Directors’ Breach of Fiduciary Duty: Motivating Factors
If a company director issues shares with an ulterior motive that is found to be improper, they could face a successful claim for breach of fiduciary duty. Company directors are under a fiduciary obligation to exercise their powers in accordance with the company’s constitution and must exercise them only for the purposes for which they are conferred.
A recent ruling1 shows how this ‘purpose’ test turns on comparing the purpose of the power conferred and the primary (or ‘dominant’) purpose for which it was actually exercised. This duty is strict and does not require bad faith to be established.
What’s the background?
This was a complex case, but in simple terms - a compensation claim was brought by the liquidators of scientific research company against five directors for exercising their powers for an improper purpose, recklessly and in bad faith.
It was alleged that they “gerrymandered” a vote at the company’s EGM in order to defeat resolutions which were aimed at altering control of the board. The conduct complained of included (among other things) the issuance of 75 million ordinary shares to a new investor on terms which permitted deferred the £3m payment for up to two years (even though the company was in dire financial straits).
A couple of days later, the defendants issued a further 2,625,000 shares to another investor under a cash retainer on completion of a planned equity fundraising. Both the new shareholders voted against the resolutions to change the board, thus preventing a take-over.
In its claim, the liquidators said the defendants had pursued a dishonest strategy to maintain control of the board, breaching their statutory and fiduciary duties. Had the defendants not breached their duties, the board would have changed hands at the EGM and the company would not have gone into liquidation.
The High Court ruled that the directors had breached their statutory duties. They had become “desperate” in the search for an investor in order to defeat the resolution at the EGM but it was not open to them to issue shares for the purpose of converting a minority into a majority. This was – and was motived by - an improper purpose and in breach of their fiduciary duties – and one shared by all five of the directors.
What does this mean?
This ruling illustrates the significance of motivating factors involved in exercise corporate powers including fiduciary duties. If, as in this case, the motivation for a director taking a course of action under its powers is for an improper purpose – it can be struck down.
Directors’ powers are invariably wide-ranging but must always be exercised in accordance with the company’s articles and within the constraints of company law – in the interests of others. If in doubt, always take specialist advice from an expert corporate lawyer.
1TMO Renewables Ltd (in liquidation) v Yeo and others
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