Defending a director being pursued for alleged breaches of duty

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When a business fell into financial difficulties, they sought money from every possible source. Having searched under the sofa they got the bright idea of suing one of their former directors for alleged breaches of director’s duties. This former director was a well-known (and, more significantly for them, very wealthy) individual in the hospitality industry, with his fingers in many strictly metaphorical pies. He was a non-executive director hired to add gravitas. His background and connections were flaunted in the prospectus the business issued for EIS investment.

The business, and subsequently its liquidators, based their claim on breaches of director’s duties. Their claims related to transactions which the business had conducted with other businesses in which our client was a director or shareholder. For our purposes, the two most significant claims related to recruitment fees and the purchase of second-hand equipment.

Recruitment Fees

During the period he sat on the board, our client was also a director and shareholder of a recruitment company which specialised in placing people into management positions in the same sector. The business used this recruitment company to hire a manager, who turned out to be a poor fit for the role. When it fell into financial difficulties, the liquidators of the business claimed that the other directors had been unaware of our client’s connection to the recruitment company, meaning he was in breach of his duty to declare an interest in a proposed transaction or arrangement.

Outline claim against the director

The liquidators claimed for:
  1. The fees paid by the business to the recruitment company;
  2.  Various damages relating to lost income from missed bookings and other losses incurred as a result of the manager’s incompetence; and
  3. The fees to hire a replacement manager.

As a preliminary point, Gannons pointed out that the liquidators had misunderstood what they were potentially entitled to recover. As a point of principal, they could not recover both the fees paid to the recruitment company and the replacement fees paid to another recruiter; one or other of these sets of fees would have been paid in any event. Likewise, they could not claim for both the recruitment fees and the losses sustained as a result of the manager’s poor work. The damages relating to the manager’s performance would be recoverable as equitable compensation, whereas the claim for fees would have been to account for expenditure which otherwise would not have taken place. The liquidators were potentially entitled to equitable or legal remedies, but not both. They would have to choose.

Should the director have disclosed his business interest?

However, on the facts we established they would not be able to recover anything at all. Under s.177 of the Companies Act 2006 a director does not need to declare an interest in a transaction if:

  1. The transaction cannot reasonably be regarded as likely to give rise to a conflict of interest; or
  2. If the other directors are already aware of it (with the other directors being treated as being aware of anything of which they ought reasonably to be aware).

We contended that both these exceptions applied. It was very unlikely that the benefit of the comparatively small recruitment fees would have enriched our client as a shareholder in the recruiter by any discernible margin. Even if it had, the company was clearly aware of our client’s connection with the recruiter, and had even boasted about the connection in prospectuses given to potential investors.

Second-hand equipment

During his time on the board of the business, our client was also a director of another chain which was going out of business. He arranged for some of the second-hand equipment to be sold to the business. The board approved this transaction, but it was true that our client had made the introduction and arranged the deal.

Claim against the director

Subsequently, the liquidators argued that our client was in breach of his director’s duties because he had:

  • failed to avoid conflicts of interest; and
  • failed to disclose his interest in the transaction.

They claimed that the business had suffered a loss as some of the equipment was overpriced and surplus to requirements.

Avoiding a conflict of interest

The claim that our client had failed to avoid a conflict of interest was swiftly knocked back. Under the Companies Act states that the duty to avoid a conflict does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. In terms of the director’s requirement to disclose his interest in the transaction, we once again pointed out that the other directors knew or ought to have known about our client’s connection with the seller.

Even if there had been a conflict, we contended that the business suffered no loss. The equipment was estimated to have been worth significantly more than the amount which the business paid. While the liquidators claimed that some of the equipment was not needed, they had taken no action to sell the equipment which they claimed was surplus. If anything, it seems that our client had enriched the business, rather than damaging it.

Sending the liquidators on their way

To further underscore the point that the liquidators were unlikely to be able to recover anything from our client, we drew their attention to a provision of the Companies Act, which allows the court determine a director has no liability for breach of duty where it appears that the director acted honestly and reasonably and that having regard to all the circumstances of the case he ought fairly to be excused.

While in our case this helped ward off liquidators pursuing an innocent director, we imagine that coronavirus and its economic effects will see many more directors asking courts to hold there is no liability. The key takeaway for those seeking to rely on this provision is to act honestly and reasonably. If a director does that, a court may grant relief even where there is a technical breach of director’s duties.

End result

In the end, thanks to arguments put forth by Gannons, the liquidators abandoned their pursuit of the Director. It may sound like over kill but it really is important to disclose your interests in directorships and shares and those of people connected with you who are involved in transactions with the business. The easiest justification is to make a note in the board minutes, circulate the note to all directors whether in attendance or not, and keep a record.