Without motive: directors’ breach of fiduciary

Directors are reminded of the need to avoid the risk of inadvertently breaching their fiduciary duties when issuing new company shares. The award-winning commercial lawyers at Bahamas law firm ParrisWhittaker advise directors and corporates on their fiduciary duties, as well as disputes relating to other obligations and duties.

A recent High Court¹ ruling from the UK is a salutary lesson for directors who manipulate their powers for a purpose which is not permitted. The ruling has persuasive authority on the courts in The Bahamas and should be noted by directors and shareholders.

Among a raft of legal obligations and responsibilities, company directors owe a fiduciary duty to exercise their powers in accordance with the company’s constitution. They must exercise their powers only for the purposes for which they are conferred (the ‘purpose test’).

What’s the background?

To distil a complex case in simple terms, the liquidators of a research company sought compensation against five directors who it said had exercised their powers for (among other things) an improper purpose. They said the directors had “gerrymandered” a vote at the company’s extraordinary general meeting (EGM) with the purpose or dominant purpose of defeating resolutions aimed at altering control of the board.

What the directors had done included issuing 75 million ordinary shares to a new investor on terms which permitted deferred the payment for up to two years, despite the fact that the company was in serious financial trouble. Two days later, they issued 2,625,000 shares to another investor under a cash retainer on completion of a planned equity fundraising.

At the EGM, the new shareholders voted in favour of the status quo and preventing a takeover. In so doing, the liquidators alleged that the directors had pursued a dishonest strategy to maintain control of the board, in breach of their statutory and fiduciary duties and directly leading to the company going into liquidation.

The court agreed with the claimants, finding that the directors had breached their statutory duties. In desperation, they had searched out an investor so they could defeat the resolution. However, the court said it was not open to them to issue shares for the purpose of converting a minority into a majority. This was plainly an improper purpose shared by all five directors, which breached their fiduciary duties.

The court also made clear that the application of the ‘purpose test’ turns on comparing the purpose of the power conferred and the primary, substantial or dominant purpose for which it was exercised.  Bad faith does not have to be established.

What does this mean?

This ruling makes clear that a company director who decides to issue shares with an improper ulterior motive, could well face a successful breach of fiduciary duty claim. The context of such conduct will be a relevant factor if it becomes necessary to determine what is the dominant, overarching reason for it.

This will apply to the misuse of other directors’ duties; and care must be taken before embarking on a course of action where the ultimate purposes could be deemed improper.

If in doubt, contact the experienced commercial disputes lawyers at ParrisWhittaker for robust assistance and representation as early as possible.

¹TMO Renewables Ltd (in liquidation) v Yeo and others [2021] EWHC 2033