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Corporate law update: to what extent are duties owed by a director after they have resigned?

Gateley Legal

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In this episode, host Sophie Brookes provides an update on the latest developments in corporate law. Topics that are covered include the extent of the duties owed by a director after they have resigned, the rules for determining who is the contracting party and (yet another!) case where a buyer’s notice of warranty claim fell short of the relevant contractual requirements.

In this episode:

  • We explain how the conduct of directors of dissolved companies will come under greater scrutiny.
  • We review a case where a buyer’s notice of warranty claim fell short of the relevant contractual requirements.
  • We consider the rules for determining who is the contracting party in a case involving a missing Ferrari gearbox.

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This episode is part of our Talking Business podcast series. Learn more about the series and what we cover. This podcast is available on iTunes, Spotify and Soundcloud.

Read the transcript:

Sophie Brookes: Welcome to Talking Business, your straight talking guide to dealing with corporate matters. Whether you are a private or public company, an owner-managed business or an entrepreneur, a director, company secretary, or in-house counsel, this is the podcast for you. My name is Sophie Brookes, and I'm a partner in our corporate team. I was a transactional lawyer for a number of years before becoming a professional support lawyer, which means I'm now responsible for know-how across our corporate team. Each month I'll provide an update on the latest developments that matter to you and we'll be joined by an expert to take a deep dive into a key corporate law topic.

First up this month, I thought I'd mention some new legislation which is going to make it easier for the conduct of directors of dissolved companies to be scrutinized by the Insolvency Service, and then as a result, for those directors to face disqualification if their conduct doesn't meet the required minimum standard. So the new proposals were born out of the Government's 2018 Consultation Papers setting out proposals to improve the corporate governance of firms that are already in or are approaching insolvency. And that consultation identified various gaps in the current system, and in particular, concerns that the company disillusion process was being used and abused by unscrupulous directors in order to avoid liabilities.

So at the moment, the Insolvency Service can investigate the conduct of directors of companies which have entered an insolvency process. But if a company has been dissolved, then the conduct of its directors can't be investigated without first restoring that company to the register. And that the restoration process is both costly and time-consuming. So it would lead to delays and investigations, and also obviously an increasing burden on the public purse in paying for those restorations.

So the new law is going to remove that barrier and it's going to allow disqualification proceedings to be brought against a director of a dissolved company where their conduct as a director of that company makes them unfit to be concerned in the management of any company. And it's not going to be necessary any longer as a precursory step to restore the company first before bringing those disqualification proceedings. An application for disqualification in respect of a former director of a dissolved company has to be made within three years of the relevant company being dissolved, but these provisions are going to have a retrospective effect so that the Insolvency Service can investigate a former director's conduct which occurred before the new provisions came into force, including companies which aren't actually dissolved at that time.

So looking at the explanatory notes which accompany the new proposals, it seems that a driving factor behind that retrospective nature of the new powers is to enable greater scrutiny of companies which have taken out government-backed loans to support them during the COVID-19 pandemic. In particular, the government's Bounce Back Loan Scheme. So clearly, the Government hopes that these new measures are going to prevent directors from using the disillusion process as a method of avoiding repayment of those loans. Clearly, they're concerned that people who've taken out those Bounce Back Loans and used them perhaps just to personally benefit the directors are then going to just try and dissolve the company in order to avoid having to repay the loans.

It's also, again, looking at the explanatory notes, it's also intended that the new measures will help to prevent directors avoiding liabilities for applying... Sorry, by applying for a company to be dissolved. That kind of so-called phoenixism, where a company seizes trading leaving its creditors unpaid, but then a new company effectively takes over that business without its outstanding liabilities and rises from the ashes, but leaving behind those old liabilities.

So these new measures are contained in the very snappily titled Rating Coronavirus and Directors Disqualification Dissolved Companies Bill. So that's currently making its way through parliament. We don't know yet when it will become law, but in any event, when it does, that retrospective nature that I mentioned is going to kick in and the new powers will enable the conduct of directors before a company is dissolved to be investigated.

Okay, next up, I've got a few cases for you just to run through which I thought would be interesting. So there have been various cases recently where a buyer's post-completion claim for breach of warranty has failed, not because the underlying claim itself wasn't valid, but just because the buyer actually failed to give proper notice of that particular claim. To set the scene a bit for you, in a sale and purchase agreement, the seller will typically give a number of warranties about the business being sold, for example, that it's not involved in any litigation, that maybe its assets aren't subject to any charges, that it's complied with all relevant laws. So if one of those warranties turns out to be untrue and the seller hasn't already disclosed the relevant details to the buyer, then the buyer can bring a claim against the seller for breach of warranty.

But the agreement will also typically say that the seller won't be liable unless the buyer gives notice of its claim by a certain date. Sometimes that limitation was just to say, well, the buyer just has to give notice without any further details. But more usually now, it says something like the buyer has to give reasonable details of the relevant claim. Or maybe it goes further than that and it says the buyer has to state in reasonable detail the matter which gives rise to the claim, the nature of the claim, and the amount claimed. So there's been a string of cases historically which have consistently shown that the success or failure of a bias claim can turn on whether or not the buyer manages to comply with the relevant contractual provisions about making a claim, and in particular, provisions concerning the contents of its notice.

So a key point here which was highlighted in the previous case is that every notification clause turns on its own individual wording. So the buyer has to ensure that it strictly follows that wording and meets the specific requirements of the relevant agreement. So it's got to look at the particular words, particular language used in the relevant agreement and make sure that it complies with those requirements, not the requirements of another clause in another agreement which are relevant.

So there was a case where, to give an extreme example of this, the judge said, "If the clause had said that notice had to be on blue paper, it would have been no good serving notice on pink paper." So the latest case that we've got here is called TP Icap Limited versus NEX Group. And in this one, the seller gave various warranties about the target company, including one under which the seller confirmed that the target had not contravened any applicable law or regulation, which had then resulted in a fine or other liability that had a material adverse impact on the operation of the target's business.

Again, there was that provision that I've mentioned in the agreement that said the buyer would not be liable for a warranty claim unless, by a specified date, the buyer had given written notice of that claim, and the buyer had to state in reasonable detail, the nature of the claim, and if practical, the amount claimed.

So after completion, it came to light that in fact, there were various investigations into the target's trading activities, including by the US Commodities and Futures Trading Commission and by the UK Financial Conduct Authority. There were also some investigations by German authorities in relation to the tax history of the target. So as a result of all of that, the buyer brought a claim against the seller for breach of certain warranties in the agreement, including that warranty that I mentioned about not having breached any applicable law, but the seller then applied for the buyer's claim to be struck out on the basis that the buyer's purported notice of claim didn't actually give the required reasonable detail that the agreement said it had to be set out in that buyer's notice.

So the High Court considered what the relevant contractor requirements for the buyer's notice of claim meant in the context of the specific breach of law warranty. Remember that warranty referred to a breach of law which resulted in a fine which had a material adverse impact on the target. So the court said that the requirement to state in reasonable detail, the nature of the claim meant that the buyer's notice had to do three things. So it had to describe the broad nature of the alleged contravention of the law or regulation. So that included giving details of the particular law or regulation that had been breached.

Secondly, the buyer's notice had to make clear that as a result of that contravention of law, it was making a warranty claim against the seller, and it wasn't sufficient for the buyer to state as it had done in this case, that as a result of particular circumstances, a claim may be made in the future. They had to say, actually, I am making a claim now. And then thirdly, because of the nature of the warranty, in this case, the buyer had to describe how any resulting fine or penalty had gone on to have a material impact on the target's business operations. The court said that element of the warranty was a necessary and important element of it and it couldn't just be left for the seller to infer that from the contents of the buyer's notice. So in this case, because the buyer's notice had failed to meet those particular requirements, the court allowed the seller's application to strike out that part of the claim on the basis that it showed no reasonable cause of action.

So once again, as I say, there've been a number of cases here, and that decision again, highlights how easy it is really for a bias claim to fail on what you might think is sort of a technicality. So buyers have got to be really scrupulous in ensuring that their notice of claim complies with the strict requirements of the relevant agreement. And obviously, if you're the seller, then potentially, you might be able to give yourself a helping hand, maybe even a way of avoiding a warranty claim by requiring additional information to be included in the notice of claim and then frankly, hoping that the buyer is going to fail to meet that required standard down the line if it does indeed bring a warranty claim.

There have been quite a few cases in this area over the last 10 years. And I think possibly that's as a result of disputes following the 2008 economic crash. And remember it takes a while for cases to come through the courts. But I think perhaps following that 2008 crash, there were a number of circumstances where the parties, typically a buyer's change in financial circumstances post-crash led them to look at ways of recouping losses through warranty claims. And I do wonder whether as a result of the COVID-19 pandemic, in a few years, we're going to be seeing another round of cases as again, people start to look in-depth at agreements to see where they can recover losses that they've incurred as a result of that pandemic.

Okay, the next case that I wanted to mention I think is going to be a particular interest to directors. So it concerns their duty to avoid conflicts of interest. And in particular, the extent to which that duty applies after a director has resigned. So I think we're all pretty familiar with the idea that directors are subject to a bunch of duties for as long as they are directors, but this case is interesting because it looks at the position in one specific area after a director has actually resigned.

So the case is called Burnell versus Trans-Tag, and it involved two companies. One was a design company which designs certain computer hardware and software, and the other was a manufacturing company, which then manufactured, developed, and sold products based on and using that hardware and software. So the design company had granted the manufacturing company a license to use the intellectual property and the products in return for a royalty. The manufacturing company was founded by a chap called Mr. Aird, and later on, Mr. Burnell invested in the company and was eventually made its CEO. But the business wasn't as successful as they'd hoped, and over time, the relationship between Mr. Aird and... Sorry, Mr. Aird and Mr. Burnell deteriorated as did the relationship between the manufacturing company and the design company.

So Mr. Burnell resigned from the manufacturing company, but following that resignation, interestingly, he was presented with the opportunity to invest directly in the design company, so the other company, and he did do that. And eventually, he actually went on to become the sole director of the design company. So at that point, he then terminated their license arrangement which the design company had with the manufacturing company, and as sole director of the design company, he caused the design company to start legal proceedings against the manufacturing company. And then he also brought proceedings directly against the manufacturing company himself to recover his investment. And it was in those proceedings that the manufacturing company then counterclaimed against Mr. Burnell for breach of duty as a director.

So in particular, what the manufacturing company said was that, well, Mr. Burnell has breached his duty to avoid a conflict of interest. So the particular language about that duty, which is set out in the Companies Act now, says that the director must avoid a situation in which they have or can have a direct or indirect interest that conflicts or possibly may conflict with the interests of the company. And it goes on to say that that applies in particular to the exploitation of any property, information, or opportunity, whether or not the company itself could have taken advantage of that property, information, or opportunity.

So, as I said earlier, as a general rule, when a person stops being a director of a company, they stop owing any duties to the company, but there are certain duties which do continue to apply. And this includes the duty to avoid a conflict of interest, but only in relation to the exploitation of any property, information, or opportunity of which the director became aware at a time when they were a director. So if you become aware of an opportunity when you're a director of a company and then resign, you are still prevented from taking advantage or exploiting that property, information, or opportunity after you have ceased to be a director.

So the manufacturing company said, well, Mr. Burnell has breached that duty because having acquired control of the design company, he then used information that he'd acquired whilst he was a director of the manufacturing company to the manufacturing company's detriment in particular by terminating the license arrangements and then causing the design company to continue legal proceedings against the manufacturing company. So the court had to consider the extent to which that no conflict duty continues to apply after a director has resigned. And the judge said that by using his control of the design company to terminate the license and continue that litigation against the manufacturing company, Mr. Burnell had indeed breached a continuing duty which he owed to the manufacturing company to avoid a conflict of interest.

So historically, any claim against the former director for exploiting a business opportunity was based on the director's pre-resignation conduct rather than anything that he did after resigning. But the language in the director's duties now that is set out in the Companies Act is clear that specifically, in so far as it relates to the exploitation of property, information, or opportunity that the director became aware of before resigning, well, the duty to avoid a conflict of interest does continue after someone ceases to be a director. And the court can take into account the director's conduct both before and after they've resigned as part of a wider merit-based assessment of the case. That's what the judge said here.

So in this case, the court said that Mr. Burnell had breached his duty by using information he'd obtained as a director of the manufacturing company to end the license arrangements and pursue litigation against the manufacturing company. So it was one of the first cases this really to consider the nature of director's duties after resignation since the new codified duties were introduced in October, 2008 in the Companies Act.

And it's interesting to see really the approach that the court took because obviously, the court have got to balance the right for a director to use their skills and experience acquired to pursue their future interests with a need to prevent them from just resigning in order to exploit opportunities that arose during the directorships. I think a point of reassurance for directors from the case is that although the judge said that the director who resigned in order to exploit an opportunity or information that rightfully belonged to the company would be in breach of duty, one who simply took advantage of an opportunity that arose before their resignation, albeit informed by the information they acquired while a director, that person would not be in breach of duty.

Okay, the final case that I thought I'd just mention in this episode relates to the rules for determining who is a party to a contract, and therefore who can sue on that contract, where there's a discrepancy between the way the parties described in the agreement and the way the agreement is signed. That sounds quite dry, but the fact that in this case, the contract was for the sale of a Ferrari 250 GTO for $44 million does make it slightly more interesting. So in this case, the Ferrari had become separated from its original gearbox, which was in the possession of a third party. And under the contract, the seller agreed to use his best efforts to recover the gearbox and then deliver it to the buyer. And if he managed to do that, then the buyer agreed to pay an additional $500,000. So although the seller did manage to locate the gearbox, a dispute had arisen between the buyer and the seller when the buyer wanted to inspect the gearbox at Ferrari's premises in Italy, but the seller refused to pay the additional costs required to ship it there.

So as this situation between the parties deteriorated, the seller alleged that the buyer had repudiated the contract, meaning the seller was no longer obliged to deliver the gearbox. But the buyer thought otherwise and tried to enforce the contract via an order for specific performance. So there were a number of issues here between the parties that were considered in the court, which ultimately found in favour of the buyer and made an order for specific performance, but the seller then appealed against that decision. And in particular, one of the things the seller argued was that the party to the litigation, which is a company called Gregor Fisken Limited, was not entitled to force the contract. And the seller's case here rested on the fact that the contract described Gregor Fisken Limited as an agent for an undisclosed principal. Now, in fact, Gregor Fisken Limited wasn't acting as the agent for any unidentified buyer, but it was negotiating the sale for itself as principal with a view to then reselling the Ferrari to profit, which in fact it did actually do, but it didn't tell any of that to the seller.

So when the case came before the court of appeal, the court said that where a person signs a contract and there's no qualification about the capacity in which they sign, then that person will be a party to the contract, unless the document makes it clear that they contracted as an agent. So in this case, although the buyer was described in the contract heading as an agent for an undisclosed principal, its actual signature on the contract was unqualified and there was nothing in the signature block to indicate that Gregor Fisken Limited was acting as agent for an undisclosed third party. The court of appeal said that simply describing a person as an agent in the heading of a contract was not sufficient to outweigh the effect of an unqualified signature. So the court basically said, well, Gregor Fisken Limited is the contracting party, and therefore, that entity, the buyer is entitled to enforce the contract.

So what can we learn from that? Well, I think it's a useful reminder that that signature principle is going to operate to resolve any discrepancy between the way a contract has been signed and the description of the party and the body of that contract. And as the court said, in the absence of any qualification to the signature, it will be the signature that will prevail to confirm the identity of the contracting party. But obviously, it would be preferable to ensure that there wasn't any discrepancy by actually getting the drafting of the contract right in the first place.

Thank you for listening to Talking Business. To find out more about the series, please visit gateleyplc.com/talkingbusiness. From there, you can subscribe for all updates, meet our speakers, and get more information on all of the topics being discussed.

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