Article / 1 Dec 2024
In this month’s update we:
The Court of Appeal has held that two directors of a company were not in breach of their fiduciary duties when taking preparatory steps to set up a competing business (Cheshire Estate & Legal Ltd v Blanchfield and others [2024] EWCA Civ 1317).
Mr Blanchfield and Mr Montaldo were directors of a corporate firm of solicitors, CEL, specialising in financial mis-selling and fraud claims. As such, the two directors owed certain fiduciary duties to CEL – to act in good faith in the best interests of CEL and not to place themselves in a position where their own interests conflicted with those of CEL.
The two directors were also each party to a consultancy agreement under which they provided legal services to CEL for 40 hours per week. Those agreements contained a 12-month restrictive covenant that prevented the directors from soliciting CEL’s clients with a view to supplying services to them in competition with CEL.
The directors resigned from office on 10 January 2023 and, at the same time, gave the required six months’ notice to terminate their consultancy agreements.
CEL then discovered that in the five months leading up to the resignations, the directors had been taking various steps to set up a new business which would also provide legal services. In particular, this included: registering the trading name of the new firm; incorporating a new company to be the trading vehicle; opening a bank account; applying to the Solicitors Regulation Authority (SRA) for the required regulatory approval; and entering into discussions with a litigation funder with whom the directors had previously negotiated on behalf of CEL.
CEL brought proceedings against the two directors alleging they were in breach of their fiduciary duties and the restrictive covenant.
The trial judge found that the directors’ preparatory steps had not put them in a position of conflict and that they were not in breach of the restrictive covenant in their consultancy agreements.
CEL appealed the decision. Having found that there was no evidence of the directors soliciting clients of CEL, and therefore no breach of the restrictive covenant, the Court of Appeal focused on whether the directors had breached their fiduciary duties. The Court confirmed that “whether preparatory actions, short of active competition, are consistent with a director’s fiduciary duty to the company is highly fact sensitive”. Simply making a decision to set up a competing business at some point in the future would not be a conflict of interest; but clearly, soliciting customers or actually carrying on a competing trade would be a breach. It is the wide range of activities that fell between these two ends of the spectrum that would be fact sensitive in each case.
In relation to the particular steps taken by the directors in this case, the Court found that:
Accordingly, the Court dismissed the appeal.
This case is a useful reminder that whether or not a director is in breach of their fiduciary duties will turn on the specific facts of each case. Even if a director has formed an irrevocable intention to establish a competing business, that will not automatically give rise to an obligation to disclose this to the company. However, whilst they may be able to take a range of preparatory steps (such as setting up a company, opening a bank account, applying for authorisations, etc.), they must stop short of actually competing. Where any particular activity sits on this spectrum must be carefully considered in each individual case.
The High Court has found that an undocumented, oral agreement between a father and son to transfer their shares in a family business to each other on their death overrode the father’s earlier will under which the shares had been left to his wife (the son’s mother) (Lane v Lane [2024] EWHC 2616 (Ch)).
In 2001, a father made a will under which his wife was appointed as his sole executor and all his assets would pass to his wife on his death.
Two years later in 2003, the father and son decided to go into business together, setting up a construction company. Based on advice from their accountant, the shares in the company were issued as to 40% to each of the father and son, and 10% to each of the wife and the son’s wife (the daughter-in-law).
Crucially, the son alleged that when the accountant attended a meeting with the four family members to discuss the formation of the company, it was agreed that if the father died his shares would go to the son and, conversely, if the son died his shares would go to the father. The wife, however, alleged that no such agreement was reached and the question of what should happen to the shares on the death of either the father or the son was not discussed. To the extent that the accountant had suggested the parties should document the arrangements in a shareholders’ agreement, the family had declined on the basis that they were close and trusted each other.
In 2009, the father died. The accountant subsequently filed documents at Companies House which showed that the father’s shares had transferred to the son on the date of the father’s death. Nothing was said to or by the wife in relation to the father’s shares at that stage or in the following years. However, in 2017 relations between the parties broke down following which the wife brought proceedings against the son and the company, arguing that the father’s shares should have passed to her under the will and in accordance with the relevant provisions in the company’s articles of association.
As the judge noted, there was a “dearth of contemporaneous documentation” and therefore he had to rely on the oral evidence of the witnesses involved. Based on that, the judge was satisfied that there was an oral agreement between the four shareholders that on the death of either the father or the son, the deceased’s shareholding would be transferred to the survivor of those two.
Factors that the judge took into account in reaching that decision included:
In this case, the father’s will had effectively been overridden by the oral agreement. As that was an agreement entered into by the deceased, his executor (the wife) was bound by it. Since the shares had already been registered in the son’s name, no action was required to perfect the agreement. But if the shares had in fact passed to the wife in accordance with the will, the Court made clear that the wife would have been required to transfer the shares to the son.
Perhaps the most important lesson from this case is the old lawyer’s mantra of “put it in writing”! If the family had taken the advice of entering into a shareholders’ agreement recording the arrangement in writing, there would have been no dispute as to its existence. Sadly, it is all too often those “close family” relations who “trust each other” who suffer from a lack of clear, documented arrangements when things go wrong.
In Allianz Funds Multi-Strategy Trust & Ors v Barclays Plc [2024] EWHC 2710 (Ch), the High Court ruled that to satisfy the reliance requirement under section 90A Financial Services and Markets Act 2000 (FSMA), a claimant had to have read and considered the relevant misleading publication (or someone who influenced their investment decisions had to have read it). “Price/ Market Reliance” was not sufficient to satisfy the statutory requirement.
This ruling, which resulted in 60% of the claims against Barclays being struck out, amounts to a significant hurdle for any “passive” investor looking to bring a section 90A claim in the future.
Section 90A FSMA establishes a statutory liability regime under which issuers may be liable in respect of misleading information published to the market (for example, in periodic financial reports). The substantive provisions of the regime are set out in schedule 10A FSMA.
To establish a section 90A/ schedule 10A claim, an investor will need to show that:
For section 90A misstatement or omission claims (but not for dishonest delay), the investor will have to prove that they relied on the issuer’s published information when deciding what to do with their shares. The required standard of reliance can be difficult to prove and the Allianz v Barclays case appears to have raised that bar to an even higher level.
The case involved a shareholder class action against Barclays brought under section 90A/ schedule 10A FSMA. The claimants (all institutional investors) alleged that Barclays had made false and misleading statements in published information or had omitted to include certain matters within that published information.
The claimants had been divided up into three categories based on the different ways in which they had relied on the published information. A significant proportion of the claimants – Category C – were index or tracker funds that had neither actively read nor considered any of the published information. Instead, these “passive” investors based their claim on “Price/ Market Reliance”, where the Barclay’s share price would be assumed to reflect the contents of all published information. This meant that in making investment decisions based on price, the investors were still placing reliance on the accuracy of the published information.
Barclays applied to strike out the claims of the Category C claimants on the basis that Price/ Market Reliance did not meet the statutory requirement for reliance as contained in schedule 10A FSMA.
The Court agreed with Barclays, finding that the claims of the Category C investors had no real prospect of success.
The Judge concluded that Parliament’s intention was for “reliance” in section 90A/ schedule 10A to mean the same as in the common law tort of deceit. In his view, the test for reliance as it applies to express representations requires the claimant to prove that they read or heard the representation, that they understood it in the sense which they allege was false, and that it caused them to act in a way which caused them loss. This meant that the requirement for reliance could not be satisfied if the claimant (or a third party who influenced the claimant's investment decisions) had not read or considered the published information.
As the Category C investors had not read or considered the relevant documents, their claim failed.
The Court also held that “reliance” has the same meaning whether investors allege that they relied on a misleading statement or on an omission. In the case of omissions, investors are not required to prove that they had relied on the omission (i.e. that they realised that the issuer had failed to include something in the published information) but they are required to prove that they relied on the published information itself.
Subject to any appeal, this decision could significantly reduce the ability of passive investors (which make up approximately 30% of UK markets) to seek redress for loss resulting from misleading publications.
If Price/ Market Reliance does not meet the statutory requirement for reliance under section 90A, then investors will need to prove that the published information was factored into their investment decisions in some other way. It remains to be seen whether Artificial Intelligence processes, for example, would satisfy this test or whether the exercise of some human discretion would be required.
If passive investors are unable to show the necessary level of reliance due to the very nature of their trading practices, then they may well be left without a remedy when an issuer in which they have invested misleads the market. This seems a surprising outcome, and one which could have serious ramifications for investor protection in the UK.
First published in Accountancy Daily.
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