High Court: When does a Director owe a duty of care to a Shareholder?

HHJ Paul Matthews sitting in the High Court has handed down the highly anticipated judgment in Carmela De Sena v Joseph Notaro and others [2020] EWHC 1031 (Ch) regarding directors and when they may owe a fiduciary duty to shareholders.

Background

Carmela (the first claimant), her sibling Joseph (the first defendant) and other family members were shareholders and directors of their family business in the property industry. The business was established by their father and incorporated in 1965 as S Notaro Limited (the “Company”). When the father passed away in 1993 Joseph became the managing director of the company.

On 28 April 2011 the Company underwent a corporate demerger. The effect of the demerger was that the first claimant gave up her shares in the Company, and assets of the Company or its subsidiaries were transferred to the second claimant (Meltor Developments Limited), a company formed for the purpose, owned and controlled by the first claimant.

What was the basis for the claim?

The claim against the first and second defendants (the Company) was that the demerger, and therefore the acquisition of the first claimant’s shares in the Company was procured by undue influence of the first defendant, who also acted in breach of fiduciary duty towards her, and that the second defendant has been unjustly enriched at the expense of the first or alternatively the second claimant.

The claims against the third defendant (a firm of accountants) and the fourth defendant (a firm of solicitors) are that, in relation to the demerger they acted in breach of contract (fourth defendant only), breach of fiduciary duties and of a duty of care owed to the first claimant, and in breach of a duty of care owed to the second claimant.

Carmela argued that as a result of this that she should be able to set-aside the demerger (so as to return to her previous position as a shareholder in the family business) and/or receive financial compensation.

What is a fiduciary relationship?

A fiduciary relationship arises between two parties (A) and (B) under common law where A and B agree that A will act on behalf of or for the benefit of B in circumstances which give rise to a relationship of trust and confidence. A clear example of a fiduciary relationship therefore is that of between a director and a company.

Under equity, directors have owed fiduciary duties to their companies. Chapter 2 of Part 10 of the Companies Act 2006 (CA 2006) codifies some of their duties. The relevant statutory duties under the CA 2006 are:

• To act within powers.
• To promote the success of the company.
• To exercise independent judgment.
• To avoid conflicts of interest.
• Not to accept benefits from third parties.
• To declare an interest in a proposed transaction or arrangement.

What is undue influence?

Undue influence arises where a relationship exists between two parties where there is trust and confidence, reliance, dependence or vulnerability on the one hand, and ascendancy, domination or control on the other (Royal Bank of Scotland Plc v Etridge (No 2) [2002] 2 AC 773). The doctrine of undue influence is over 200 years old.

What is unjust enrichment?

For a claim of unjust enrichment, it is not simply enough for the claimant to show that the defendant has been enriched, it must have been an ‘unjust’ enrichment.

The “unjust factors” recognised by the courts include the following:

• The transfer of the benefit may be involuntary. For example, money may be paid by mistake.
• The benefit (usually money) may have been transferred to the defendant in return for a consideration that has totally failed.
• The benefit (usually services or goods) may have been transferred to the defendant at his own request.
• The defendant may have been enriched as a result of his own wrongdoing.

What was the judgment by the court?

On the primary claim of undue influence the main allegations are that the first defendant became increasingly controlling after 1993, in 2003 started a campaign to expel the first claimant from the Company, in 2007 proposed a demerger, in 2010 told the first claimant she would have to leave the Company, and put pressure upon her until she agreed to the first defendant’s terms. HHJ Matthews held:

The business relationship between shareholders is not the same as a relationship between family members and should not be judged as if it were. In my judgment, it does not make any difference that the first claimant was handling the family litigation on behalf of herself and the first defendant. In any event, the first claimant was not a timid housewife, inexperienced in business. On the contrary, she was an experienced businesswoman, used to dealing with professional advisers in relation both to the corporate business and to her personal affairs. In my judgment the first claimant has not proved any conduct on the part of the first defendant which can properly be regarded as acts of improper or illegitimate pressure or coercion. This was a case of a hard negotiation by experienced business people in a commercial transaction, and nothing more. As a result, the claim in undue influence must fail.

HHJ Matthews, para 218

On the secondary claim of a breach of fiduciary duty the problem for the first claimant was to show that the first defendant, as a fellow director and shareholder, owed fiduciary duties, not only to the
company, but also to her. In HHJ Matthews judgment he held:

This head of claim fails at the first hurdle, because the first claimant is unable to show that the first defendant owed her (as opposed to the company) any fiduciary duties. As the authorities examined earlier show, no such duties arise by virtue of the mere fact of the first defendant’s being a director, but only because there is a ‘special relationship’ between the director and shareholder.

HHJ Matthews, para 234

Was there a ‘special relationship‘?

Almost always in those cases where such a ‘special relationship’ is found to exist, the
claimant is not a fellow director, but simply a fellow shareholder of the defendant,
and there is a serious imbalance in power and access to information. That is not this
case.

On the final claim of unjust enrichment HHJ Matthew held:

The claims in unjust enrichment against the second defendant were consequential on the substantive claims against the first defendant. Without the wrong of the undue influence there would be no unjust enrichment. So in the circumstances that the claim in undue influence fails they too fall away.

HHJ Matthew, para 242

What does this judgment mean for directors?

The court’s judgment in this case shows a reluctance to impose fiduciary duties in commercial transactions, unless properly justified. It also provides an entirely conventional approach to determining when fiduciary obligations will arise, outside the well-established relationships. The key requirement is the existence of a relationship giving rise to an (objectively judged) expectation that the fiduciary will not use its position in a way that is adverse to those of its principal.

You can read the full judgment here.

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