The recent decision of the English High Court in the case of Fry v Sherry [2012] (In the matter of Ruscoe Ltd (In Liquidation)) serves as a timely reminder of the potential personal liabilities faced by directors should they breach their fiduciary duties. 

Summary of the facts

The Court held that a director of Ruscoe Ltd (the Company) had acted in breach of his fiduciary duties by authorising weekly payments by the Company to a shareholder for the purchase of its own shares pursuant to an agreement which was in breach of the Companies Act 1985 (the Act) (the relevant legislation in force at the time the agreement was made).  The Company did not have sufficient distributable profits to enable it to enter into the repurchase agreement (which was a requirement under the Act), none of the statutory requirements pursuant to the Act had been complied with (such as, obtaining a special resolution of the members authorising the terms of the purchase contract) and the transfer of shares to the Company was never completed.  In summary, the Company had paid £259,200 to its shareholder (as it turned out, to the detriment of its creditors) and received nothing in return. 

The decision

The director of the Company who had authorised the weekly payments was held to be  personally liable and was ordered to repay the Company in respect of such payments because, despite acting honestly when entering into the repurchase agreement, he had: (i) acted unreasonably by failing to obtain professional advice in relation to satisfying the statutory requirements for such agreements; and (ii) breached his fiduciary duties owed to the Company by authorising those weekly payments pursuant to an agreement that was void.  

The High Court held that it is reasonable to expect a director to obtain professional legal advice in the circumstances of a company purchasing its own shares. 

Implications for directors

A director of a company is subject to a range of duties, deriving from both statute and customary law.  Fiduciary duties emanate from general customary law principles which have been developed by the courts over time (and such decisions have been significantly influenced by English common law).  The position of director is fiduciary in nature and the courts will therefore hold directors to stringent standards. 

Such fiduciary duties are extremely general in nature since they are based, among other things, on the courts' interpretation of what amounts to fair and reasonable behaviour.  Whilst the courts have not fixed a definition of what constitutes fair and reasonable behaviour, the standard duties imposed are (without limitation): to act honestly and in good faith in the best interests of the company; to act for proper purposes; not to make a secret profit; to avoid conflicts of interest and to exercise their powers in accordance with any statutory limitations.  

The decision in Fry v Sherry is a useful example of what the courts' consider to be unreasonable behaviour and highlights the fact that the scope for breaching a director's fiduciary duties is very wide.  The court went on to explain that the following steps would have been reasonable for the director of the Company to take in the circumstances: (i) to inform the shareholder that the purchase agreement was void; (ii) to explain that professional advice was being obtained; (iii) to stop the monthly payments; and (iv) to request a meeting to reach a valid agreement on the same or equivalent terms (and, if necessary and as a sign of good faith, set aside the funds whilst the situation was resolved).  The director failed to take any such steps and as a result was found to be in breach of his fiduciary duties owed to the Company.

This case sends a clear message to directors that statutory procedures must be complied with otherwise each director causing the company to act in breach of such procedures could be at risk of breaching his fiduciary duties owed to the company and thus face personal liability.  There is no limit as to the damages that a director may be held liable to pay for a breach of duty.

If a director is involved in a proposed transaction which has a clear statutory procedure and, in particular, if it concerns the payment of funds to shareholders, that director must consult the relevant law and be clear on the requirements set out therein.  If in any doubt, it would be prudent (and most likely expected) for that director to seek professional advice.