Latest / Howes Percival Podcast / The Supreme Court ruling every director needs to know: Saxon Woods v Costa
Transcript
- Gary Pitt: Welcome to the House Percival podcast. I'm Gary Pitt, a partner in the commercial dispute resolution team at House Percival in Leicester, and I'm joined today by my colleague Jeremy. Jeremy: Hi, thanks Gary. I'm Jeremy Hyde and I'm a corporate partner in Leicester and I head up the Leicester team. Gary Pitt: we're here today to talk about some new developments in the sphere of directors' duties, which have followed the recent Supreme Court decision in the case of Saxon Wood Investments Limited and Francesco Costa. let me give you a little bit of background first as to the case and why it's relevant. I think the background was probably best encapsulated by Lord Briggs, who gave the leading judgment on this, where he says this is an appeal concerned with the standard of conduct required of a company director when the director genuinely disagrees with his or her fellow directors as to the best route. to achieving success for the company. In what follows I'll refer to the director as he because the director in the present case is a man. can he simply act single handedly in driving the company towards his preferred objective, if necessary, concealing what he is doing from his colleagues, or is his status as a fiduciary owing a duty of loyalty to the company and a requirement that he act in good faith sufficient to require him to disclose his opinions to his colleagues, to discuss it with them, and to assist them in forming a collective view as to the best way forward for the company? Is the choice between those alternative courses simply one for that director, with which the court is powerless to interfere? If the route chosen by the director is one which later causes the company loss or unfairly prejudices one or more of its shareholders. Now, in this case, the matter involved a company called Spring Media Investments Limited, which for ease we will call the company. it was a holding company for a group of companies providing creative services in the fashion, beauty, and luxury brand sectors. Mr. Costa was a director and at the relevant time was also the chairman. Mr. Costa was not a shareholder of the company himself. But he held a substantial indirect investment through a company based in Luxembourg. Saxon Wood Investments Limited was a shareholder and held about twenty two percent of the shares in the company. In may twenty sixteen, the shareholders of the company entered into a shareholders agreement, and we'll touch on that later, in which, among other things, the company and the investors agreed to work together in good faith to achieve an exit no later than the thirty first of december twenty nineteen. the company delegated the conduct of that exit or sale process exclusively to Mr. Costa. The process was not carried out in accordance with the shareholders' agreement, as Mr Costa believed that a sale later on would return more to the company and investors. Mr Costa did a number of things to ensure that this happened, including ensuring that no other director, say for one, knew about the process, misleading the board by giving updates that the company was fulfilling the aims of the shareholders' agreement, and failing to disclose to the board that his instructions to the company's advisors did not actually encompass achieving the sale before the end of twenty nineteen. Mr Costa did successfully delay the sale beyond the thirty first of december twenty nineteen. But then the prospect of a profitable exit was destroyed by COVID. Saxon Wood presented an unfair prejudice position under Section nine nine four to nine nine six of the Companies Act. There was an original High Court judgment, which both parties appealed, then a Court of Appeal hearing before it finally made its way to the Supreme Court. It was ultimately the Supreme Court that Mr Costa had acted in breach of Section one hundred seventy two of the Companies Act, and we will move on to that in a minute, and he was ordered to buy out Saxonwood shareholding in the company despite not being a shareholder himself. So that's the background. Now a lot of this turns on certain issues in respect of both Section one hundred seven two of the Companies Act, but but also shareholders agreements. Jeremy, obviously in the corporate team you have a lot of dealings with shareholders' agreements. Are you able to just tell us a little bit about what they are and why they are important? Jeremy: Thanks Gary, yeah, absolutely. So shareholders agreements are really important because they're effectively private contracts between the shareholders and also potentially the company. you can put lots of different points within a shareholders' agreement. So you may have certain veto rights whereby shareholders have to vote on decisions made by the board. and so they're very important. And the other point around it is that they will effectively set out a rule book as to how the directors and also the other shareholders need to act. so shareholders agreements are very important because in effect whenever we're starting to work with a business we would suggest a shareholders agreement to govern the relationship between the two shareholders or even more and also to then dictate how the board acts. Gary Pitt: And particularly in circumstances like this where you've got a stated aim to exit the business within a certain time frame, that shareholders' agreement is a binding obligation on the company, the shareholders, the investors in this instance to all work towards that stated goal, right? So it gives you sort of a a a primacy of that as an objective that you you want to be working towards. Jeremy: think that's right and and also the fact that when you review within the case the provisions that have been set out, they were really clearly drafted. and so there was a good understanding as to what the intentions of the parties were and how they should go about it. So I think that it was a well drafted provision. Gary Pitt: Well, absolutely, it it turned out being successful in the Supreme Court, so so someone's someone's earned their crust on a on a drafting point. the other point then is that a lot of this interacts with the director's duties. It in particular the court considered at length the duty at section 172 of the Companies Act. Now that's the duty to promote the success of the company. there are a number of other duties that that parties owe, and one of the things that the court found here is that an act can be a breach of a number of duties. Within the companies act at the same time. So you can breach the duty to promote the success of the company, as well as breaching any of the other duties. In terms of those other duties, very brief run through on what they are. You've got your duty to act within your powers under section 171, the duty to exercise independent judgment under section 173, exercising reasonable care, skill, and diligence in 174, avoiding a conflict of interest in 175, not to accept benefits from third parties. under one seventy six and then a duty at one seventh to declare interest in proposed transactions or arrangements. But the key here really was section one hundred seventy two. you able to tell us a little bit about section one hundred seventy two, Jeremy, what it means. Jeremy: Yeah, absolutely. And think just in terms of a helpful background around these rules, is that they were effectively common law principles that were developed through case law. So more your area, Gary. but then in terms of what's happened under the Companies Act two thousand six, these were effectively codified. So they were brought into law. And one hundred seven two, which is the duty to promote the success of the company. If I'll just read out the first element of it. So in effect, a director of a company must act in a way he considers in good faith would be the most likely to promote the success of the company for the benefit of its members as a whole. And in doing so, to have regard amongst other matters, and then there's a various list of other points that we can touch upon. But things like the likely consequence of any decision in long term, the interest of the company's employees, the need to foster the company's business relationships with suppliers, customers and others. the impact of the company's operations on the community and in the environment, the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between the members of the company. So you can see that it's quite a broadly drafted legislative provision and that obviously gets picked up as part of the case. Gary Pitt: Yeah, and I think what's really interesting here, right, is is all of this really turned on that that small clause in section one hundred seven two one where it says the director of a company must act in a way that he considers in good faith would be most likely to promote the success of the company. It's that in good faith which all this turns on, right? And the argument here was whether a director could form a private opinion that that a course of action would, in his own opinion, in good faith, be in the best interest of the company and therefore conceal that from his fellow directors and from the board and from the company in order to pursue that objective. so I think what the court ultimately found is that this is a key consideration. There's both a subjective and an objective assessment to be made here. Mr. Costa said, really, it's a subjective test, right? Did I, as a director, think in good faith, I was doing the right thing for the company? But the court found that in reality, if that was the case. If a director genuinely believed that a certain course of conduct was best, then he would be free, or maybe even required, to do whatever he can to bring that about, regardless of whether that involved, objectively speaking, lying, cheating, deceiving, acting dishonestly to his fellow board members. so the question then became can this clause require a director to act in a way that a well informed observer would regard as in bad faith? Saxon Woods' argument, which was ultimately successful, was that the requirement for good faith extends not only to the director's thinking, but also to his conduct in achieving what he believes is the best course of action for the company. So in essence, you have to both pursue a course that you think in good faith is the best, but you also have to behave with good faith towards your fellow directors and towards the company, which is a really key important key decision, right? This is this is it it doesn't sound much when you put it like that, you know, is all turning really on those three words. But this is a a massive development in terms of those duties that directors owe and how they have to discharge those going forwards. Jeremy: I think that's right. And I also think that it shows the importance of having a shower's agreement in place that, you know, in effect you can now look to enforce and control certain decision making points of the board. so that's that's sort of been reinforced by this case. And I think it shows that to have a shower agreement is is a sensible thing to have when you've got more than one shareholder and also competing interests as to what the shareholders' provisions meant. Gary Pitt: So you know think it almost goes beyond that as well because there is a shareholders agreement here, but that's not a panacea for all ills, right? If you have a shareholders' agreement and you have, as in this instance, delegated a particular action to one member of the board, they have one, they have a duty if they disagree with you to bring that back to the board and for that to be debated and for them to then follow on the agreed course of action. But two, you as board members should not simply rely on washing your hands and handing this over to director to to bring about that course of action, right? We we we should be checking in on what they're doing, making sure that they're they're following up on that. now clearly nothing is perfect and in this instance Mr. Costel was misleading the board as to what he was up to, but the other board, should be alive to this as an issue. You know, if you are a a board member and you have delegated a task to a a fellow director, it is worth checking in on the progress of those tasks to make sure that those are are dealt with And really to ensure that there's transparency, openness and monitoring at at board level. Jeremy: Yeah, I think that's a really, really good point, Gary, about monitoring. And I think you can obviously build that into any shadows agreement and that's probably why when you're thinking about certain provisions to include, actually you need to go to a professional that's able to then think outside of the direct aim to ensure that you therefore can monitor that individual that's looking to progress the action that's within a shelter agreement. Gary Pitt: Yeah, and I think some of this turns back to to the board packs that are circulated at board meetings, right? You know, in this instance you're talking about a sale process. Well, it's all well and good director coming to the board and saying, I have done X, Y, and Z in terms of the sale process. But it is not an you know, a particularly onerous obligation to say to him, Okay, can I see your last meeting notes with, you know, the sale advisors on this? Or can we see the last couple of emails with the solicitors who are bringing about this sale or the corporate finance guys who are taking this company to market? You know, you can ask for evidence rather than simply taking them at their word. And I think that's part of the obligation of monitoring as well as a board member. Jeremy: Yeah, and we're s we're seeing a lot of clients now that ask us to help with governance early doors. so it kind of feeds into the hand in hand point, doesn't it? So that you're quite right, you should be able to ask further questions, but then also from a professional perspective, we can give the clients the tools to then ask those questions or put things in place so that that good governance structure is there already. Gary Pitt: Absolutely. And then the other thing that comes out of this case, and this is a a point for for me as a litigator that I found particularly interesting, is that it has always been known that section nine nine four to nine nine six, the unfair prejudice petition section of the Companies Act, gives quite a wide range of scope in terms of what the court can order by way of relief. Now, often that is an order that a party buys out the other party's shares, or something similar. Now, in this instance it's quite an interesting relief that was granted because Mr. Costa was not a shareholder in the company himself. He was the shareholder in a company in Luxembourg that ultimately held shares in the company, but he didn't own shares. However, at the end of this appeal, and following the Court of Appeal decision as well, it was held that Mr. Costa personally was liable to buy Saxon Wood's shareholding in the company. you may have run into issues whether that would be enforceable or how difficult it would be to enforce against a company in Luxembourg. Well they've circumvented all of that by ordering that Mr. Costa has to buy those shares personally. So there's a a number of things here that really are interesting. I think if I was to to sort of summarize this, I think there's a couple of takeaways from this case that are key. First one is as we've discussed shareholders agreements, the the relevance of them not just as a tool to be entered into at the outset, but also something to be monitored and kept abreast of as the company develops and to be checked back in on really throughout the life of the company. You don't just sign them off at the beginning, forget about them and then revisit them if you fall out with your fellow shareholders and directors. Actually, it is a live document that you should be checking back on as part of a governance process. I think the second point then is if you are a director and you disagree with a course of action you are being instructed to take, you need to do something about that proactively. You need to raise that disagreement with the board. you need to put it to your fellow directors or call a shareholder vote if that may change things to try to come to a resolution that you can live with. If you fundamentally disagree, you should either comply with the instruction of the board or resign your role as a director, ultimately, right? That is it. Y this going off and and on a covert level pursuing the course that you think is best is no longer good enough. and then I think the third point that we touched on, Jeremy, is that board governance point really is that you need to be monitoring what's going on. at board level and keep checking in and ensuring that that good faith is is carried out all the way through. Jeremy: think that's super helpful summary to be honest with you Gary in terms of what's come out of this and it's going to be interesting to watch it develop over a period of time as well. you've touched upon the government points. I suspect clients will hopefully revisit what they've got in place and that actually they'll consider this case with that regard. Gary Pitt: No, absolutely, I think that's that's really helpful. So look, from here there will be further updates. this is obviously something that's breaking news and we wanted to get a a podcast out to our audience quickly to give an update as to why it's relevant to you and and how we can help moving forward. So in terms of next steps for more legal updates, you can follow both myself, Gary Pitts, and my colleague Jeremy Hyde on LinkedIn. we will also leave a link in the description to this episode with details of our mailing list and where you can find further information about how the corporate and commercial dispute resolution teams at House Percival can assist you. That's been another episode of the House Percival podcast. Thank you for joining us.