Context is key to considering a breach of director duties — Humphrey v Bennett in the Court of Appeal

A recent Court of Appeal decision in Humphrey v Bennett [2023] EWCA Civ 1433 (Humphrey v Bennett) provides guidance on when directors will be deemed to have breached their duties concerning conflicts of interest.  

The decision emphasises the significance of context and highlights that the steps required to satisfy directors’ duties might be quite different in a small, informally run company when compared with a larger company that has a formal board structure and lines of reporting.

Here, Senior Associate and experienced commercial litigator Matthew Moy explains what this decision means for directors and shareholders of companies. 

Directors’ duties under the Companies Act 2006 (CA 2006)

In Humphrey v Bennett, the Court of Appeal considered directors’ duties under the CA 2006 and the importance of a director’s conduct around managing a conflict of interest.  

The court considered two director duties in particular:

• Section 175 — Duty to avoid conflicts of interest — a director must not, without the company's consent, place themselves in a position where there is a conflict or possible conflict between the duties that they owe to the company and either their personal interests or other duties that they owe to a third party.
• Section 177 — Duty to declare interest in proposed transaction or arrangement — directors may not have an interest in a transaction or arrangement with the company unless the interest has been authorised by the members.

The court also considered section 1157 which provides that a director can be relieved of liability for breach of duty if it appears that the director has acted honestly and reasonably in all of the circumstances and ought to be excused.

Failure to disclose a conflict of interest

Humphrey v Bennett involved a small, informally run property development company — Esprit Land Ltd (Esprit), set up by two couples — Mr and Mrs Humphrey and Mr Bennett and Mrs Murphy.

The company purchased a piece of land and obtained planning permission to develop it.  Mr Bennett and Mrs Murphy were majority shareholders of Esprit and later sold the land to another company that they were connected with.  

Mr and Mrs Humphrey brought a claim on behalf of Esprit alleging that Mr Bennett and Mrs Murphy had wrongfully transferred the land and diverted the opportunity to develop it for their own benefit. They claimed that there was an obvious conflict which Mr Bennett and Mrs Murphy had failed to disclose.

In response, Mr Bennett and Mrs Murphy alleged that they had asked Mr and Mrs Humphrey to inject the additional capital that was required for the development, but they had declined and said that they didn’t want to proceed.

Mr Bennett and Mrs Murphy argued that Mr and Mrs Humphrey had therefore understood that they would continue to pursue the development themselves and that this was enough to authorise the conflict of interest.

Mr and Mrs Humphrey did not agree and applied for summary judgment (a procedure where the court may decide a claim or a particular issue without a trial).  

Summary judgment at the High Court

Mr and Mrs Humphrey were awarded summary judgment against Mr Bennett (who was the sole shareholder of the connected company), on the basis that:

• There was insufficient evidence that Mr Bennett had complied with sections 175 and 177 of the CA 2006 and/or insufficient evidence that Esprit had authorised the transaction.
• It would be inappropriate and highly unusual to award Mr Bennett relief under section 1157 of the CA 2006 where a benefit (the land) had been retained – an extremely powerful case would be needed.

Mr Bennett did not agree and appealed. 

The standard of disclosure imposed on a small business was too high

The Court of Appeal allowed the appeal and held that the judge had imposed too high a standard of disclosure on the directors in relation to their duties under the CA 2006.

Section 175 — If (as Mr Bennett alleged) Mr and Mrs Humphrey had rejected the development proposal and it was understood and agreed that Mr Bennett and Mrs Murphy could pursue the development outside of Esprit, this could constitute the necessary authority required under section 175 of the CA 2006.

Section 177 — If Mr and Mrs Humphrey had agreed that Mr Bennett and Mrs Murphy were able to pursue the project outside of Esprit, they should have considered that this might involve them acquiring the land themselves. This could constitute the necessary approval required under section 177 of the CA 2006.

Of particular relevance to the court’s decision was the informal way in which the directors had previously conducted their business and dealt with the assets of Esprit.  In particular, there had been no formal board or shareholder meetings about the development. The court suggested that the scope of what the directors needed to disclose was therefore arguably less than might normally be required.

Section 1157 — The court held that if a director falls short of the specific requirements of sections 175 and 177 of the CA 2006 then this does not necessarily mean that a director is not entitled to relief if they have acted honestly and reasonably overall. The relief should be applied broadly and Mr Bennett’s perception of what he had been authorised to do and the informality of how Esprit was operated were both key factors to be considered.
 

Directors must regularly review and declare conflicts

It is important to remember that this was an appeal against summary judgment. The Court of Appeal was not required to determine whether Mr Bennett and Mrs Murphy had breached their duties. Instead, the court was asked to determine whether there was a reasonable possibility that their argument would succeed at trial. It remains to be seen what approach the court will now take at trial.

The decision suggests that directors of smaller, more informally run companies may be subject to less onerous disclosure obligations than larger, more formally run companies under sections 175 and 177 of the CA 2006. It also provides important guidance on the application of section 1157 of the CA 2006.

The judgment demonstrates the significance of recognising potential conflicts of interest early and dealing with them appropriately. Directors should still err on the side of caution and be explicit about their interests with other companies and/or proposed transactions — regardless of the size of the company or how it is run.

In addition, directors should stay alert to any potential conflicts that other directors may not have recognised and regularly remind each other of their duty to declare conflicts and to question any uncertainty.

Talk to us

If you need advice on directors’ duties or shareholder disputes, talk to our commercial litigation team.