Honest belief is not enough: the Supreme Court clarifies directors’ duties

Directors must meet objective standards of good faith to discharge their duty under section 172 Companies Act 2006 and cannot simply rely on honest belief.

The Supreme Court handed down judgment in the Saxon Woods v Costa unfair prejudice litigation on 14 July. This is the first time the Supreme Court has considered the scope of a director’s duty under section 172(1) of the Companies Act 2006 (“the Act”) to act in the way they consider, in good faith, would be most likely to promote the company’s success for the benefit of its members as a whole.

In a decision which should be of interest to directors and shareholders alike, the Supreme Court has confirmed that whilst subjective belief matters, the test is broadly an objective one. A director cannot hide behind an honest belief if their conduct falls short of the objective standards of good faith. 

Background

The litigation concerned a shareholders’ agreement which specified that the parties must act in good faith towards an exit/sale by the end of 2019. Mr Costa, the majority shareholder and director responsible for negotiating the sale, believed that delaying the sale beyond 2019 would generate a better financial return and adopted various tactics to achieve that objective, including excluding other directors from the process and misleading the board about instructions given to the company’s advisers. The subsequent COVID pandemic destroyed the value of the company and the prospect of a profitable exit.

The minority shareholder, Saxon Woods, presented an unfair prejudice petition against Mr Costa for acting in breach of the shareholders’ agreement and in breach of his statutory duties.

The High Court held (and the Court of Appeal agreed) that although Mr Costa was motivated by the reasonable view that a better price could be sought for the company if a sale was delayed, his conduct was unfairly prejudicial to the minority shareholder in that it deprived shareholders of the opportunity to try and achieve a sale of the company, in breach of the shareholders’ agreement.

However, the High Court also held that Mr Costa’s conduct in delaying the sale did not constitute a breach of his duties as a director under section 172 of the Act, because he subjectively believed that he was acting in the best interests of the company.

The Court of Appeal disagreed, finding that whether a director has acted honestly requires both a subjective test of the director’s actual belief, and an objective test as to whether an ordinary person would determine the director had acted dishonestly. On the facts, Mr Costa had misled the Board and concealed the fact that he was attempting to prevent the sale of the company, which constituted objectively dishonest behaviour (notwithstanding his honest belief that it was in the best interests of the company). An honestly held belief that delaying that exit was in the company’s best interests was no defence.

The Court of Appeal granted a buy-out order, requiring Mr Costa to buy the petitioner’s shares, valued on the basis of a pro rata proportion of the value of the company (with no minority discount) had the agreed exit been achieved in 2019.

Mr Costa appealed to the Supreme Court, on the basis that his duty under section 172 of the Act was purely a subjective one, and that he had not acted in breach because he honestly believed he was acting in the company’s best interests.

The Supreme Court’s decision

The Supreme Court has rejected that argument and unanimously dismissed Mr Costa’s appeal.

Their decision reinforces the general rule that the Court will not interfere with the business judgment of the board provided that their belief is genuine – even if it conflicts with the objective view of what is in the company’s best interests – and to that limited extent there is a subjective element to the test. But a director’s duty to promote the success of the company must be viewed in the context of whether their conduct was objectively (in the view of the hypothetical reasonably well-informed observer) in good faith. In this case, the breach of duty lay in Mr Costa’s covert attempts to mislead the board, regardless of his motives for doing so.

The decision serves as a reminder for directors of their duties to the company, and may offer minority shareholders further grounds to challenge unfairly prejudicial conduct by the majority.