At a directors meeting attended by Ann, Bob, Dotty and Evan, with Frank attending by telephone, the directors passed the following resolutions.

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1 Corporate Law practice questions Question 2 2. Clutch plc is a car supermarket company. Ann, Bob, Dotty, Evan and Frank are its directors. Ann is the Operations Director, Bob is the Purchasing Director, Dotty is the Finance Director and Evan and Frank are non-executive directors. Between them the directors own 55% of the shares in Clutch plc. Grow LLP owns the remaining 45% of the shares. At a directors meeting attended by Ann, Bob, Dotty and Evan, with Frank attending by telephone, the directors passed the following resolutions. (i) (ii) (iii) The directors resolved to dispose of drums of contaminated oil using the services of Slick, a sole trader whose prices were 25% of those of two other companies who had quoted for the work. Ann, who recommended Slick s quote to the other directors, joked that he may well be dumping the barrels offshore for all she knew, but as the price was right, that was his business. Frank could be heard snoring at the end of the phone and when he was woken up to vote on the waste disposal resolution, he simply said, Yes, yes, whatever Ann thinks is best. Bob had been approached by Moon plc which offered him 100 brand new Moonie GTs, a model of car proving very popular with young drivers, for 600,000, an excellent price. Bob recommended the purchase to the directors and the directors resolved to authorise Bob to contract with Moon plc for Clutch to buy the cars, which Bob subsequently did. Finally, the directors resolved to guarantee the repayment of a 10,000 loan from Hard Bank to Dotty. Dotty did not vote on this resolution. When the Moonie GTs were delivered they were found to be left-hand drive vehicles which are unsuitable for use in the UK. An article in Green Daily has identified Clutch as the source of oil drums found floating in the Irish Sea which caused an oil slick and significant environmental contamination. Clutch s reputation has been damaged and its sales have fallen. Bob and Ann were embarrassed and their fellow directors were angry with them but as the contracts had been approved by a resolution of the directors, a general meeting was called to pass a resolution ratifying the conduct of the directors in relation to the waste disposal contract and the Moonie GT purchase contract. Grow LLP voted against the ratification resolution but the resolution was recorded as approved based on the 55% of votes cast in favour of it. Grow LLP is very unhappy. Required Advise Grow LLP of Clutch plc s rights and whether or not Grow LLP would be able to enforce those rights.

2 Question 2 commentary and indicative answer The material relevant to answering this question is covered in the ICSA Study Text in chapters 12 & 13 on directors duties and minority shareholder protection. The rubric of this question first requires you to advise Grow LLP of Clutch plc s rights. The facts depict a number of breaches of the general duties owed by a director to the company with all five directors potentially in breach. The company guarantee of the bank loan to Dotty also raises the question of compliance with the Companies Act 2006 s As directors owe their duties to the company (s. 170(1)) and not to the shareholders, the company is the proper claimant. Enforcement of the rights of the company is a problem because the wrongdoers are in control of the organs of the company with the power to commence legal proceedings on behalf of the company: the board (article 3) and, in default, the general meeting. The unwillingness of those in control to cause the company to enforce its rights is underlined by the passing of a resolution purporting to ratify the conduct of the directors in relation to the cars and disposal of the oil drums. This raises the question who else may be able to enforce the company s rights? Together, the rubric and the facts suggest division of the answer into two parts: the wrongdoings by the directors the availability of a mechanism by which a shareholder is able to enforce the rights of Clutch plc (the statutory derivative action in the Companies Act 2006 s. 260) Wrongdoings by the directors When considering wrongful behaviour by directors, be sure to consider not only the general duties (s & 182), but also the sections of the Companies Act 2006 dealing with specific types of contracts/arrangements between a director and the company. The main sections are the Companies Act 2006 ss. 190 (substantial property transactions), 197 (loans to directors & guarantees), 188 (long term director service agreements) & 215 (payments for loss of the office of director)). It is often helpful to deal with the sections governing specific types of transactions first. The remedies available for non-compliance with these sections are set out in the 2006 Act and are very broad. When considering how to structure your answer to a question involving breaches of directors duties it is often a choice between dealing in turn with: particular individuals/directors each scenario or contract within the question individual legal duties or sections of the 2006 Act dealing with particular transactions or adopting a structure reflecting a mixture of two or all of these. It is rarely a good idea to write an answer in which you take each legal duty in turn and consider whether or not it has been breached. This is, however, necessary as part of planning your answer as it enables you to be confident that you have checked all duties and not omitted to mention any important ones. Also, when planning, be sure to take each director in turn and consider his or her particular behaviour even if you decide to structure 2

3 your answer around the factual scenarios. A good approach to this question is to deal with each of (i), (ii) and (iii) in turn. When considering whether particular behaviour amounts to a breach of duty or not, having considered each relevant duty in turn select the most appropriate duty or duties and focus on it or them, dealing with them in detail. Do not write generically about there being a breach of directors duty without linking it to one (or more) directors. State the duty accurately and identify precisely what needs to be established to argue successfully that the duty has been breached. For example, do not simply write, Bob is in breach of the duty in s. 174, or, Bob is in breach of the duty of care and skill. When considering the duty in s. 174 you need to specify that it is a duty requiring a director to exercise reasonable care, skill and diligence. This should be explained as meaning the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by that director in the company. You should also point out that the general knowledge, skill and experience that the director under consideration actually has may enhance expectations and require a director to do more than a person who does not have his knowledge and experience, to satisfy the duty. The limited knowledge or experience of a director can never be relied upon to dilute expectation below the objective standard Having stated the duty clearly and specifically, identify the facts (the behaviour of the director) that might amount to a breach of that duty. For example, Bob, the Purchasing Director, purchased 100 cars at a cost of 600,000 without checking that the steering wheel was on the right had side of the car, or that the vehicles were appropriate for driving in the UK. This level of attention to detail falls short of the care, skill and diligence that would be exercised by a reasonably diligent person in Bob s position in the company, i.e., the purchasing director of a company engaged in the business of buying and selling cars. Unless the rubric indicates otherwise, you should also consider the remedy available for each breach you identify. Remember that section 178 confirms that the remedies for breach of the general duties are not set out in the 2006 Act, but are found in case law, and that the general duties are fiduciary in nature with the exception of s. 174, which is a common law duty. Advising Grow LLP first on the legal rights of Clutch plc in relation to the waste services contract with Slick, Ann has played a particular role. She appears to have managed the waste disposal services procurement process and has selected a preferred contractor and recommended to the other directors that the company use him, on the basis of which, all five directors have voted to use Slick. There is no evidence that the directors considered the environmental implications of their decision and there is evidence that Frank was not paying attention to any of the information about the contract. Frank simply relied completely on Ann s judgement without exercising any judgement of his own when voting to approve the resolution. The key duties to consider in relation to these facts are found in ss. 172, 173 & 174. Section 172 contains the duty of a director to act in good faith in what he considers would be most likely to promote the success of the company for the benefit of its shareholders as a whole. In doing so a director must have regard to six listed matters (amongst others, i.e., the list is not exhaustive). Subsection 172(1)(d) identifies the impact of the company s operations on the community and the environment as a matter to which directors must have regard. The failure of all five directors to consider the environment is a breach of s. 172 by each of them. 3

4 In addition to breaching s. 172, none of the directors appears to have exercised reasonable care or skill in deciding with whom to contract for waste disposal services. No director appears to have asked any questions. In particular, the suspiciously low pricing of Slick s services does not appear to have prompted any enquiry into his methods of disposal of what the directors should have known was environmentally hazardous material. Accordingly, all five directors appear to have breached s The duty in s. 173 to exercise independent judgment appears to have been breached by Frank. He has stated that he will support whatever decision Ann thinks is best. Although a director is entitled to rely on another director s expertise, he must demonstrate reasonable care and skill in assessing the expertise of the other director and assuring himself that the other person is using his or her expertise. Ann s comment about where the drums end up could be interpreted as sufficient to put Frank, and the other directors, on notice that Ann herself has not addressed her mind to the environmental impact of Slick s methods or taken reasonable care. Accordingly, neither Frank or any other director is able to argue successfully that to the extent that he relied on Ann s judgment, he was entitled to do so and was acting in accordance with s. 173 (see Re Barings plc No 5). The purchase of the Moonie GTs was also approved by all the directors, this time following a proposal by Bob. As with the waste disposal services, the price was good but there was a problem with another aspect of the contract, specifically, the description of the cars to be delivered. Again, the duties to consider are those found in ss Bob is clearly in breach of s. 174 (see analysis set out above). It is not clear that the other directors are in breach of s They could argue that they were entitled to expect Bob to have and use a level of expertise and skill in contracting to buy cars at least equal to that to be expected of a Purchasing Director in a car supermarket company and consequently were under no duty to read the contract terms themselves. They would run a similar argument, i.e., the right to rely on Bob s expertise, to avoid any question of liability under s.173. Unlike the situation with the waste disposal, there were no facts or circumstances alerting the other directors to the need to question Bob s decision or to suspect that Bob would demonstrate reasonable care and skill. The application of s. 172 is more straightforward in relation to the car contract because none of the matters listed in the section are of particular relevance. The question to determine whether or not the duty has been breached is, taking each director in turn, did he or she act in good faith in what he or she considered would be most likely to promote the success of the company for the benefit of its shareholders as a whole. The test is believed to be wholly subjective (Regentcrest plc v Cohen), making it very difficult to establish breach in the face of directors testifying that they believed their actions would promote the success of the company. The guarantee of the 10,000 loan to Dotty without securing an ordinary resolution of the shareholders looks at first blush as if it is a contravention of s However, loans up to and including 10,000 fall outside the section (s. 207). This leaves the situation to be governed by the general duties and the articles. Dotty has complied with Model Article 14 by not voting on a resolution in which she has an interest. The granting of the guarantee does not put Dotty in breach of s. 175 because s. 175(3) states that the duty to avoid a conflict of interest does not apply to any conflict of interest arising in relation to a transaction or arrangement with the company and Ann s conflict arises here out of the guarantee. The duty of Dotty to declare her interest to the other directors pursuant to s. 177 is not engaged as the other directors were aware of her interest. This excuses her from the obligation to declare her interest (s. 177(6)(b)). 4

5 In addition to the potential liability of the director benefiting from the loan (Ann), the liability of the other directors must be considered. The duties potentially breached are those in ss. 172 and 174. The subjective nature of the duty in s. 172 will make it very difficult to establish a breach (see above). That leaves s Insufficient facts are given to reach a conclusion as to whether or not the four directors who voted to approve the guarantee exercised reasonable care and skill in arriving at their decision to support the resolution approving the guarantee. The validity of the attempted ratification of the breaches in (i) and (ii) above would need to be considered. This requires analysis and application of s. 239 to the facts. The votes of a shareholder whose behaviour as a director is being ratified are disregarded (s. 239(4)). The ratification is therefore ineffective. Grow LLP enforcing the rights of Clutch plc Having advised on the potential breaches of duty, compliance with s. 197 and the effect of the purported ratification, the next issue to consider is Grow LLP s ability to enforce Clutch plc s rights. This requires consideration of the basis of a s. 260 derivative action and process and factors to be considered by a court in deciding whether or not to consent to the claim continuing. A little background is useful if you have time, such as explaining that as directors duties are owed to the company, the proper claimant for breach of duty is the company (Foss v Harbottle). The common law exception to this rule found in Cook v Deeks, where there was fraud on the minority and the wrongdoers were in control of both the board and the general meeting, has now been put on a statutory basis, in s. 260 Companies Act The conditions to be satisfied to bring a derivative action are that Grow LLP must be a shareholder, which it is. Grow LLP must be able to plead a case supporting a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by one or more directors of the company (s. 260(2)(b)), which it can plead based on the breaches outlined above. After drafting and issuing the claim, Grow LLP must apply to the court for permission to continue the claim (s. 261(1)). The court must refuse permission to continue the claim in three situations: if there is no prima facie case for giving permission (s 261(2)) (the facts indicate that there is), if the behaviour complained of has been ratified by the company (the ratification here is ineffective), or if a director acting in accordance with s. 172 would not seek to continue the claim (s. 263(2)). If permission is not refused for one of these reasons, the court must include in its consideration of whether to grant permission or not (s. 263(3)), the good faith of Grow LLP (which is not an issue on the facts), the importance attached to continuing the claim by a s. 172-compliant director, any ratification (none); whether the company has decided not to pursue the claim (the wrongdoing directors are not able to make this decision) and whether or not Grow LLP has a personal cause of action it could pursue (for example, a s. 994 application). Also, s. 263(4) requires the court is to have particular regard to views of members who have no personal interest direct or indirect in the matter (but no such shareholders exist on the facts). The two key factors to consider in more detail are how the courts apply the s.172-compliant director test and whether the court would consider it to be more appropriate for Grow LLP to pursue a s. 994 petition. Case law indicates that the question the court should ask at the first stage, to determine whether or not it must refuse consent is whether no director acting in compliance with s. 172 would seek to continue the claim (Franbar Holdings v Patel and Iesini 5

6 Westrip Holdings Ltd). This means that few cases will be refused permission for this reason. The s. 172-compliant director comes in again, however, when the court considers the importance such a director would attach to continuing the claim. Little guidance currently exists on how courts will approach this question. The value of the claim to the company will be important and we are not given sufficient evidence to decide what this is. In relation to the oil drums, for example, the company s liability for any clean up, whether it has insurance to cover its liability and the ability of any of the directors to pay any judgments against them in favour of the company will all be relevant. In relation to the cars, the loss made and the ability of the directors to compensate the company for this loss will be relevant. Similarly, little guidance exists in relation to when a court might refuse consent due to the claimant (Grow LLP) being able to petition the court under s Accordingly, it is not possible to advise with certainty on the given facts whether or not Grow LLP would be permitted to continue a claim. ICSA,