DIRECTORS’ DUTIES: REMEDIES AND RELIEFS AND DIRECTOR DISQUALIFICATION
Directors’ duties: Remedies and reliefs and director disqualification
AIMS AND OBJECTIVES
After reading this chapter you should be able to:
Understand common law and equitable remedies for breach of directors’ duties
Understand the civil consequences of failure to comply with statutory provisions governing directors contracting with their companies
Recognise the defences and reliefs potentially available to directors in breach of their directors’ duties
Understand the concept of ratification and the limits on directors ratifying their own wrongdoings
Analyse a fact situation and identify:
the remedies potentially available for each breach of duty or contravention of the Act
any defence a director may be able to argue
any relief a director may be able to claim
whether or not the breach or contravention can be ratified
Understand when a director may be disqualified from being a director or taking part in management of a company
Understand the effects of a disqualification order or undertaking, both civil and criminal
As indicated in the introduction to Chapter 11, this chapter covers the final part of our study of directors’ duties, statutory provisions governing directors’ contracts with the company and the liabilities that may flow from breaches and contraventions of those duties and statutory provisions. We look in turn at the common law remedies, equitable remedies and statutory remedies before turning to reliefs from liability. In the final section of this chapter, we look briefly at the closely related issue of director disqualification pursuant to the Company Directors Disqualification Act 1986, as amended.
Codification of the remedies for breach of directors’ duties was a step too far for the reform process and the remedies potentially available for breach of s 174, a common law-based duty, and ss 171–173 and 175–177, the equity-based duties, are the same as would apply if the corresponding common law rule or equitable principle applied (s 178(1)). Given that the remedies for failure to obtain shareholder approval for substantial transactions, loans and other credit arrangements between a director and the company are set out in the statute (s 195 (substantial transactions) and s 213 (loans etc): see section 13.2.3), it would not have been too difficult to set out the remedies for breach of the general duties in the 2006 Act. The approach taken, however, leaves the remedies flexible and able to evolve. Unfortunately this flexibility is secured at the price of not achieving the clarity and accessibility the statutory statement of directors’ duties was intended to deliver.
13.2.1 Remedies for breach of duty to exercise reasonable care, skill and diligence (s 174)
The duty to exercise reasonable care, skill and diligence is a common law duty rather than an equitable duty. Consequently, the usual remedy available to the company against a director who is found to be in breach will be damages for breach of duty. Damages will be based on tort principles. Accordingly, the company must be able to show:
loss to the company that is not too remote;
a causal link between the breach and the company’s loss (Cohen v Selby  1 BCLC 176).
13.2.2 Remedies for breach of the equity-based duties (ss 171–173 and 175–177)
With the exception of the duty to exercise reasonable care, skill and diligence, the general duties of directors are equity-based duties for which equitable remedies may be available. Equitable remedies are never available as of right. The company must satisfy the conditions for the court to grant relief sought. Your equity or trusts studies will assist you to understand equitable remedies for breach of duty. Essentially, depending upon the circumstances, four potential remedies are available to the company, as follows:
return of property a director has received in breach of duty (or its traceable proceeds);
account of profits a director has made as a result of breach of duty;
rescission of contracts made in breach of duty;
Return of property received in breach of duty
A director may be ordered to restore to the company property transferred to him in breach of fiduciary duty. This remedy is based on ordinary trust principles – the director holds such property as constructive trustee for the company (Harrison (JJ) (Properties) Ltd v Harrison  1 BCLC 162).
The remedies available when a fiduciary receives a bribe or other unauthorised benefit have been clarified by the Supreme Court in FHR European Ventures LLP v Cedar Capital Partners Co Ltd  UKSC 45. In holding that a fiduciary holds a bribe, secret commission or other unauthorised benefit on trust for the person to whom he owes fiduciary responsibility, so that the claimant can choose between a personal and proprietary remedy, the Supreme Court upheld the Court of Appeal decision (FHR European Ventures LLP v Mankarious  EWCA Civ 17) and the Privy Council decision in AG of Hong Kong v Reid  1 AC 324. In doing so it overruled two long-standing decisions of the Court of Appeal (Lister & Co v Stubbs (1890) 45 ChD 1 and Metropolitan Bank v Heiron (1880) 5 Ex D 319) and all subsequent cases to the extent that they relied on those two cases, including Sinclair Investments v Versailles Trade Finance  EWCA Civ 347.
Account of profits made as a result of breach of duty
A director may be ordered to account to the company for any profits he has made as a result of the breach of duty. The principal object of an account of profits is to deter directors from breaching their duties and not to compensate the company for loss (United Pan-Europe Communications NV v Deutsche Bank AG  2 BCLC 461). Accordingly, the director may be made to account even if the company has suffered no loss, and even if the company could not have made the profit itself, as was the case in Regal (Hastings) Ltd v Gulliver  2 AC 134.
‘The rule of equity which insists on those, who by use of a fiduciary position make a profit, being liable to account for that profit, in no way depends on fraud, or absence of bona fides; or upon such questions and considerations as whether the profit would or should otherwise have gone to the plaintiff, or whether the profiteer was under a duty to obtain the source of the profit for the plaintiff, or whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff had in fact been damaged or benefited by his action. The liability arises from the mere fact of the profit having, in the stated circumstances, been made. The profiteer, however honest or well-intentioned, cannot escape the risk of being called upon to account.’
Rescission of contracts made in breach of duty
A contract made in breach of fiduciary duty may be voidable at the option of the company. Each party must return any property transferred by the other pursuant to the contract. This may be relatively straightforward where the contract is between the director and the company but where the contract is between the company and a third party, rescission may not be possible due to the effect it would have on the third party. Rescission may be awarded if the third party has requisite knowledge of the breach of duty (Logicrose Ltd v Southend UFC Ltd  1 WLR 1256).
A director may be ordered to pay equitable compensation to the company for loss the company has suffered as a result of the breach of duty. Equitable compensation is different from damages for breach of contract or compensation for a tort. It is closer to an indemnification, although in the commercial context a causal connection is required between the breach and the loss. The importance of causation in determining equitable compensation was made clear by Lord Brown-Wilkinson’s judgment in Target Holdings Limited v Redferns  1 AC 421 (HL), a case in which the House of Lords quashed the Court of Appeal’s order that a solicitor in breach of fiduciary duty must compensate his client for losses that had not been caused by the breach. The losses would have been suffered even had there been no breach of duty and therefore were not recoverable as equitable compensation for the breach of duty.
‘At common law there are two principles fundamental to the award of damages. First that the defendant’s wrongful act must cause the damage complained of. Second that the plaintiff is to be put “in the same position as he would have been in if he had not sustained the wrong for which he is now getting his compensation or reparation”. Although … in many ways equity approaches liability for making good a breach of trust from a different starting point, in my judgment those two principles are applicable as much in equity as at common law. Under both systems liability is fault based: the defendant is only liable for the consequences of the legal wrong he has done to the plaintiff and to make good the damage caused by such wrong.’
13.2.3 Remedies for failure to obtain shareholder approval for specific transactions
In contrast to the remedies for breach of the general duties of directors, when a contract is entered into without securing statutorily required shareholder approval the remedies available against directors are set out in the 2006 Act. Section 195 (relating to substantial property transactions with directors) and s 213 (relating to loans, quasi-loans and credit transactions) provide that:
the transaction is voidable at the instance of the company;
a director may be required to:
account to the company for any benefit or profit made from the transaction, and
indemnify the company for any loss or damages resulting from the transaction.
Note that liability extends beyond the director who enters into the transaction. Any director of the company who has authorised the transaction is also liable to account for any profit he has made and is jointly and severally liable to indemnify the company for any loss or damage resulting from the transaction (ss 195(4)(d) and 213(4)(d)). A director could be liable even if, rather than taking any active part in authorising it, a director has merely acquiesced in the transaction (Queensway Systems v Walker  EWHC 2496). In McGregor Glazing Ltd v McGregor  GWD 19, Sheriff Hammond referred to a ‘consistent strand of judicial authority to the effect that passive ignorance will not protect the director who has through inactivity, lack of enquiry or the abdication of this own responsibilities, allowed other directors to act to the prejudice of the company’.
Where a director is in breach of duty, the shareholders may decide to remove him as a director either pursuant to any power to do so in the articles or pursuant to s 168 (see Chapter 9). The company may also seek to terminate any service contract he has with the company. The rights of the director in relation to his service contract are principally governed by employment law. In particular it will be a matter of construction of the service contract whether or not the behaviour of the director is sufficient to allow termination for cause. Company law simply provides for service contracts of longer than two years’ duration entered into without securing shareholder approval, as required by s 188, to be terminable by reasonable notice.
13.3 Relief from liability, indemnification, exclusion of liability and insurance
We have seen above that directors may be able to obtain authorisation in advance for what would otherwise be a breach of duty. This authorisation may be obtained from:
directors in relation to conflicts of interest (s 175(5));
shareholders, as allowed by any rule of law (s 180(4));
a provision in the articles of the company (s 180(4)).
We have also seen that disclosure to the board in accordance with s 177 will protect a director’s contract with the company, or one in which he has an interest, from being set aside (s 180(1)(b)).
In this section we focus on post-breach relief. After a breach, a director may be able to obtain relief from the consequences of his breach by:
ratification by the shareholders pursuant to s 239;
court-granted relief pursuant to s 1157.
Shareholder ratification (s 239)
The starting point at common law and in equity, based on majority rule and the proper plaintiff principle, is that a breach of duty by a director can be ratified after the event by the shareholders by general resolution. Section 239 is a new provision which applies to ratification of a director’s conduct amounting to negligence, default, breach of duty or breach of trust in relation to the company. In effect, it provides for ratification by:
general resolution of disinterested shareholders; or
unanimous consent of shareholders.
Subsection 239(7) states that s 239 does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to acts that are incapable of being ratified by the company. In doing so it preserves the uncertainty that exists regarding limits on the ratification power of shareholders. Because of s 239(7), even if a breach is apparently ratified by a disinterested majority as required by and in accordance with s 239, it may be possible to argue that the apparent ratification is ineffective. This issue could very well arise in the context of a shareholder seeking permission to continue a derivative claim (considered at section 14.3.2) as the court is precluded from giving such permission if the act complained of has been ratified (s 263(2)(c)(ii)).
Court-granted relief (s 1157)
A court that finds a director liable in respect of negligence, default, breach of duty or breach of trust may relieve the director from liability either wholly or in part if the court finds that the director acted honestly and reasonably having regard to the circumstances of the case (s 1157). The test to be applied was stated in Re Duomatic Ltd  2 Ch 365 at 377:
‘[Was the director] … acting in the way in which a man of affairs dealing with his own affairs with reasonable care and circumspection could reasonably be expected to act in such a case.’
An example of when the court will exercise this power is Re D’Jan (of London) Ltd  1 BCLC 561, considered at section 11.4. In Re D’Jan, the court held that the predecessor to s 1157 contemplated that conduct may be reasonable for the purposes of that section despite amounting to lack of care at common law.
13.3.2 Indemnification, exclusion of liability and insurance
Subject to three important exceptions, s 232 renders void any provision which, in connection with negligence, default, breach of duty or breach of trust in relation to the company, purports to:
exempt a director to any extent from any liability that would otherwise attach to him; or
directly or indirectly provide a director with an indemnity to any extent against any liability.
Section 232 does not, however, prevent a company from:
purchasing and maintaining liability insurance for its directors (s 233);
indemnifying a director against liability he incurs to third parties (subject to limits in relation to criminal liability and proceedings) (s 234);
indemnifying a director of a company that is a corporate occupational pension scheme trustee against liability he incurs in connection with the company’s activities as trustee of the scheme (subject to limits in relation to criminal liability and proceedings) (s 235).
Also, to avoid arguments that they are exclusions of liability, otherwise lawful provisions in a company’s articles dealing with conflict of interest are expressly excluded from the s 232 prohibition (s 232(4)). The model articles for both private companies (Arts 52 and 53) and public companies (Arts 85 and 86) contain identical provisions permitting the company to indemnify directors in respect of liability incurred in connection with being a director, as far as such indemnification is not prohibited or unlawful, and to purchase and maintain directors’ liability insurance for the benefit of directors.
13.4 Director disqualification
13.4.1 The basis for disqualification orders and undertakings
Director disqualification cases are now a key part of the modern law of directors’ duties. Under the Company Directors Disqualification Act 1986 (CDDA), as amended (in particular by the Insolvency Act 2000), subject to the power to accept undertakings in lieu (see below), the court may (and in proceedings under s 6 and 9A must) make an order in the terms of s 1 disqualifying the defendant from promoting, forming or taking part in the management of a company or LLP, including being a director, in the following defined circumstances:
where a person is convicted of an indictable offence in connection with the promotion, formation, management, liquidation or striking off of a company, or with the receivership or management of a company’s property (s 2);
where a person has been persistently in default in relation to provisions of companies legislation requiring returns or accounts to be filed with the registrar of companies (ss 3 and 5);
where a person has been convicted of a relevant foreign offence (s 5A, if Pt 9 of the Small Business, Enterprise and Employment Bill 2013 (SBEEB 2013) is enacted);
where it appears that a person has been guilty of an offence of fraudulent trading (Companies Act 2006 s 993) or any other fraud in relation to the company (s 4);
where a person is or has been a director of a company which has become insolvent and his conduct as a director of that company (either taken alone or taken together with his conduct as a director of any other company or companies) makes him unfit to be concerned in the management of a company (s 6);
where a person had instructed a person disqualified under s 6 (s 8ZA, if Pt 9 of the SBEEB 2013 is enacted);
where a person is or has been a director of a company and his conduct (as revealed in the course of an investigation under the Companies Act 1985 (see Chapter 17)) makes him unfit to be concerned in the management of a company (s 8);
where he is a director of a company that has committed a breach of competition law and his conduct as a director of that company makes him unfit to be concerned in the management of a company (s 9A);
where a declaration of liability is made against a person or director under the fraudulent (s 213) or wrongful (s 214) trading provisions of the Insolvency Act 1986 (s 10).
The majority of disqualification orders are made on the application of the Secretary of State under ss 6 (insolvency) and 8 (public investigation). Under both provisions, the court is required to have regard to the matters listed in Sched 1 to the Act in determining the question of unfitness. (Note that Sched 1 will be amended if Pt 9 of the SBEEB 2013 is enacted as drafted at the time of writing.) A new s 7A, proposed by the SBEEB 2013, will require liquidators and administrators to write a conduct report about each person who was a director of a company, at the time of the company’s insolvency or within three years thereof, describing any conduct which may assist the Secretary of State in deciding whether to disqualify any of the directors (or accept an undertaking in lieu). The 2013 Bill also extends the period in which to apply for a disqualification order against directors of an insolvent company to three years from the date of insolvency.
The option to accept a disqualification undertaking in lieu of a disqualification order was introduced in 2000 (see CDDA ss 1A, 7(2A), 8(2A), 8A and 9B). Essentially, the Secretary of State can accept an undertaking if it appears to him that it is expedient in the public interest that he should do so instead of applying or proceeding with an application to court for a disqualification order. The option to accept undertakings is limited, however, to where disqualification is being considered under s 6 (insolvency and unfit director), 8 (following a company investigation) and 9A (breach of competition law).
An out of court procedure whereby a director accepts a binding undertaking not to act as a director for a defined disqualification period without the consent of the court, in lieu of being disqualified under the Company Directors Disqualification Act 1986 (as amended)