as having been given. English case law shows that the "best interests of the company" means the best interests of the company as whole, assessed by reference to the interests of all the members (present and future) and having regard to  their long-term as well as short-term interests. The interests of particular members or other group companies may be pursued by the board only if this is consistent with the best interests of the company itself.

Where necessary, an act or omission of the directors of a Jersey company may be cured of a breach of either duty in Article 74(1) by all-member approval, provided that the solvency test set out in Article 74(2)(b) is satisfied. Retrospective ratification by the members in general meeting of other breaches of duty by the directors is also possible at common law, subject to certain exceptions.