2017 ZA/B Q7 Director Duties

Jose and Philip are directors of Diggers plc, which makes gardening equipment. Simone, a qualified
accountant, has never been appointed a director of Diggers, but often attends board meetings.
When Jose agreed to become a director, he advised Diggers that his other commitments would
prevent him attending many board meetings. Diggers accepted this.

In 2016, Diggers was offered the opportunity to purchase, for £2 million, Earthers Ltd, which also
makes gardening equipment. A board meeting of Diggers was held. Jose, who had not attended
any board meeting for over a year, was not present. Simone was present, and told Philip that she
had looked over Earthers’ accounts, and believed Earthers was on the verge of insolvency. In fact,
Earthers was in excellent financial health. Philip and Simone agreed that Diggers would not buy
Earthers.

Philip decided he would like to buy Earthers himself, and set up in competition with Diggers. For
two months, he did not tell Diggers of his plans. During that time, he negotiated for the purchase
of Earthers, and arranged the 16 finance he needed. In December 2016, he resigned as a director
of Diggers, and in January 2017 he acquired Earthers for £1.9 million.

Earthers has proved very profitable since Philip acquired it, and Philip has persuaded many of
Diggers’ former customers to switch their orders to Earthers.

Discuss whether Jose, Philip or Simone might face any liability to Diggers.

In dealing with Jose, Philip and Simone, the relevant law to be discussed here will be
revolving around the duties of directors which were given statutory footing in the S.171 – S.177 of
Companies Act 2006 (CA 2006). Hence, each director will be discussed separately and assessing their
breaches and liabilities respectively.

Jose

On the case of Jose, the relevant statutory provision to be discussed her will be S.174 of CA
2006. The effect of S.174 is that a director’s actions will be measured against the conduct expected
of a reasonably diligent person which will be assessed objectively that may reasonably be expected
of a person carrying out the same function as carried out by that director in relation to the company.
However, subjective considerations will also apply according to the level of any special skills that
particular director may possess. Since the fact is silent on whether Jose possesses any special
expertise, so the issue here will be considering Jose’s potential liability under S.174 for his absence
from the meeting in an objective manner.

In the case of Lexi Holdings Plc v Luqman and Others (2009) where the the court held that
by failing to ask questions of the managing director regarding his actions, the other two inactive
directors were themselves in breach of their duties to their company. It is submitted that directors
must keep themselves informed about what is going on in the business and participate in its
management which means they should not sit by and let other directors act without being prepared
to challenge them, regardless of how dominant they are.
 Thus, in the case of Raithatha v Baig (2017) where the directors breached their duty under
S.174 CA 2006 by failing to have ongoing obligation to monitor those to whom tasks where
delegated and directors must also acquire sufficient knowledge of the company to enable them to
do so. This case which concerns the company had failed to register for a sales tax and the directors
believed that the company’s accountants were dealing with the issue of registration, therefore they
assumed to place the responsibility of registration of tax upon accountants. But the court
emphasised that it was the responsibility of the directors themselves to check those matters with
their accounts. In addition, the court further held that the directors may have acted honestly, but
needed to act reasonably as well and they did not.

Applying on our facts, Jose’s act of not attending the meeting regularly is arguably breaching
his duty as a director as not exercising reasonable care, skill and diligence as this would lead to a loss
to the company if the acquisition of Earthers was presumably a valuable opportunity to the
company. Despite Jose’s expressed informing of the company that he will not be attending the
meeting due to sheer amount of obligations, this does not indicate that he will be absolved from his
act of delegation of tasks to the other directors. It can be seen that Jose is required to have at least a
minimal level of involvement in the affairs of the company. Thus, Jose should be demanded to have
certain minimum responsibilities and functions and a directors are expected to monitor their
delegates’ performance and ensure they are carrying out the activities assigned to them in an
appropriate way.

On the other hand, Jose may try to counter argue hat his presence would not have made any
difference even if he opts to have differing view. Since Simone is a qualified accountant, Jose may
argue that Simone’s advice may carry the most significant weight and it would be a better choice to
rely on Simone’s expertise. However, it is unlikely that Jose will be successfully in defending from
this trajectory, since he is liable for absence from meeting in the first place, Jose is likely to have
breached the S.174 and thus his liability shall outweigh his defence.

The consequence for a breach of his duty as a director may lead to the removal of his
position as a director from the office. Phillip and Simone may opt to initiate the removal of Jose from
the office by an ordinary resolution at a meeting under S.168(1) of CA 2006. It is submitted that a
special notice which is to inform Jose has to be received by him upon removal – S.168(2) of CA 2006.

Contrarily, Jose may try to rely on the power of court to grant relief under S.1157 of CA 2006
in terms of wholly or partially relief. Under the provision of S.1157, the officer has to show that he
acted honestly and reasonably, thus having regard to all the circumstances of the case, that he
thought fairly to be excused on such grounds as the court thinks fit. In the case of Re D’Jan of
London Ltd where the director had signed the proposal without reading it and thus breached his
duty as a director. Hoffman LJ thought that it was the kind of mistake that could be made by any
busy man and therefore granting the director partial relief from liability. However, this case deemed
to be interpreted in its own peculiar fact since the director held 99 percent of the company’s share
and the economic reality was that the interests the director had put at risk were those of himself
and his wife.

Applying it on our facts, it seemed that Jose’s act of not attending the meeting is likely to
have breached his director’s duty under S.174. Since Jose’s fact may differ with the case of Re D’ Jan
London Ltd where it is assumed that Jose does not own majority of the share of the company and
thus, his act of not knowing the current affairs within the operation of company may not constitute
to the standard of acting honestly and reasonably. Therefore, Jose is likely to be liable under breach
of S.174.

In dealing with Simone, despite the fact that she has never been appointed as a director of
Diggers, but her act of attending board meetings regularly does amount to a de facto director. Under
S.250 of CA 2006, it provided that one is sufficient to be regarded as director that as long as a person
hold the position of a director, regardless of whatever name being given. In the case of Re Hydrodan
(Corby) Ltd (1994) where Millett J defined a de facto director by stressing the necessity of the
person in question being “held out” as a director by the company. But the requirement of “holding
out” was criticized by Lloyd J in Re Richborough Furniture Ltd (1996) where he preferred to lay
emphasis on the functions performed by the individual. It is apparent that Simone is under the
category of a de factor director and thus he will owe fiduciary duties as well as duties imposed by
statute.

The tests formulated in Re Hydrodan and Richborough were reviewed by Jacob J in SOS for
Trade and Trade v Tjolle (1989) where the judge acknowledged the difficulties in framing a decisive
test. He stressed that this nature of the exercise was necessarily fact intensive and was a question of
degree. Although Jacob J doubted whether holding out in itself was decisive, it would definitely be a
factor in the court’s determination and could raise a rebuttable presumption of a de facto
directorship.

The Supreme Court’s decision in The Commissioners for HM Revenue and Customs v
Holland (2010) is of particular important because the highest UK court was finally given an
opportunity to review the case law on the issue of de facto directorship. Having considered the case
law, the court took the view that the basis of liability for a de facto director is an assumption of
liability together with his being a part of the company governing structure. This stance was later
reaffirmed in the case of Re Sports Management Group (2016).

Applying on our facts, Simone’s position is undoubtedly being in the governing structure of
the company and this explains why she is capable of presenting his idea of not purchasing Earthers.
Since his act of proposing is rather proactive, it could be safely to say that Simone has assumed a
liability on her part upon his suggestion not to buy Earthers. In addition, it is apparent that Simone’s
act exercised “real influence” in the corporate governance of the company which is sufficient to
cause the company to swerve its direction. – Re Kaytech International. Hence, Simone can be
considered as a de facto director.

After establishing Simone’s role as a de facto director, it is to be said that he owes the same
standard of fiduciary duty as a normal director. Since she is a qualified accountant, her act of
persuading not to buy Earthers which led to a subsequent loss to the company may constitute a
breach of director duties under S.174 on her failure to exercise reasonable care, skill and diligence.
In particular, this will require us to assess the subjective part which laid in S.174(2)(b) which
stipulated that the director’s general knowledge, skill and experience has to be take into account.

In the case of Dorchester Finance Co v Stebbing (1989) where the company had gone
insolvent and made a claim against Mr Stebbing and two other non-executive director accountants
who often signed blank cheques which were later countersigned by Mr Stebbing. The system of
signing blank cheques was held to be negligent and liable for lossess under S.214 Insolvency Act
1986. The court further held that the directors must display such skill as may reasonably be expected
of a person with his knowledge and experience, thus he must at all times take such care as a prudent
man would take on his behalf.

On the fact, Simone was present in the meeting and her statement of “excellent financial
health” on the prospect of Earthers may sufficient to indicate that she has been relying on her
accounting expertise and will reasonably induce Philip to believe on her judgment. In failing to
recognize the exact financial condition of Earthers is arguably to have breached her duty under the
subjective test of S.174(2)(b). In addition, Simone may unlikely to be relieved from this liability
referring to the case of Dorchester, Foster J held further that it would not be appropriate for the
court to exercise its discretion to relieve the directors on the basis that they acted “honestly and
reasonably” under S.448 of the Companies Act 1948 (now S.1157(1) CA 2006).

Regarding Philip, he might be in breach of S.174, but since we are not told he has any
particular qualification of expertise, he is more likely to be judged by an objective standard of care
and skill. Thus, he is more likely to be in breach of S.175 CA 2006 which directors owe a duty to avoid
conflicts of interest. S.175(1) CA 2006 provides that a director of a company must avoid a situation
which possibly involving himself in a direct or indirect interest which will conflict with the company.
The principle that a person having a fiduciary position should not make a profit out of it, applies to
the director as well, despite the fact that the position of the director is not like that of a trustee. In
Regal (Hasting) v Gulliver where the four directors made some incidental profit because of their
position as being the directors. The court made them accountable for their profit although they
worked in a bona fide manner. The reason was given that fraud and lack of good faith were
immaterial to the directors’ liabilities. The new owner of the Regal would receive a windfall and this
would lead to the reduction of the shares’ price, paid by them for their share, as stated by Lord
Porter. Thus, in the recent case of Burns v FCA (2017), the court held that a director must not put
himself in a position of actual or potential conflict with the interests of the company.

Applying on our facts, Philip’s conduct can be broken down into different stages, each of
which raises different issues. Firstly, his action in secretly buying Earthers for himself. It occured
during the time when he negotiated for the purchase of Earthers and did not disclose his plan to
Diggers, thus he was still in the position of a director at the time. Recent common law decisions have
made it clear that the general fiduciary obligations of a director do not prevent him from taking the
decision, while still a director, to set up competing business after his directorship has ceased and
taking some preliminary steps to investigate or forward that intention provided that he did not
engage in any competitive activity while his directorship continued. In the case of Balston v Headline
which held the mere intention to set up a competing business whilst employed as a director was not
a breach of fiduciary duty so long as there is no actual competitive activity, such as competitive
tendering or actual trading, while he still remains a director.

However, applying on our facts, it could be said that Philip did not breach S.175 at this stage
yet since he only possess the intention of buying Earthers at that particular stage and had not turn
his intention into any specific action which will pose a threat to Diggers yet.

Secondly, Simone took the further step in setting up in competition in Diggers which can be
argued to breach S.175. Once he starts takings steps to further his competitive intentions, he should
disclose those intentions to the board, or ‘resign’. He seems to do neither until December 2016,
when he resigned as a director of Diggers and in January he acquired Earthers successfully. In the
case of British Midland Tool v Midland International Tooling, a group of directors to set up a new
company to compete with their existing employer, working on their plans when still employees. The
judge took the view that while they were directors of the previous company, they owed it a duty of
care, which would include informing the company of any activity that might cause it loss. On our
fact, it could be seen that Simone arranged the finance he needed for acquiring Earthers does
amount to breaching of his duty as director.

On the other hand, Philip might try to argue that his resignation might absolve him from the
liability he owed to Diggers of setting up a competitive business. However, S.170(2)(a) provided that
a person who ceases to be a director continues to be subject to the duty in S.175. Thus, in IDC v
Cooley, in which Cooley, the managing director of IDC, had been negotiating a contract on behalf of
the company, but the third party wished to offer the contract to him personally and not to the
company. Without disclosing his reason to the company, he resigned in order to take the contract
personally. It was held that he was in direct breach of his fiduciary duty as he had profited personally
by use of an opportunity which came to him through his directorship. It was therefore he was
accountable to the company for the benefits gained from the contract. This indicates that a director
may still be subject to the duties even after he ceases to be a director.

Thirdly, Philip’s act of persuading many of Digger’s former customers to switch their orders
to Earthers may constitute a corporate opportunity. This makes it a breach of fiduciary duty by a
director to appropriate for his own interest an economic opportunity which is considered to belong
in equity to the company – S.175(2).

On the fact, in 2016, Diggers was offered the opportunity to purchase Earthers for $2
million. Philip knew this but wanted to acquire it for himself. Although his acquisitions happens after
he ceases to be director, but S.170(2)(a) provided that he will still be bound by S.175.

In considering the case of Thermascan Ltd v Norman (2011), if the knowledge Philip is using
is his ‘general fund of knowledge’ developed while being the director of Diggers, it will not amount
to breach of S.175. However, it would be contrary if he was exploiting confidential information or
trade secrets. On the fact, Philip has persuaded many of Digger’s former customers to switch their
orders to Eathers. The list of customers undoubtedly is one of the confidential information that
being owned by Diggers and thus, Philip is likely to be held liable under breach of S.175.