The Supreme Court has handed down an important judgment on the nature of a director’s fiduciary duty towards a company when they genuinely disagree with fellow directors as to the best route to achieving success for the company. Upholding the Court of Appeal’s decision, the Court held that the requirement of good faith under s.172 of the Companies Act 2006 imposes a fiduciary duty of loyalty on directors, meaning that a director cannot engage in conduct which subverts the management of the company and undermines the stated intentions of the board even if they genuinely believe it to be in the best interests of the company.

The case concerned the activities of Spring Media Investments Limited, a holding company for a group of companies which provides creative services to fashion, beauty, and luxury brands (the ‘Company’). For the relevant period, the chairman of the board of the Company was Francesco Costa who was not a shareholder himself but was described by the Court of Appeal as a “holder of substantial interest in the Company” by virtue of an investment vehicle and various investors which he had introduced to the Company and who were prepared to leave decisions relating to the Company to him. Saxon Woods Investments Limited (Saxon Woods) held the remaining 22.33% shares in the Company.

In 2016, a new shareholders agreement was signed providing, among other things, that each of the investors would “work together in good faith towards an Exit no later than 31 December 2019” and give good faith consideration to any opportunities for a sale prior to that date.

By November 2018, the board resolved the Company would hire an investment bank to commence the exit process, and that Mr Costa would take charge of the relationship with the bank.

Despite the terms of the shareholders agreement, Mr Costa had formed the view that the Company should not be sold until he could get a good price for it, and that that would not be until at least 2020. Therefore, as the High Court subsequently held, Mr Costa pursued a strategy of delaying a sale, which included conduct that meant the Company failed to give good faith consideration to an offer. Describing his conduct during this process, the High Court explained that “Mr Costa, at all times during the disposal process, seems to have taken the view that, as regards the disposal process, he was the Company. His primary focus at all times appears to have been to ensure that no director or shareholder…had any knowledge of or involvement in the Exit process”.

Ultimately no sale transpired, either at the end of 2019 as anticipated by the shareholder agreement, or thereafter, not least because of the devastating effects of the Covid pandemic on the Company.

Rather than pursuing a claim for breach of the shareholders agreement, Saxon Woods presented an unfair prejudice petition under s.994(1) of the Companies Act 2006, arguing that, in failing to perform the obligations contained in the shareholders agreement as a result of Mr Costa’s actions, the affairs of the Company had been conducted in a manner that was unfairly prejudicially to it.

The High Court accepted Saxon Woods’ argument that the Company had breached its obligations under the shareholders agreement, both in not working in good faith towards an Exit before the end of 2019, and in failing to give good faith consideration to offers. Such breaches were also held to have resulted in unfair prejudice to Saxon Woods.

The Court also held that the breaches were a result of Mr Costa’s actions since he had misled the Board. However, importantly for the purposes of the Supreme Court’s judgment, the High Court did not conclude that Mr Costa breached his fiduciary duties as a director.

Describing allegations of breaching director’s duties as “purely ancillary to the s.994 petition”, the High Court examined s. 172(1) of the Companies Act 2006, which provides that:

“[a] director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole…”

Having examined the case law on this provision, the Court explained that the duty in s.172 is a subjective one. Therefore, given that Mr Costa “sincerely believe[d] that he was acting in the best interests of the Company and its investors” by delaying a sale (describing his state of mind as “they wouldn’t like it now if they knew, but they will thank me in the long run”), the Court held that he was not in breach of s.172.

Both parties appealed various elements of the High Court’s judgment. However, the ground of appeal that is relevant for the purposes of the Supreme Court’s judgment is Saxon Woods’ contention that the judge should have found that Mr Costa breached his fiduciary duty under section 172 of the Companies Act 2006.

The Court of Appeal agreed, overturning the judgment of the High Court. In its view, the requirement of a director to act in good faith in s.172 includes a requirement that the director acts honestly towards the company. Citing a Supreme Court case from 2018 (Ivey v Genting Casinos (UK) Ltd [2017] UKSC 67), the Court of Appeal explained that the test of dishonesty is an objective one, requiring the court first to ascertain the state of the individual’s knowledge or belief as to the facts, and then to ask whether ordinary decent people would determine that their conduct is honest or dishonest.

In this case, the Court of Appeal explained that given that Mr Costa “had misled the Board and by doing so had concealed from them the fact that he was doing nothing to achieve a sale of the shares before 31 December 2019, and in fact was doing as much as he could to prevent it, could only have led to a finding that he was behaving dishonestly in the way explained in Ivey, and hence in breach of his fiduciary duty under section 172”.

In the Court of Appeal’s view, the High Court judge’s approach deprived the phrase “in good faith” of all its content and meaning, stating that, “on his approach, section 172 would work just as well if those words are simply deleted from it”. It also pointed to the some of the practical consequences if the alternative argument were to succeed, explaining not only that a director would not be in breach of his fiduciary duty if he deliberately misled the company, but also that he “could do anything provided that he (subjectively) considered that it was the course most likely to promote the success of the company for the benefit of its members as a whole. The director would be the sole arbiter of the best course of conduct to achieve that aim, and also of what constituted “success” for the company at that time”.

Mr Costa appealed to the Supreme Court, arguing that the Court of Appeal had erred in importing the test for dishonesty under the general law to the test for good faith under s.172. Again, he reiterated that the concept of good faith under s.172 was purely subjective. Furthermore, he argued that the way that the provision was drafted indicated that the requirement of good faith only related to the director’s state of mind, rather than his actions. Looking again at the provision, it states that:

“a director…must act in the way he considers, in good faith, would be…”

On Mr Costa’s case, the words ‘in good faith’ clearly qualify ‘he considers’ and not ‘must act’. Therefore, on his case, irrespective of how they act, so long as a director takes a decision in good faith, they will not be in breach of section 172.

Delivering the judgment of the Court, Lord Briggs accepted that a “rigorous application of grammatical rules” may favour the view that the requirement of good faith only governs the director’s thinking rather than his conduct. However, he explained that such an interpretation is not only inconsistent with the context and purpose of the Companies Act 2006, but would “be a recipe for chaos and paralysis in corporate governance, and destructive of the collegiality of the board of directors as a whole which all stakeholders in limited companies are entitled to expect”.

Furthermore, the Court held that such an approach is inconsistent with previous case law which stressed the core duty of loyalty owed by directors to the company. Disagreeing with the Court of Appeal that the case hinged on a general duty of honesty, the Court grounded its finding on the duty of loyalty at the heart of the requirement of good faith, and pointed to the fact that courts historically have not shrunk “from applying an objective test to determine, in any particular case, whether the fiduciary’s conduct fell short of the sometimes rigorous requirements of that duty. It was never enough for the fiduciary just to say that he genuinely believed that it did not”.

Upholding the Court of Appeal’s judgment, the Court stressed that its conclusion does not affect the longstanding principle that judges will not interfere with the views of directors as to what constitutes the best interests of the company, so long as those views are actually and genuinely held. In that sense, the test remains subjective, and the court will not intervene simply because it reaches a different objective view of what would have been in the company’s best interests. However, that deference only extends so far. A director cannot rely on their own genuinely held view of the company’s best interests to justify conduct that is objectively inconsistent with the fiduciary duty of loyalty owed to the company. In such cases, the Court held that judges are entitled, indeed duty-bound, to determine objectively whether the director has complied with that fiduciary duty, and an individual director will not “obtain carte blanche to seek to implement his dissenting view by any means, however covert or disloyal, he thinks necessary”.

To read the judgment in full, click here.