Legal Briefing

Breach of fiduciary duties: director digs hole for himself

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Dispute resolution | 01 November 2011

The recent decision of the Court of Appeal (on 28 July 2011) in the case of Philip Towers v Premier Waste Management Ltd[2011] sends out a strong message to company directors that the courts will strictly enforce their fiduciary duties. In this case, the defendant director was required to account for undisclosed personal benefits, which he had received from one of the claimant company’s customers. The director sought to defend the claim on the basis that the breach was a minor one or that the relevant company had not actually suffered any loss. However, the Court of Appeal held that these considerations were not relevant.

BACKGROUND

Premier Waste Management Ltd (the company) provides a waste and recycling service for the public and private sector. Philip Towers was a director of the company from 2001 until he left the company, on bad terms, during 2007.

In 2008, the company learnt that, in January 2003, Mr Towers had taken a loan, in a personal capacity, of two pieces of equipment to assist him in the renovation of a rundown farmhouse owned by him and his wife. Mr Towers was not charged for the loan of this equipment.

The loan was provided by Colin Ford, a client of the company. Mr Ford ran a business supplying this type of plant and machinery for hire or purchase. In his dealings with the company, Mr Ford would usually deal with Mike Rafter, an operations manager who worked in the treatment and disposal division of the company. That division was headed by Mr Towers.

The arrangements for the loan were made between Mr Ford and Mr Rafter and without any direct involvement from Mr Towers. Mr Rafter made it clear that there was to be no incentive offered to Mr Ford to enter the deal. However, the loan was arranged without Mr Towers informing the remainder of the board of the company. Therefore, the loan was undisclosed to and, consequently, unapproved by, the board of the company.

Mr Towers used the equipment, a second-hand Kubota 350 excavator and a Rough Rider dumper, over a period of approximately six months during 2003 to dig a trench to lay a mains water pipe and to carry materials around the farmhouse. However, the equipment remained at the farmhouse until 28 May 2008 when Mr Ford requested its return.

The equipment, which was old and in a poor condition, needed repairing before Mr Towers could make full use of it. Mr Rafter arranged for some of the repairs to be paid for through the company before issuing an invoice to Mr Ford in December 2005 for a sum of £1,860 on the basis that Mr Ford would be receiving back his equipment in a better condition than when he loaned it. Mr Ford paid this invoice. Mr Towers discovered the arrangements made by Mr Rafter and reprimanded him for putting the cost of the new parts through the company’s books.

In April 2008, Mr Ford sent an invoice to the company for £45,825 stating that the monies were owed for the continued hire of the equipment. As a result, the company commenced an investigation into the arrangements in 2003 before subsequently issuing proceedings against Mr Towers and Mr Ford.

The claim against Mr Towers was for an account of profit that he received in breach of his duty of loyalty to the company and his failure to observe the ‘no conflict’ and ‘no profit’ principles. The claim against Mr Ford was for a declaration that the company was not liable to pay the hire charges claimed by Mr Ford. Mr Ford counterclaimed for the cost of hiring the equipment. The latter two claims were settled between Mr Ford and the company. However, the dispute between the company and Mr Towers continued to trial.

FIRST INSTANCE DECISION

At first instance, the judge found in favour of the company. The judge was unimpressed by Mr Towers’ argument that the loan was insignificant or ‘commonplace’ and could be dismissed or ignored and held that:

‘A secret profit may be large or small; it matters not which. The vice is the fact that it is secret, undisclosed. If it was so innocent or insignificant it ought to have been and could have been disclosed, especially (if not before) when the invoice for the tracks came to light in 2005.’

The trial judge decided that Mr Towers had breached his duty to the company for the six-month period when he had been using the machinery but not for the entire period that he had possession of it. Mr Towers was, therefore, ordered to pay a total of £7,797.31 (including interest) to the company. This was the benefit that Mr Towers received and the figure was derived from the rate that Mr Ford tried to charge the company as this was the best guide as to what Mr Towers would have paid on the open market.

Mr Towers also sought to rely on s1157 of the Companies Act 2006 (the Act), which replaced s727 of the Companies Act 1985, and which was in force at the date of judgment. Section 1157 provides that directors may be relieved of liability for breach of their duties where they have acted honestly and reasonably and ought fairly to be excused, having regard to all the circumstances of the case. However, the deputy judge rejected Mr Towers’ argument that he should be relieved or excused, saying simply that ‘he acted unreasonably in failing to make disclosure’.

Mr Towers appealed and the company cross-appealed. The company stated that Mr Towers should be liable for the whole period he had the equipment rather than only the time that he was using it. The company subsequently dropped this appeal during the hearing in the Court of Appeal.

MUMMERY LJ’S SUMMARY OF THE LAW

The events that led to this dispute took place in 2003, before the Act came into force. Therefore the common law rules on directors’ fiduciary duties applied. Mummery LJ, who gave the only reasoned judgment in the Court of Appeal, briefly reviewed some of the key cases and highlighted the following principles:

  • A director of a company may not enter into arrangements that give rise to a conflict (or potential conflict) between his interests and those of the company (Aberdeen Railway Co v Blaikie[1854]).
  • A company can expect the ‘undivided loyalty of its directors’. The rule is a broad and flexible one to be fashioned according to changing circumstances and to be applied with common sense (Boulting v Association of Cinematograph, Television and Allied Technicians [1963]). Where the rule applies, however, the nature of the liability is strict and does not require proof of fraud or corruption on the part of the director.
  • A director’s liability for disloyalty in office does not depend on proof of fault or proof that a conflict of interest has actually caused a company any loss (Foster Bryant Surveying Ltd v Bryant[2007]).
  • A director’s potential conflict of interest may arise in connection with a business opportunity. If a director obtains the opportunity for themselves, they will be liable to the company for breach of duty regardless of the fact that they acted in good faith or that the company could not, or would not, have taken advantage of the opportunity.
  • The liability arises from the mere fact of a profit having been made. The director, however honest and well intentioned, cannot escape the risk of being called upon to account (Regal (Hastings) Ltd v Gulliver [1967]).
  • Equity’s response of strict liability to account for breach of a fiduciary duty is similar whether the liability is triggered by an event that breaches the loyalty duty, or the no conflict principle, or the no profit principle.

The common law principles continue to be relevant to cases where the Act will apply because s170(4) of the Act provides that directors’:

‘… general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.’

Notwithstanding the fact that the key events occurred prior to the relevant sections of the Act coming into force, Mummery LJ said that it was ‘unrealistic’ to ignore the new statutory framework because the codified duties are expressly derived from the common law rules and ‘extract and express the essence of the rules and principles which they have replaced’. He therefore identified s172 (duty to promote the success of the company), s175 (duty to avoid conflicts of interest) and s176 (duty not to accept benefits from third parties) as being potentially applicable to the facts of a case like this one occurring after the relevant provisions of the Act had come into force.

COURT OF APPEAL DECISION

On appeal, Mr Towers argued that the first instance judge had adopted an overly strict and technical approach to the application of a broad flexible principle that covered diverse situations ranging from bribes to harmless hospitality gifts. He relied in particular on the following points:

  • the comparatively small amount of money involved meant that any benefit received by Mr Towers was ‘negligible’ and ‘de minimis’;
  • the equipment was in a dilapidated condition and of no commercial value;
  • the absence of direct contact between Mr Towers and Mr Ford;
  • the fact that Mr Ford had been told that he would not receive any favours as a result of supplying the equipment and that the system of authorisations and financial controls at the company meant that Mr Towers was not in a position to provide any such favours;
  • there was no evidence that the company itself might have been interested in hiring the equipment;
  • there was no evidence that the company had suffered loss;
  • there was no evidence that the motives of Mr Towers were improper.

Mr Towers also argued that the first instance judge had wrongly overplayed his failure to disclose the loan. Mr Towers said he genuinely did not believe that the loan, which was an informal arrangement between friends, might have been unlawful or that he ought to disclose it to the company.

Mummery LJ gave these arguments short shrift, saying that they missed the point. He emphasised the importance of Mr Towers’ duty of loyalty to the company and his duty to avoid being involved in any conflict with the company, which included a duty not to make a secret profit for himself. The no conflict duty extended to the company being deprived of the opportunity to consider whether it objected to Mr Ford, one of its customers, dealing directly with a director of the company. Nor did Mr Towers’ ‘commercially sensible’ defences change the fact that he had breached his duties.

Mr Towers also argued that the first instance judge had failed to take all relevant factors into account when considering his application for relief under s1157 of the Act and he pointed to the brevity of his judgment as evidence of this. Mummery LJ dismissed this ground of appeal. He said that Mr Towers’ arguments were a ‘rehash’ of the arguments:

‘… relied on, without effect, to dilute the duty to be loyal or to cancel the fact that the duty was breached by an act of disloyalty’.

There was no mitigating factor and no evidence of injustice or hardship, which might be relevant to granting relief in Mr Towers’ favour. In fact, the ordering of new tracks for the equipment through the company, and the company’s payment of that cost, pointed in the opposite direction.

Mummery LJ also said that the first instance judge should be complimented, rather than criticised, for the brevity of his judgment on this point. There was little that could sensibly be added to what had been said earlier in the judgment and a judge should not feel obliged to be ‘a legal windbag repeating himself at length just for the sake of it’.

CONCLUSION

This decision was made under the common law and equitable principles that applied before the Act came into force. However, these principles remain relevant and Mummery LJ expressly considered the relevant provisions of the Act. It is highly likely, therefore, that the same decision would have been reached if the relevant events had taken place after the Act came into force.

Mummery LJ described directors’ duties as ‘simple, strict and salutary’ and this case is a clear example of the court taking a hard line on breaches of those duties. The offending loan was, at least in Mr Towers’ case, an informal arrangement between friends and there was no evidence that Mr Ward gained an advantage as a result of the loan. It also appears to have been common ground that the equipment was not commercially hireable, which makes it unlikely that the company would have wanted to use it. However, none of these factors made any impact on the Court of Appeal. Mr Towers’ had received a benefit in breach of his duties as a director of the company and he was required to account for that benefit. Any arguments to the contrary simply missed the point.