You can check out any time you like but…scary case about directors’ duties to avoid conflicts of interest

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Scary intro

You have to be very careful if you are a director of a company and thinking of leaving. If you get things wrong in making use of information you’ve picked up then both you and the business you move to could end up being liable to your original company for compensation or an account of profits you make.

Background

Directors have all sorts of fiduciary duties to their company. Before 2006 the law relating to these duties had developed under common law (case law). The Companies Act 2006 set out these duties in its own words, and so all subsequent cases also have to be looked at in the light of the wording of the Act.

These duties apply not just to actual appointed directors (registered as such at Companies House etc) but also to ‘de facto’ directors – people who act as though they are directors and who other directors treat as a director. They also apply to ‘shadow’ directors – someone who the other directors will automatically obey – often the controlling shareholders of a company or someone connected with them, but it can also extend to others such as business advisors or lenders.

One of these duties is to avoid conflicts of interests with the company. This duty is now contained in s175 Companies Act 2006.

Before 2006 the position was that the conduct of a director after they have left office could not of itself amount to a breach of this duty. There had to be some planning or other conduct before they resigned which was also in breach of this duty.

But s170(2)(a) of the Act changed things, as it expressly said that in certain circumstances (specifically, as regards the exploitation of any property, information or opportunity of which the person became aware when in office) the duty in s175 to avoid conflicts of interest continues after the director ceases to be a director.

This has been reinforced by a recent case.

Recent case

In a recent case (Alan Burnell v Trans-Tag Limited and Robert Aird [2021] EWHC 1457 (Ch) – I dare you to read it in full) a High Court judge ruled that the wording of s170(2)(a) was so clear that you couldn’t read it to mean that there must also have been some form of breach of the duty before the director left his role in order for it to apply.

In this case Mr Burnell was a minority shareholder in and an employee (as CEO, although not an appointed director) of Trans-Tag Ltd. Trans-Tag designed, made and sold various tagging devices which were used for remote tracking, monitoring and analysis of goods, equipment and people. It was licensed to use these devices by an Estonian company, Trans-Tag Systems Ou (‘TTS’). In early 2017 the owner of Trans-Tag had a bust-up with TTS. Mr Burnell effectively left Trans-Tag in March 2017. The court ruled that up until March 2017 Mr Burnell had been a de facto director of Trans-Tag Ltd. In April 2017 TTS asserted that Trans-Tag had breached the terms of its licence agreement, and started proceedings against Trans-Tag to authorise TTS to terminate the licence agreement and to claim damages from Trans-Tag. In June 2017 an opportunity arose for Mr Burnell to acquire shares in and became a director of TTS, and he did so.

In May 2018 Mr Burnell brought proceedings against Trans-Tag and its controlling shareholders with claims relating to loans Mr Burnell had made to Trans-Tag which he wanted back, and relating to shares in Trans-Tag which he said its controlling shareholder had promised him.

In return, Trans-Tag counterclaimed that in acquiring the shares in TTS, and in playing a part in TTS seeking to terminate its licence agreement with Trans-Tag, Mr Burnell was in breach of his duties because he had exploited opportunities and information which rightfully belonged to Trans-Tag. Trans-Tag claimed damages of just under £10 million.

The High Court judge ruled that Mr Burnell had not been in breach of his duty to avoid conflicts of interest while he had been a de facto director. But he had breached this duty after this. The judge said that there had never been an opportunity for Trans-Tag itself to acquire shares in TTS, so Mr Burnell wasn’t in breach just for acquiring shares in TTS himself. However, the judge ruled that in his acquisition of shares in TTS and in his subsequent steps to terminate the licence agreement Mr Burnell had made use of:

• his knowledge of the circumstances in which the licence agreement might be terminated and legal advice received by Trans-Tag in this regard;
• some of Trans-Tag’s information surrounding the target market for the tag devices; and
• some of Trans-Tag’s financial modelling.

So the judge concluded that Mr Burnell had breached the duty under s175 2006 by misusing this information in breach of his duty of confidence.

The judge awarded Trans-Tag damages of £200,000 linked to the loss of its rights under the licence agreement (but not damages linked to the value of Mr Burnell’s interests as a shareholder in TTS). This actually netted off to Trans-Tag still owing Mr Burnell about £50k after factoring in his £250k loan which he wanted back.

Comments and tips

• This ruling has made it clear that the duty to avoid conflicts of interest after ceasing to be a director as set out in the Companies Act 2006 is more extensive than was the case beforehand. So there is no longer any need when pursuing claims for breach of this duty to identify specific conduct which occurred whilst the former director was in office. All that needs to be shown is that their subsequent conduct was predicated by knowledge which they acquired whilst they were an officeholder.
• This could make things quite tricky for a director thinking of leaving their company and getting involved in another business in the same field. Whereas the strategy might previously have been to be very careful what they did whilst they were still a director with the information they had and the opportunities they came across, and to resign before they did do anything, this could still now get them into trouble. It will be interesting to see how the law develops in this area.
• The duty to avoid conflicts of interest does not stop directors from using in a future enterprise the ‘general fund of knowledge and skill’ they obtained in the course of being a director. But it does mean that if they ‘exploit’ specific information deemed to be ‘akin to property of the company’ obtained during a prior directorship in a future enterprise, there is a risk that they may be in breach of their directors’ duties in respect of their prior appointment, notwithstanding that that conduct all takes place after they had stopped being a director.
• So long as you remain a director all your duties as a director still apply. So in the context of a shareholder fall-out it can sometimes still help to resign as a director. Set against this is the downside that once you cease to be a director you no longer have all the rights of a director to access to company information and to a seat at the board room table.
• If you are just a shareholder the position is different. You don’t owe all these directors’ duties. But you may still owe duties of confidentiality in relation to information you have about the company. And depending on the circumstances there may be other obligations to the company or to other shareholders, particularly if these are set out in a shareholders agreement.
• On a slightly separate point, it’s worth noting that a lot of the problems resulting in the bust-up between TTS and Trans-Tag arose because they hadn’t tried to put in place legal documentation from the very beginning (when the technology was still being developed) to address the nature of their business relationship and the terms of any licensing. Another reason to consult with lawyers sooner rather than later…

Conclusion

If you are in this kind of position as a shareholder director you need to be very careful how you play things. I can possibly help. I spend much of my time advising shareholders who are also directors as regards various problems they might be having with other shareholders or directors. Ideally these problems can eventually be resolved by discussion and negotiation and an agreement as to the way forward (which might for example involve the parties entering a shareholders agreement clearly regulating their relationships with each other and with the company, or entering an agreement for a shareholder to be bought out by the others). The alternatives – often involving protracted and expensive litigation – can be horrible.

If you think you might be affected by anything discussed in any of my articles, feel free to contact me for a free no-obligation 15 minute consultation when I will help you to identify and understand issues which you might need to address and will suggest ways in which you might address them.