Good intentions are not enough: The UK Supreme Court clarifies directors’ duties

The UK Supreme Court (UKSC) has handed down a judgment that clarifies a point of English company law concerning directors’ duties: does the duty of good faith imposed on directors by s.172(1) of the Companies Act 2006 require only that a director thinks in good faith (a subjective test), or does it also require them to act in good faith (an objective test)?

Background

The relevant extract from s.172(1) reads:

The case arose from an unfair prejudice petition concerning a private company brought by a minority shareholder. The director (Mr Costa), who was the Appellant in the UKSC proceedings and Defendant in the lower court proceedings, disagreed with the board’s agreed exit strategy, as recorded in a shareholders’ agreement. Rather than raise the objections openly at board level, Mr Costa did not reveal the information regarding the exit and misled the directors and shareholders about the exit process.

At first instance, the trial judge accepted that Mr Costa believed he was acting in the company’s best interests and, on that basis, found no breach of s. 172. The Court of Appeal disagreed and reversed that finding. The Supreme Court has now confirmed the Court of Appeal was right to do so.

UKSC judgment

Prior to this decision, there was a live and unresolved question as to how far the s.172(1) duty extended. The subjective nature of the “good faith” test was well established, namely that courts will not second-guess a director’s genuine business judgment. What had never been authoritatively determined at the highest level was whether a director who genuinely holds a dissenting view could lawfully act upon it through any means – however covert, deceptive, or disloyal – provided the underlying intention was to benefit the company.

Perhaps unsurprisingly, the UKSC concluded that a director’s conduct is itself relevant when determining whether they have breached s.172. Therefore, a director who covertly subverts a collectively agreed board strategy – however sincerely they believe their own preferred course is in the company’s interests – acts in breach of s.172. While this “objective” criteria does not displace the subjective business judgment test, the effect is that individual directors do not have license to mislead the wider board.

This finding reflects that directors’ duties stem from the common law concept of fiduciary duties, in particular the ‘duty of loyalty’, which the courts have long recognised is capable of being assessed on objective grounds. To mislead the board of directors is to mislead the company itself, thereby offending s.172.

Key takeaways

Individual directors and boards who maintain corporate governance best practices are unlikely to be affected by this judgment. However, this judgment likely shuts the door on defences raised by directors facing claims brought by the company itself or insolvency officeholders. Whilst a court will still accept a director’s genuinely held business judgment as to strategy, it will objectively assess the director’s conduct in pursuit of that strategy. Therefore, a director who acted covertly or deceptively can no longer take shelter behind the sincerity of their intentions. Where conduct falls short of the loyalty required by s. 172, the duty is breached.