In January’s company update we review three recent cases focussing respectively on interpretation of clauses which may be deemed as ‘penalty’ clauses, guidance on the authority of directors to bind their company and that which can constitute a breach of fiduciary duty. Full reviews and analyses of the cases follow but, for ease of reference, we have included the following summary.
Court of Appeal provides guidance on penalties
A sale share contract was structured to include payments held in escrow and released on specific milestones and further interim and final payments based on company performance. The Sellers, who remained employed by the company, were required to protect the goodwill of the company and abide by restrictive covenants which it was subsequently claimed one of the Sellers had breached.
As a result of the breach, the defaulting Seller was not entitled to receive the interim or final payments. The defaulting Seller claimed the clauses providing for the loss of these payments amounted to penalty clauses and should be unenforceable. The court at first instance found against the Seller on the basis that the restrictions were justifiable commercially and he had failed to abide by them. Therefore, it was appropriate that he did not receive the payments.
The Seller appealed this decision and the Court of Appeal allowed unanimously the appeal. The decision reaffirmed the position that any financial penalty arising as a result of a breach must be a genuine pre-estimate of the loss arising from that breach. The judgement set out seven guidelines for determining whether a clause is a genuine pre-estimate of loss.
These guidelines are useful for preparing any deferred consideration, liquidated damages or clawback provisions to ensure that any amounts which can be claimed or clawed back will be deemed to be a genuine pre-estimate of losses.
Whether a director had actual or apparent authority to bind a football club
The ultimate owner and de-facto managing director of Watford Association Football Club Limited entered into two loan agreements on behalf of the club. The club later claimed that it did not have to repay these loans as they had not been entered into in the club’s best interest and the managing director did not have the actual or apparent authority to bind the club.
An agent who was hired personally by the managing director carried out the day to day management of the club, although he was not officially hired by the club, and witnesses indicated that he acted as if he had authority from the club and was treated by the club as if he was the voice of the managing director.
The court found that, on the basis that the club had authority to delegate a wide range of functions, it was not unreasonable for third parties (including the finance agent and the funder) to presume that both the managing director and his agent had the authority to bind the club. The failing was a lack of reporting and supervision by the remainder of the board in respect of the activities carried out by the managing director and his agent and accordingly the club was bound to repay the borrowed funds in full.
This serves as a timely reminder that company boards should always ensure that any delegation is clearly determined and agreed in respect of scope and authority and there are specified lines of reporting and approval which are enforced.
Breach of fiduciary duty?
Two directors of a company specially set up to manage options to purchase a farm sought ultimately to develop the underlying farmland for their own benefit and, accordingly, a claim that they had breached their fiduciary duties was raised.
The directors and various other third parties had entered into a shareholders agreement in respect of the specially set up company which referred to the assignment of the option agreements relating to the land to be developed. Before the transfer of options was concluded, the other directors / shareholders offered to buy-out the original two directors. The two directors claimed that they had concluded the buy-out agreement and that this had fulfilled the requirements of and superseded the shareholders agreement, released them as directors of the company and thereby leaving them free to pursue other option arrangements and development opportunities on neighbouring properties on a personal basis.
The other directors of the company stated that the buy-out agreement had not concluded formally and the shareholders agreement was still live, thereby binding the two directors to their fiduciary duties. The court ruled that, as the buy-out had not concluded, notwithstanding that it may not be capable of concluding, the two directors remained under a fiduciary duty to the original company and should have provided full details of any conflicts of interest and/or competing interests to the board. The decision of the court was based on several points (which are set out in detail in the review underneath) although it focussed primarily on the conduct and actions of the two directors which indicated clearly conflict and bad faith.
Overall, this case acts as a reminder that where a director has any personal interest in anything his company may be involved in it will always be necessary to advise the board of a potential conflict of interests and to ensure that he is transparent in all his dealings on behalf of the company or for his own personal matters.
Court of Appeal provides guidance on penalties
In El Makdessi v Cavendish Square Holdings BV and another  the Court of Appeal was asked to decide whether two clauses in an agreement for the sale of shares were unenforceable on the ground that they were penalties.
By 2008, Mr Talel Makdessi was a key figure in the advertising and marketing world in the Middle East. He had founded and was associated with an advertising and marketing group which had become the largest in the region.
The group’s holding company was Team Y&R Holdings Hong Kong Limited (“Company”). The shareholders were Mr Makdessi, Mr Joseph Ghossoub and Young & Rubicam International Group B.V (“Y & RIG”), which held 12.6% of the shares in the Company.
By an agreement dated 28 February 2008 (“Agreement”), Mr Makdessi and Mr Ghossoub (together “Sellers”) sold 47.4% of the Company’s shares to Y & RIG. These shares were then transferred to Cavendish Square Holdings B.V (“Cavendish”) and Cavendish was substituted for Y & RIG as a party to the Agreement by a novation agreement. Cavendish therefore came to hold 60% of the shares in the Company and the Sellers held 40%.
The agreement was the result of extensive negotiations between highly experienced and respected lawyers. It provided that Cavendish pay the Sellers:
a completion payment of $34,000,000;
a further payment of $31,500,000 into escrow which was to be released in four instalments;
an interim payment based on operating profit for 2007-2009 (“Interim Payment”); and
a final payment based on operating profit for 2007-2011 (“Final Payment”).
The Sellers warranted that the net asset value of the Company was $69,744,340. Clause 3.3 of the Agreement provided that the total maximum of all payments would be $147,500,000 for the 47.4% share in the Company being sold to Cavendish. Christopher Clarke LJ calculated that, given the net asset value of the Company, over half of the consideration payable by Cavendish to the Sellers was attributable to goodwill.
As part of the transaction, Mr Makdessi was appointed a non-executive director and non-executive chairman of the Company for an initial term of eighteen months.
Breach of the Agreement and consequences
Clause 11.1 of the Agreement provided that each Seller act to protect the goodwill of the Company (given its significance) and clause 11.2 of the Agreement set out a number of restrictive covenants which provided that, in order to protect the goodwill of the Company, neither Seller could engage directly or indirectly in certain activities.
In or by 2010, Cavendish had discovered that Mr Makdessi had acted in breach of his duties to the Company as a director. As such, Cavendish claimed that Mr Makdessi had breached clause 11.2 of the Agreement because he had engaged in activities prohibited by clause 11.2, including his continuing involvement with competing company, Carat Middle East S.a.r.l., which included providing services to Carat, diverting business to Carat, soliciting clients and diverting their business to Carat and setting up rival advertising agencies in Lebanon and Saudi Arabia which had poached or tried to poach a number of the Company’s customers and employees. The Company also sued for breach of fiduciary duty claiming to have suffered loss and damage in that it had lost the custom of some of its clients and the services of some of its employees.
Clause 5 of the Agreement contained ‘Default’ provisions which provided that (clause 5.1) a ‘Defaulting Shareholder’ (defined to include Sellers who breach clause 11.2) would not be entitled to receive the Interim Payment and/or the Final Payment. In addition, clause 5.6 provided that Cavendish had a call option to require a Defaulting Shareholder to sell his remaining shares in the Company (i.e. shares held by him post the sale of the 47.4% shareholdings to Cavendish) to Cavendish for an amount equal to the appropriate percentage of the net asset value of the entire share capital of the Company. This value Note: This article relates to service of process in relation to actions raised in English courts but again may be relevant to our Scottish readership did not take account of goodwill. The clause also had the effect of removing Mr Makdessi’s right to exercise a put option in respect of his remaining shares, which applied a value to the shares which did take account of goodwill.
Cavendish issued notice of the exercise of its call option on 13 December 2010. The effect of this was that, by being in breach of clause 11.2 (restrictive covenants) Mr Makdessi became disentitled to his share of the Interim and Final Payments (the loss to Mr Makdessi alone was over $44m) and was also liable to have all his retained shares in the Company acquired under the call option in return for the appropriate percentage of the net asset value of the entire share capital at the date when he became a Defaulting Shareholder. Mr Makdessi would, therefore, receive nothing for those shares in respect of goodwill.
Mr Makdessi claimed that clauses 5.1 (loss of interim and final payments for a Defaulting Shareholder) and 5.6 (call option applicable to a Defaulting Shareholder) were penalty clauses and should be rendered unenforceable. The High Court found in favour of Cavendish (broadly on the basis that the clauses were not penalty clauses because they were justified commercially) and Mr Makdessi appealed to the Court of Appeal.
The Court of Appeal allowed unanimously Mr Makdessi’s appeal. In his leading judgment, Christopher Clarke LJ examined the authorities to aid determining whether the provisions of clauses 5.1 and 5.6 were based on a genuine pre-estimate of loss or were penalty clauses and quoted Lord Browne Wilkinson in WorkersTrust & Merchant Bank Ltd v Dojap Investments Ltd  who said:
“In general a contractual provision which requires one party in the event of his breach of contract to pay or forfeit a sum of money to the other party is unlawful as being a penalty, unless such provisions can be justified as being a payment of liquidated damages being a genuine pre-estimate of the loss which the innocent party will incur by reason of the breach. One exception to this general rule is the provision for the payment of a deposit (customarily 10% of the contract price) on the sale of land…”
The underlying rationale of the doctrine of penalties is that the court will grant relief against the enforcement of provisions for payment (or the loss of rights or the compulsory transfer of property at nil or an undervalue) in the event of breach, where the amount to be paid or lost is out of all proportion to the loss attributable to the breach. If that is so, the provisions are likely to be regarded as penal because their function is to act as a deterrent.
Having reviewed the authorities, Christopher Clarke LJ identified seven guidelines for determining whether a clause is a genuine pre-estimate of loss:
A sum will be penal if it is extravagant in amount in comparison with the maximum conceivable loss from the breach;
A sum payable on the happening or non happening of a particular event is not to be presumed to be penal simply because the fact that the event does or does not occur is the result of several breaches of varying severity;
A sum payable in respect of different breaches of the same stipulation is not to be presumed to be penal because the effect of the breach may vary;
The same applies in respect of breaches of different stipulations if the damage likely to arise from those breaches is the same in kind;
A presumption may arise if the same sum is applicable to breaches of different stipulations which are different in kind;
There is no presumption that a clause is penal because the damages for which it provides may, in certain circumstances, be larger than the actual loss; and
Where there is a range of losses and the sum provided for is totally out of proportion to some of them, the clause may be penal.
Christopher Clarke LJ cautioned against taking these guidelines as absolute, saying that their application will have limitations, each case turning on its facts and any presumption will not be irrebuttable and, even if there is a presumption, the clause may still be penal. Christopher Clarke LJ went on to identify further matters to be taken into account in deciding whether a clause is penal:
It is for the party who claims that it is to establish that [a clause is penal]. It may be possible to do so by reference to the terms of the clause itself. It may, however, be necessary to adduce evidence as to its effect or any other matter which is said to render it unconscionable;
The contract must be examined as a whole in the circumstances and context in which it was made;
The court will not be astute to find that a clause contained in a commercial contract is unenforceable because it is penal, especially if the parties are of equal bargaining power and have had a high level of legal advice. The court recognises the utility of liquidated damages clauses and that to hold them to be penal is an interference with freedom of contract. It is, therefore, predisposed to uphold clauses which fix the damages for breach;
To that end the court will adopt a robust approach. If the likely loss is within a range, an average figure or a figure somewhere within the range is likely to be acceptable. If the loss is difficult to assess, a figure which is not outrageous may well be acceptable. A pre-estimate does not have to be right to be reasonable. The fact that it may result in overpayment is not fatal and the parties are allowed a generous margin. Further, the fact that a breach may give rise to trifling or substantial damage may not be determinative if the parties can be regarded as having regarded the trifling as unlikely;
The fact that the clause has been agreed between parties of equal bargaining power who have competent advice cannot be determinative. The question whether a clause is penal habitually arises in commercial contracts, which enjoy no immunity from the doctrine.
Applying these principles to clauses 5.1 and 5.6, Christopher Clarke LJ stated that, at the time of the Agreement, the sums which might be withheld from Mr Makdessi under clause 5.1 (being the Interim Payment and the Final Payment) were undetermined. They could be anything from $0 to over $44,000,000, depending on the operating profit figure. Although it was possible that a default on the part of Mr Makdessi could reduce the goodwill of the Company to such an extent that the two payments might be $0, it was far more likely that Mr Makdessi would forfeit millions of dollars.
The fact that the amount which might be withheld under clause 5.1 was indeterminate negates the clause being a reasonable pre-estimate. Liquidated damage clauses may well incorporate formulae to determine that which is payable which make them entirely reasonable, but in the present case the effect of the formula was that upon the first and any breach by Mr Makdessi, whether material or not, Mr Makdessi became a Defaulting Shareholder and no further payment of consideration in respect of the goodwill attaching to the shares purchased was to be made. The whole of that which would otherwise be payable is forfeit. There was no proportionate relationship, even a rough and ready one, between the breach which triggers the operation of the clause and the amount withheld.
A provision that Mr Makdessi should forfeit the totality of the outstanding price so soon after he became a Defaulting Shareholder seemed to the Court of Appeal an extravagant one. A trifling breach (such as an unsuccessful attempt to solicit business) or one that is very short-lived had the same effect as a breach of very substantial gravity.
In respect of clause 5.6 similar considerations apply. The result of the clause was to require Mr Makdessi, on the exercise by Cavendish of the call option, to sell his remaining shares at a value which took no account of goodwill and deprive him of any opportunity to exercise the put option which applied a value which did take account of goodwill. The effect was (a) that in so far as his remaining shares have, at the date when he became a Defaulting Shareholder, a value which was attributable to goodwill he will not receive it; and (b) that he would be unable to exercise an option, which, when exercised, would provide a consideration which took account of goodwill.
The potential loss arising from an inability to exercise the put option was up to $75,000,000 less the proportion attributable to his percentage of the net asset value at the relevant time, which he would receive under clause 5.6, which Cavendish put at about $9 million.
The Court of Appeal was satisfied that the clauses, taken in the context of the Agreement as a whole, were not genuine pre-estimates of loss. On the contrary, they were extravagant and unreasonable. However, that was not necessarily conclusive. A commercial justification may mean that a clause which is not a genuine pre-estimate is not penal.
In relation to whether or not there was commercial justification, the payment terms of clauses 5.1 and 5.6 did not serve to fulfil some justifiable commercial or economic function, such as (as exemplified in the cases) a modest extra interest in respect of a defaulting loan; a provision for the payment of the costs of earlier litigation; a generous measure of damages for wrongful dismissal; an allocation of credit risk; or the provision of capital which would be needed if a promised guarantee of a loan was not forthcoming.
In summary, the Court of Appeal held that the amount Mr Makdessi would forfeit or lose was out of all proportion to the loss attributable to the breach. There was also an unacceptable double recovery mechanism, in that Cavendish had the remedies provided by the Agreement and at the same time Mr Makdessi remained liable to the Company, which the law, for reasons of public policy, precludes. Clauses 5.1 and 5.6 went “way beyond compensation and into the territory of deterrence”.
This case provides useful guidance on when a contractual provision will be regarded as penal and draws attention to the need for care when linking deferred consideration with breach of a seller’s restrictive covenants in a share sale situation. It is important to ensure that such provisions do not go way beyond compensation and into the territory of deterrence and are not drafted as a blanket enforcement against all and any breaches so that they are at risk of being regarded as penal.
It is crucial from a drafting point of view that the consequences of a breach of covenant are measured according to the severity of the breach and its consequences, unless there is an overwhelmingly commercial reason which negates the likelihood that the provision will be deemed a penalty clause.
Alternatively, as mentioned in the judgment, the clause could be structured so that the payment of consideration is conditional upon the covenants being complied with and not something to be forfeited if there is a breach.
Whether a director had actual or apparent authority to bind a football club
In LNOC Limited v Watford Association Football Club Limited  the High Court considered whether the managing director of a football club had actual or apparent authority to enter into two transactions on behalf of the Club.
LNOC Limited sought £900,000 plus interest from Watford Association Football Club Limited to cover the amount not repaid under two loans. The Club claimed that it was not bound to repay the loans as the transactions to which they related were not entered into in the Club’s best interests and Mr Bassini, the ultimate owner and de facto managing director, did not have actual or apparent authority to bind the Club when he entered into them.
The facts are complex. The Club at the relevant time was in the Championship and subject to the rules of The Football League as set out in The Football League Regulations 2011-2012. From May 2011 until June 2012, the Club was owned and controlled by Mr Laurence Bassini. The other directors of the Club at the relevant time were Mr Graham Taylor, the former England manager, Mr David Fransen, a successful businessman and Professor Stuart Timperley. The board was small and the directors, other than Mr Bassini, non-executive.
In June 2011, the Club received a bid from Swansea City Football Club (“Swansea”) of £3.5 million for striker Danny Graham to be paid in instalments. This raised the possibility of ‘forward funding’ the transfer (the process whereby football clubs assign income due in instalments in exchange for an immediate discounted lump sum from a funder) which would provide funds to complete development of the south west corner stand.
Mr Weiss, an agent who specialised in finding private funders for football clubs, proposed that a funder, LNOC, could lend the Club £900,000 in return for the assignment of two promissory notes, each of £500,000, from Swansea. This came to be called the Danny Graham Transaction.
On 5 August 2011, Mr Weiss told Mr Barrea, Mr Bassini’s associate, that funds were available for the proposed Danny Graham Transaction from LNOC. He also confirmed that funds were available from LNOC for the forward funding of nine payments of £200,000 to the Club from the Football League. This came to be called the Football League Transaction.
Mr Weiss was told that Mr Barrea was “a consultant duly authorised to bind the Club on behalf of Mr Bassini, a director”. When prompted to provide evidence of this authority, Mr Barrea produced a signed statement from Mr Bassini which confirmed that Mr Barrea had authority to bind the Club. Mr Barrea was a consultant to Mr Bassini without an official Club position but was effectively in charge of its day to day running. Witnesses acknowledged that his instructions were complied with as if he was the voice of the owner. Mr Barrea had a Watford Association Football Club e-mail address and an office at the Club and became a signatory on the Club’s bank account. He attended board meetings and reported to the board.
The mandate for the Danny Graham Transaction was signed on 24 August, the documents were executed on 7 September and, on 19 September, Mr Weiss brought the promissory notes from Swansea to the Club so that they could be endorsed in favour of LNOC. On 13 September, Mr Weiss gave Mr Barrea a draft assignment of the money due from the Football League. The Club was to issue promissory notes, whereby it promised to pay the £200,000 instalments to LNOC as they were received into the Club’s account.
The two transactions were not disclosed to the other directors and senior employees at the Club and were held by a football disciplinary commission to be in breach of the Football League Regulations.
The Club failed to pay the first instalments due to LNOC under the terms of the Danny Graham Transaction and the Football League Transaction. Eventually, LNOC received £500,000 in respect of the Danny Graham Transaction and £900,000 in respect of the Football League Transaction. The £900,000 payment was challenged at the Club’s next board meeting partly because no paperwork was available in respect of it. Mr Bassini told the board untruthfully that the payment was for the development of the south west stand.
Mr Bassini sold the Club at the end of June 2012. Mr Weiss wrote to the Club to remind them that the final payment for the Football League Transaction was due on 1 September 2012. The Club responded claiming that no one had any knowledge of the agreement and refused to pay. It maintained this position, causing LNOC to make this claim to recover the £900,000 due.
The Club’s defence was that Mr Bassini had no authority to enter into the transactions. The defence was based on four propositions of fact and law:
The transactions were a breach of the Football League Regulations and, by entering into them, Mr Bassini exposed the Club to extremely serious sanctions which had potentially catastrophic consequences.
There were alternative methods of funding available to the Club at the time and there was no pressing financial need to enter into the transactions. Furthermore the Club did not, in fact, benefit financially from the transactions.
The transactions were not in the best interests of the Club for the purposes of section 172 of the Companies Act 2006 and so, as a matter of law, Mr Bassini and/or Mr Barrea had no actual authority to enter into them. Furthermore, they were aware of this as they hid the transactions from the board and others at the Club.
Mr Weiss had sufficient knowledge of the nature of the transactions to know that Mr Bassini and Mr Barrea lacked actual authority to enter into them. Alternatively, he had sufficient knowledge to trigger an obligation to make relevant enquiries but he chose not to do so. He turned a “Nelsonian blind eye”. As a result the Club was not bound by the transactions in accordance with section 44(5) of the Companies Act 2006.
LNOC claimed that Mr Bassini had actual or at least apparent authority to enter into the transactions.
Authority to manage the affairs of a company is vested in its board of directors; a managing director will have implied actual authority to do all such things as fall within the usual scope of that office. There need not be a formal appointment of a managing director-an individual allowed by the board to be a ‘de facto’ managing director will have the same authority as if he was formally appointed.
Further, a director must act in a way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (section 172(1) of the Companies Act 2006).
It follows that a director cannot have actual authority to act in a way which he does not consider in good faith to be in the company’s interests.
The two issues under actual authority were first, the extent of Mr Bassini’s role in the Club and secondly whether the Club could establish that when he entered into the transactions he did not act in what he considered in good faith to be the Club’s best interests. It was irrelevant whether, with the benefit of hindsight, the transactions were ill-advised.
The Club alleged that Mr Bassini was not acting in what he honestly believed were the best interests of the Club when entering into the transactions. It was claimed that he knew the transactions exposed the Club to risk of sanction and that other funding was available and there was no pressing financial need for the Club to enter into the transactions.
Judge Mackie found that the money was being raised for the development of the Club’s stadium and that there had been no evidence to suggest that other methods of funding were available for that purpose. Moreover, at no point was any evidence produced to show that Mr Bassini had turned his mind to the Football League Regulations. During his time at Watford, Mr Bassini appeared not to have taken much interest in detail or regulations generally. He did not take legal advice about the transactions until April 2012, long after the transactions had been entered into.
Mr Bassini and Mr Barrea had been remiss in not informing the board of the transactions but the transactions were not concealed actively. It had not been shown that when Mr Bassini entered into these transactions he was not acting in what he believed honestly to be the best interests of the Club.
The court held that Mr Bassini had actual authority to enter into the transactions.
Judge Mackie then considered whether Mr Bassini also had apparent authority to enter into the transactions, as the Club had claimed that Mr Weiss knew that the transactions were not entered into by Mr Bassini acting in the best interests of the Club.
Under section 43 of the Companies Act 2006, a contract may be made either by some duly authorised person acting on behalf of the company or by the company itself by writing under its common seal. By section 44(2) of the Companies Act 2006, a document is validly executed by a company if it is signed on behalf of the company by two ‘authorised signatories’. By section 44(3), every director and the company secretary of a company are ‘authorised signatories’. By section 44(4), a document signed in accordance with section 44(2) has the same effect as if it had been executed under the company’s common seal.
In this case, the relevant contracts were signed by Mr Wastall, the Club’s company secretary, and Mr Bassini who were ‘authorised signatories’ for the purposes of section 44(3) and so the relevant contracts had the same effect under section 44(4) as if those documents had been executed under the common seal of the Club. Section 44(5) of the Companies Act 2006 protects a buyer acting in good faith where a document purported to have been signed in accordance with section 44(2) had not in fact been so signed. LNOC’s primary case was that because the relevant documents were in fact signed by a director and a company secretary it was unnecessary to rely on section 44(5). However, section 44(5) presumes irrefutably authority in favour of a purchaser in good faith.
The Club claimed that LNOC was not acting in good faith as:
the transactions breached Football League Regulations;
Mr Bassini must have known this; so
they were not in the best interests of the Club; and
Mr Weiss, as LNOC’s agent, knew or should have known that.
Judge Mackie considered Mr Weiss’s knowledge as an agent of LNOC. If Mr Weiss had not acted in good faith, then LNOC would not be a purchaser in good faith and could not enjoy the protection of section 44(5) of the Companies Act 2006.
It was found that it was highly improbable that Mr Weiss would imperil the goodwill of his business or the money of his client (and personal friend) by acting improperly as regards the Club for the sake of Mr Bassini. Mr Weiss’s duty was to his client and not the Club; he had asked for evidence of authority to enter into the transactions and he had been provided with that. It was clear to Judge Mackie that Mr Weiss genuinely believed that Mr Bassini had authority to enter into the transactions and Mr Weiss had acted in good faith.
Mr Bassini therefore also had apparent authority to enter into the Transactions and the defence based on apparent authority failed.
Having decided that Mr Bassini had authority to enter into the transactions, Judge Mackie held that the Club was bound by them. The Club was free to delegate wide ranging authority to a managing director but it had to take the consequences of doing so. The Club, acting through the de facto managing director it appointed, borrowed money but had not paid it back. It should have done so. The defences of lack of actual or apparent authority failed.
This case highlights the problems associated with the way a board of directors operates and communicates and the delegation of authority. Where boards are kept properly informed, there should not be a situation where one or a portion of them bind the company to a questionable transaction. Directors do have the ability to bind the company and there is a presumption in favour of the other party so long as that party acts in good faith.
For a party in the position of LNOC, there is some comfort in the fact that sections 44(4) and 44(5) of the Companies Act 2006 do protect them. However, proper due diligence by a potential funder can mitigate the risk of similar events occurring.
Breach of fiduciary duty?
In Pennyfeathers Ltd and Others v Pennyfeathers Property Company Ltd and Others  the High Court considered whether two company directors had breached their fiduciary duties by pursuing an opportunity which belonged to their company to develop farm land for their own benefit.
The case concerned a plan to develop 76 acres of farm land on the Isle of Wight. Mr Steer and Mr Taylor were granted an option to purchase a farm in 2005 (the “2005 Option”). They approached a Mr Attwell for financial support. Mr Attwell in turn approached a Mr Bowdery, who had experience in the construction industry, and Mr Bowdery approached a Mr Donnellan, who operated through Market Distribution Solutions Ltd (“MDS”).
Mr Donnellan incorporated Pennyfeathers Limited (“Pennyfeathers UK”) in June 2006 to take the farm project forward. Mr Steer, Mr Taylor and Mr Donnellan were the initial shareholders and, in January 2007, a shareholders’ agreement was concluded between the three of them (Mr Donnellan through his company MDS) and Trimount Residential (Isle of Wight) Ltd (“Trimount”), which had been set up by Mr Attwell and Mr Bowdery. The agreement provided for Mr Steer and Mr Taylor to assign the 2005 Option to Pennyfeathers UK. Mr Attwell, Mr Bowdery, Mr Steer and Mr Taylor were all directors of Pennyfeathers UK.
The 2005 Option was never assigned to Pennyfeathers UK as the shareholders’ agreement envisaged. Why this did not happen was a matter of dispute between the parties.
In December 2007, it was decided that Mr Attwell and Mr Bowdery would buy Mr Steer’s, Mr Taylor’s and MDS’s shares. Whether this proposed buy-out was the subject of a binding contract between the parties was one of the matters in dispute. The claimants said that no agreement was ever concluded that accordingly the terms of the Shareholders’ Agreement still operated and that the fiduciary duties owed by Mr Bowdery and Mr Attwell to Pennyfeathers UK continued in effect. Mr Bowdery and Mr Attwell argued that a binding buy-out agreement was concluded. This, they say, superseded the Shareholders’ Agreement and entitled Mr Bowdery and Mr Attwell thereafter to pursue the development of the farm for their own benefit, free of any duty to act in the best interests of Pennyfeathers UK.
In anticipation of acquiring complete control of Pennyfeathers UK, Mr Attwell and Mr Bowdery set up Pennyfeathers Property Company Ltd (“Pennyfeathers Jersey”) in March 2008. In April, Pennyfeathers Jersey entered into a contract (the “2008 Contract”) for the conditional purchase of the farm (over which the 2005 Option had been granted) for £16 million.
Pennyfeathers Jersey also entered into several option agreements over land surrounding the farm. There was a dispute over whether Mr Taylor and Mr Steer knew about and consented to the acquisition of the “surrounding land options”. By the middle of 2009 the relationship between Mr Bowdery and Mr Attwell on the one hand and Mr Taylor, Mr Steer and Mr Donnellan on the other had broken down and Mr Attwell and Mr Bowdery resigned as directors of Pennyfeathers UK.
The claimants alleged that Mr Attwell and Mr Bowdery were in breach of their fiduciary duties as directors of Pennyfeathers UK, and also that the five men were ‘joint venturers’ and Mr Attwell and Mr Bowdery were in breach of their fiduciary duties owed to their ‘joint venturers’ in the project by diverting unlawfully the opportunity to enjoy the fruits of the development of the farm from Pennyfeathers UK to Pennyfeathers Jersey. As a result, the benefit of the 2008 Contract and the surrounding land options were held by Pennyfeathers Jersey on constructive trust for Pennyfeathers UK.
Rose J established that there were a number of issues to be resolved including:
The issue of whether a binding buy-out agreement was concluded in December 2007. This issue was decided in the claimants’ favour (i.e. that no agreement was ever concluded). Therefore, Mr Attwell and Mr Bowdery’s obligations as directors of Pennyfeathers UK were not terminated or superseded.
The judge held that the fact the 2005 Option was never assigned to Pennyfeathers UK by Mr Steer and Mr Taylor was not a repudiatory breach of the shareholders’ agreement and was never treated as such by Trimount. Mr Attwell and Mr Bowdery affirmed the shareholders’ agreement beyond the time it became apparent that the assignment of the 2005 Option may not be possible. The negotiations for the buy-out deal were all based on the assumption that the shareholders’ agreement was still in place and there was no mention at that meeting of termination for alleged breach. The judge found therefore that the failure to assign the 2005 Option did not affect the fiduciary duties owed by Mr Bowdery and Mr Attwell to Pennyfeathers UK.
The conduct of Mr Attwell and Mr Bowdery, in entering into the 2008 Contract for conditional purchase of the farm and the conclusion of the surrounding land options, was found to be in conflict with the interests of Pennyfeathers UK, which had been incorporated for the purpose of developing that farm and, as such, they were in breach of their fiduciary duties to the company.
If there was a conflict of interest, did Mr Bowdery and Mr Attwell have the consent of Mr Taylor, Mr Steer and MDS to their conduct? The judge found that no informed consent had been given.
Mr Attwell and Mr Bowdery were found to have acted in bad faith towards Pennyfeathers UK by pushing ahead with plans for the development of the farm and by concluding the 2008 Contract and the surrounding land options without concluding an agreement for the buy-out of the other shareholders’ interests in Pennyfeathers UK. They had attempted to conceal the details of option agreements entered into over the land surrounding the farm and the real nature of their connection with Pennyfeathers Jersey.
Mr Attwell and Mr Bowdery did not owe equitable duties to Mr Steer, Mr Taylor or MDS arising out of a joint venture. The judge cited the Court of Appeal decision in Ross River Ltd v Waverly Commercial Ltd & Peter Barnett  where the Court of Appeal reviewed the case law on when a fiduciary duty is owed by one joint venturer to another and the content of that duty. The principles that Rose J derived from that case were as follows:
As a matter of general principle, the court should be slow to introduce uncertainty into commercial transactions by the over-ready use of equitable concepts such as fiduciary obligations. Thus, the court should not use equitable principles “to make up for what might be seen as deficiencies (in the events which happened) in the agreed contract”; 6.2 Where the relationship is governed by contract, then the terms of the contract are of primary importance and wider duties will not be implied lightly, in particular in commercial contracts negotiated at arm’s length between parties of comparable bargaining power;
The fact that the alleged fiduciary has his own, personal interest in the exploitation of the development, to which he is entitled to have regard, does not rule out the existence of a fiduciary duty; and
The existence of a fiduciary duty in such a case is very fact-sensitive.
Applying these principles to the facts of this case, when the shareholders’ agreement was signed, there was no expectation that Mr Attwell and Mr Bowdery would be handling the project without the involvement of the other parties to the agreement. The agreement was a ‘shareholders’ agreement’ and not a joint venture, and contained a ‘no partnership’ clause.
Finally, the fact that the 2008 conditional purchase and the surrounding land option agreements were entered into by Pennyfeathers Jersey, rather than Mr Attwell and Mr Bowdery personally, did not prevent those actions being a breach by Mr Bowdery and Mr Attwell of their fiduciary duties. The assets held by Pennyfeathers Jersey were held on trust by that company for the two of them.