Good intentions aren't good enough: Saxon Woods Investments Limited v Francesco Costa and the objective test for directors under section 172 of the Companies Act 2006

The proceedings concerned an unfair prejudice petition under s.994 of the Companies Act 2006. Saxon Woods Investments Ltd ("Saxon Woods"), a minority shareholder holding 22.33% of the shares in Spring Media Investments Ltd (the "Company"), brought the claim against Mr Costa, the chairman of the Company, who held his own substantial indirect interest through investment vehicles.

Central to the dispute was a shareholders' agreement, between the Company's shareholders and the Company itself (the "SHA"), which required all parties to work towards a sale of the Company by 31 December 2019. A financial advisor was appointed to lead the exit process, with several potential buyers identified. However, Mr Costa, acting as the primary point of contact with the financial advisor, misled the board so as to delay the exit process until 2020, in the belief that doing so would create more value for the Company and its shareholders. The subsequent COVID-19 pandemic then significantly reduced the value of the Company's shares.

Saxon Woods subsequently brought a claim for unfair prejudice, alleging that Mr Costa’s actions not only caused the Company to breach its obligations under the SHA (by obstructing the agreed exit), but also breached his fiduciary duties under s.172.  However, Mr Costa's position was that he had been acting in the best interests of the Company by delaying the sale in the belief that it would ultimately create greater value.

High Court

At first instance, the High Court found in favour of Saxon Woods and held that the Company's affairs had been conducted in a way that was unfairly prejudicial. Mr Costa had caused the Company to breach its obligations under the SHA, including by not working in good faith towards an exit, and that breach resulted in unfair prejudice to Saxon Woods.

However, in respect of the question of the alleged breach of duty under s.172, the Court ruled that the test remained subjective; insofar as Mr Costa genuinely believed he was acting in the Company’s best interests, he was not in breach of his statutory duty of good faith, even though he had deliberately misled the board. The trial judge therefore dismissed the s.172 claim on the basis that Mr Costa subjectively believed his conduct was in the best interests of the Company.

Court of Appeal

Both parties appealed the decision of the High Court; Saxon Woods on various grounds, including that the Judge had erred in finding that Mr Costa had not breached his duties under s.172.

The Court of Appeal allowed Saxon Woods' appeal and found that Mr Costa had clearly breached his duty under s.172.  It rejected an interpretation of s.172 which focused solely on Mr Costa's subjective belief.  It held that s.172 does require a director to act in what they consider, in good faith, would be most likely to promote the success of the Company, and that the requirement of good faith includes, as a core fiduciary duty, that the director acts honestly.  Per Ivey v Genting Casinos [2017] UKSC 67, honesty requires not just a subjective test, but also an objective test of what an honest director would have done.

Misleading the board and concealing material information to delay the exit process, regardless of whether Mr Costa genuinely believed it to be in the Company's best interests, was inconsistent with the requirement to be honest by the standards of ordinary decent people. Mr Costa's conduct was, therefore, dishonest and in breach of s.172.

Mr Costa appealed the decision to the Supreme Court.

The Supreme Court dismissed Mr Costa's appeal.

Key takeaways from the Supreme Court's judgment are as follows:

1. Good faith governs conduct, not merely thought. Counsel for Mr Costa submitted that the test for the breach of s.172 must be purely subjective; the Court must be concerned with a director's state of mind, and their consequential conduct is irrelevant. Counsel argued that, if the director genuinely believed that the relevant conduct promoted the company’s interests, then s.172 could not be breached (notwithstanding that other directors' duties may capture this conduct instead). Counsel went so far as to argue that such a director is not only permitted to act in accordance with that genuinely held view, but is actually under a duty to subvert the decision-making organ of the company if they genuinely believe in good faith that is the best course of action for the company. The Court strongly rejected this analysis, holding that the requirement to act in good faith, as drafted in s.172, extends to the director's conduct in pursuing what they believe to be in the company's best interests, not merely the sincerity of their belief about what ought to be the optimal strategy. The Court emphasised that, if the construction of good faith in the statute is limited to the director's thought process, this would be a "recipe for chaos and paralysis in corporate governance" and would result in a director being permitted (and indeed perhaps obligated) to adopt any course of conduct they wish "regardless whether, objectively speaking, his conduct involves lies, cheating, deception, dishonesty or disloyalty, ie what any reasonably well-informed observer would regard as plain bad faith" and thus cannot have been what Parliament intended.
   
   
2. The subjective test under s.172 has limits. The Court made it abundantly clear that it is not willing to substitute its own objective assessment of the company's best interests and will respect the business judgement of a company's directors. However, this does not give a director "carte blanche to seek to implement his dissenting view by any means, however covert or disloyal, he thinks necessary". Pre-existing case law clearly establishes that the Courts have always applied objective standards to determine a breach of fiduciary duty.
   
   
3. Proving dishonesty is unnecessary where fiduciary duty applies. The Court departed from the Court of Appeal's analysis on this, stating that where a director already owes a fiduciary duty of loyalty, the question is simply whether that duty has been breached. It is therefore irrelevant to delve into the concept of dishonesty established in the Ivey case. The fiduciary duty itself supplies the relevant analytical framework; dishonesty may be evidence of breach but is not a separate gateway.
   
   
4. The SHA did not conclusively determine the Company's success strategy. Although the Court did not wish to express a concluded view on this limb of the claim (as it was unnecessary for the determination of the appeal), Lord Briggs emphasised that the agreement by means of the SHA to pursue a particular strategy did not preclude reconsideration on the part of the board. However, he noted that, in circumstances in which the directors seek to reconsider the course which they have previously committed the company to pursue, the changing of that course would be a matter for the business judgement of the board, not a single director acting covertly.
   
   
5. Duties of disclosure under s.172. The Court confirmed that a director's duty to disclose material information to fellow directors (including their own dissenting views and conduct) is properly characterised as part of the s.172 duty of loyalty, not a freestanding obligation.

In the light of the Supreme Court's decision, directors should be alive to the following practical considerations:

1. Directors cannot treat subjective good intention as an impenetrable shield. They need to assess decisions not only by reference to their belief but by how the conduct would appear to an objective observer. 
   
   
2. Board transparency is all important. A director who disagrees with the board's strategy must be transparent and seek to persuade the board of their dissenting view. Covertly pursuing an alternative strategy, no matter if they genuinely believe it is the best course of action for the company, will constitute a breach of s.172.
   
   
3. The judgment emphasises the importance of contemporaneous documentation of board discussions, consistent disclosure between directors, and collective consultations of the board on key company matters. In any future dispute, the Court will assess conduct objectively. Consequently, directors who cannot point to a documented decision-making process showing transparent engagement with the board may struggle to defend their position.
   
   
4. Where a company board delegates a specific function to an individual director, the director must be careful to exercise their delegated authority only for purposes consistent with the board's instructions. The delegation may not confer autonomous discretion to redefine the objective.
   
   
5. Directors retain the ability to reconsider a course which the board previously committed to pursue, provided that this change is a collective board decision and not the unilateral action of an individual director.