Comfort to directors making commercial decisions when company faces financial problems

Prior to its liquidation, Regentcrest Plc ("Regentcrest") carried on, through a large number of subsidiaries, the business of property development. Mr Don Richardson ("DR") and his brother Mr Roy Richardson ("RR") acquired a 29.9% interest in Regentcrest in 1985 and at that time became directors of Regentcrest. In 1988, by share sale agreement (the "Agreement"), Regentcrest acquired all the issued shares in Greenground Limited ("Greenground"), which was effectively a single asset company. The asset was a piece of development land valued for the purposes of the Agreement at £4.25 million (the "Development Land"). The vendors of the Greenground shares were Mr Cohen, Mr Scott and Mr Farley. Scott and Farley were also directors of Regentcrest. Cohen was a former shareholder and former director of Regentcrest. The Agreement contained machinery for an adjustment of the consideration for the Greenground shares by reference to any change in the net asset value of Greenground on practical completion of the proposed development (in effect, any change in value of the Development Land) as compared with its net asset value as at the date of completion of the Agreement. In the event of a decrease in the net asset value of Greenground, the vendors of the Greenground shares were liable to repay to Regentcrest the amount of the shortfall in cash. This was known as the "clawback" provision. Although the proposed development never took place, practical completion was deemed to have occurred on 15th August 1990 by which time it was calculated that the value of the Development Land had fallen by £1.5 million since completion of the Agreement. Accordingly, Regentcrest had a potential claim of £1.5 million against the vendors of the Greenground shares: Cohen, Scott and Farley.

By early 1990 Regentcrest was in severe financial difficulties and in May 1990 the Richardson brothers acquired all the remaining issued shares in Regentcrest for a cash consideration of £5.7 million. In June 1990 the Richardson brothers injected £2 million of their own resources into Regentcrest on an unsecured basis and in August 1990 they injected a further £3 million of their own resources. In each case the injection of cash was to help Regentcrest meet its cash flow difficulties. At this time, RR was in negotiations with Regentcrest's creditor banks in an attempt to obtain breathing space on the repayments of its loan facilities. Throughout this period the directors of Regentcrest were DR, RR, Scott and Farley.

On 5th September 1990 a board meeting of Regentcrest was held where it was resolved that in consideration of Scott and Farley, with the assistance of Cohen, carrying out for the next three years such duties as Regentcrest might require, Regentcrest would waive all claims against them under the Agreement, including the clawback claim. Due to their obvious conflict of interest, Scott and Farley took no part in proceedings at the meeting and did not vote on the resolution. The Richardson brothers voted in favour of the resolution which, as the meeting was quo rate, was accordingly carried.

RR continued to negotiate with the Banks. However, the negotiations proved unsuccessful and on 21st November 1990, a compulsory winding up order was made against Regentcrest. The liquidators brought various actions concerning the Agreement. However, by the time the case reached the High Court, the liquidators' claim was limited to a claim against DR for damages for breach of fiduciary duty as a director of Regentcrest in voting in favour of the resolution to waive the clawback claim.

Arguments of the Parties

The liquidators claimed that, as a director of Regentcrest, DR owed Regentcrest a fiduciary duty to act honestly and with the utmost good faith and at all times in the interests of Regentcrest and to use his best endeavours to promote the interests of Regentcrest. They argued that the resolution to waive the clawback claim was to DR's knowledge not in the interests of Regentcrest because it was passed at a time when the directors of Regentcrest knew that:

(a) Regentcrest was insolvent and was not going to be able to continue trading;

(b) there was no real prospect of the vendors of the Greenground shares or any of them carrying out duties for Regentcrest for 3 years (in other words, the consideration given for the waiver of the clawback claim was worthless);

(c) the value of such services provided by the vendors could not possibly have amounted to adequate consideration for the waiver;

(d) the vendors had no claims against Regentcrest under the Agreement; and

(e) the waiver made no commercial sense from Regentcrest's point of view as it only benefited the vendors.

In his defence, DR argued that when voting on the resolution to waive the clawback claim he honestly believed that he was acting in Regentcrest's best interests. At the time of the board meeting on 5th September 1990, the directors had every hope that Regentcrest would continue trading. Notwithstanding that Regentcrest was technically insolvent on 5th September 1990, DR believed there were good commercial reasons for voting in favour of the waiver of the clawback claim. He argued that the Richardson brothers had recently injected £5 million of their own resources into Regentcrest, that every effort was being made to enhance the financial position of Regentcrest and these efforts continued after the 5th September 1990 (for example attempting to delist Regentcrest shares with a view to increasing the flexibility of the company and facilitating the provision of continued financial support for Regentcrest) the prospects of recovery under the clawback claim were minimal due to the financial standing of the vendors and their intention to defend any claim and that on 5th September 1990 it was in Regentcrest's best interests that Scott and Farley continue to serve on the Regentcrest board.

Held

Parker J stated that the duty imposed on directors to act bona fide in the interests of the company is a subjective one. Accordingly, the question to be decided was whether the director honestly believed that his act or omission was in the interests of the company. The question was as to the director's state of mind not whether, viewed objectively by the court, the particular act or omission was in fact in the interests of the company. In particular, it was not relevant whether the court, had it been in the position of the director at the relevant time, might have acted differently. Parker J did however state that where it was clear that the act or omission under challenge resulted in substantial detriment to the company, the director would have a harder task persuading the court that he honestly believed it to be in the company's interests. However, this was not enough to detract from the basic subjective nature of the test.

Parker J was clearly mindful of the dangers of applying hindsight. He took into account the fact that the relevant period was extremely fraught so far as Regentcrest was concerned and that the board were attempting to minimise expenditure and were continually negotiating with the banks in an attempt to give Regentcrest breathing space. He considered that it was too easy to analyse the situation after the event and to pick over specific decisions taken at the time without making proper allowance for the exigencies of the moment. The fact that the Richardson brothers had invested £5 million into Regentcrest during the period together with the negotiations with the banks indicated that they were completely committed to the survival of Regentcrest. RR had negotiated with the banks with the aim of achieving a relaxation of their payment requirements and it was only when Den norske Creditbank Plc persisted in its demands for an immediate capital repayment of £500,000 that RR decided not to support Regentcrest any further. This point was not reached until 28th September 1990. Parker J considered that until that time RR was willing to support Regentcrest.

It followed that on 5th September 1990, when the board resolution to waive the clawback claim was passed, the Richardson brothers had not walked away from Regentcrest. At that date, they remained willing to support Regentcrest and were working together with the rest of the board to try to ensure its survival as a going concern. Parker J held that although the board recognised that despite all their efforts Regentcrest might nevertheless fail, they genuinely believed that there was "at the very least a real chance" that negotiations with the banks would be successful and Regentcrest would survive the current crisis and be able to carry on trading. On that basis Parker J considered the board resolution of 5th September 1990.

In giving evidence, DR had acknowledged that he had relied on his brother's assessment of the background to, and the reasons for, the waiver of the clawback claim. However, he had made it clear, and Parker J accepted, that the decision he took to approve the waiver was his own decision and the reasons for reaching that decision were his reasons and not those of his brother. Parker J considered that the evidence suggested that the Richardson brothers thought that there were good commercial reasons for the waiver of the clawback claim.

In assessing the commerciality of these reasons, Parker J attempted to ignore hindsight and place himself so far as possible in the directors shoes as at 5th September 1990. He considered that there was clear commercial benefit to Regentcrest in retaining the services of Scott and Farley free of charge on a formal basis for the specified period of three years due to their knowledge and experience in seeking to realise the various properties in the Regentcrest Group's property portfolio. Although they were already working for Regentcrest free of charge, there was nothing to say that situation would have continued had the Richardson brothers decided to pursue the clawback claim against them.

In addition, Parker J clearly felt that the Richardson brothers had no detailed knowledge of the financial circumstances of any of the vendors as at 5th September 1990 and the information available to RR raised at the very least a question mark as to the vendors' ability to meet any judgement. It was unrealistic at that stage to have expected RR to undertake a detailed investigation into the financial circumstances of the vendors. The fact that the vendors had indicated that they would defend any action brought against them on the clawback claim added a further element of uncertainty to the situation.

However, the most decisive consideration in both the minds of the Richardson brothers in deciding whether there was commercial benefit to the waiver, was the need to maintain a united board in the face of bank and creditor pressure. Parker J also considered this to be the major factor. The prospect of a split board, with two of the directors, Scott and Farley, being sued by the company, could have been the last straw so far as the banks and creditors were concerned, leading to the collapse of the ongoing negotiations with the banks and any attempts to save Regentcrest. Parker J held that the need to avoid litigation against two of Regentcrest's directors was a weighty consideration and one which could reasonably have led a businessman in the position of the Richardson brothers on 5th September 1990 to conclude that the waiver of the clawback claim was in the interests of Regentcrest, notwithstanding that the information before the board as to the vendors' ability to meet any judgement was far from complete.

Accordingly, Parker J held that in voting in favour of the resolution to waive the clawback claim on 5th September 1990, DR honestly believed he was acting in the best interests of Regentcrest and was not trying to protect the vendors, in particular Scott and Farley, in the event of the liquidation of Regentcrest. The claim for damages for breach of fiduciary duty against him therefore failed.

Comment

Directors should beware of taking this decision as carte blanche to act as they like, thinking that if they plead it was their honest belief that an act or omission was in the best interests of the company, the Court will subsequently sanction their actions. It seems that Parker J was influenced by the commitment, in particular financial commitment, which the Richardson brothers had shown in attempting to achieve the survival of Regentcrest as a going concern. However it would appear, and Parker J stated as much in his judgement, that the court will take a more sceptical view of what a director honestly believes, if it appears to the court that the director's act or omission actually resulted in substantial detriment to the company. In addition, an honest belief that he is acting in the best interests of the company will only be a defence to an action for breach of fiduciary duty. It will not protect a director from, for example, claims against him for acting for a collateral purpose, negligence or under the wrongful trading provisions of the Insolvency Act 1986.

For more information, contact Steve Hair in CMS Cameron McKenna's Corporate Recovery Team at [email protected].