All well and good until it goes wrong – directors duties and personal liability for the conduct of fellow directors

The recent case of Atkinson & Mummery v Kingsley and Smith [2020] EWHC 2913 (CH) scrutinised a director’s duty to promote the success of a company, as enshrined in section 172 of the Companies Act 2006.

Disputes between directors can and do happen regularly, and a common theme of such disputes is the use, or misuse, of a company’s money. When considering the use of a company’s money, particularly under circumstances where a company is experiencing financial difficulties, what constitutes promoting the success of a company is not entirely clear. 

Facts of the case

The relationship between two directors of a company, Mr Kingsley and Ms Smith, had deteriorated and part of the company’s business was in a loss-making position. As a result of the company’s financial position, the directors decided to wind down the business and divide any profits that remained.

The liquidators of the company issued proceedings against Mr Kingsley and Ms Smith to recover £83,000 which was transferred from the company’s bank account prior to the liquidation. At the time the transfer was made, the bank account did not require the signatures of both directors to transfer monies, and the transfer of the £83,000 was made by Mr Kingsley alone, without the knowledge of Ms Smith.

Despite the transfer having been made by Mr Kingsley without Ms Smith’s knowledge the liquidators only pursued a claim against Ms Smith, as the liquidators became aware during proceedings that Mr Kingsley had been declared bankrupt.

The liquidators believed that £83,000 payment was made for no consideration and was therefore unlawful. Furthermore, the liquidators argued that because of the severe breakdown of the relationship between the directors, Ms Smith failed to promote the success of the Company by putting in place arrangements to prevent Mr Kingsley from transferring funds from the company’s bank account without her authorisation. Ms Smith’s failure to prevent the transfer was alleged to have breached the duty to promote the success of the company under section 172 and the duty to exercise reasonable care, skill and diligence in under section 174. Ms Smith stated the payment was in fact a lawfully declared and paid dividend. 

Decision of the High Court 

The Court disagreed with the liquidators.

The test for determining if a director has complied with the duty to promote the success of the company is subjective, therefore the court was required to consider whether or not Ms Smith had honestly believed that not restricting Mr Kingsley’s ability to transfer funds without her approval was in the best interests of the company. Ms Smith had not considered this at all.

It was left to the court to apply an objective test instead, which considered whether or not an honest and intelligent person in Ms Smith’s position would have left Mr Kingsley in a position where he could transfer funds from the company’s bank account without restriction.

In the judge’s view, there was no evidence that the deterioration of the relationship between the directors had affected their mutual trust sufficiently to justify restricting access to the company's bank accounts. Mr Kingsley had not abused his access the company's bank accounts previously.

Even if Ms Smith had been found to have breached her duty to promote the success of the company, the judge stated that she ought to be excused because she had acted honestly and received no benefit from the payment. 

Implications of the decision

Cases on breaches of directors’ duties are often fact-specific.  It is therefore difficult to draw too many conclusions from them. However, this case demonstrates that whilst it is helpful to record directors’ considerations that they have complied with their duties under the Companies Act 2006, a failure to do is not necessarily give rise to a breach of such duties.

There are two tests when assessing whether or not a director has breached his or her duties under the Companies Act 2006:

1. A subjective test – based on the information available, did the director honestly believe that they were acting in the best interests of the company and its shareholders?
2. An objective test – would an honest and intelligent person have taken the same actions to comply with their duties? This ensures that directors cannot simply ignore things and absolve themselves of responsibility.

The objective test applied by the court does create a higher standard for company directors to meet in the event they do not actively consider their duties under the Companies Act 2006, but it does not require an investigation into whether a director was on notice or aware of a potential misapplication of company funds.

Despite the High Court’s ruling, the case highlights the importance of being alert to possible misconduct by fellow directors. If a company director becomes aware of any facts, matters or circumstances which give rise to a concern that a fellow director may misuse company funds, or otherwise act in a way which may harm the interests of the company or its shareholders, such concerns must be documented and advice should be sought on the best steps to take to mitigate against potential personal liability for the independent acts or omissions of fellow directors.  In the current climate shareholders and directors should also consider reviewing existing shareholder agreements or where they have no agreements already in place, putting in place agreements to govern their conduct and relationship as shareholders and directors of the company.