Court of Appeal considers what interest a director needs to disclose

It is a long-established principle of English company law that a director – as an individual who owes a range of good faith duties to the company – shouldn't put himself in a position of conflict of interest with the company when it comes to a proposed transaction or arrangement, at least not without it being declared and authorised.

In considering whether such conflict has been authorised or waived by the company, the courts' approach of strict compliance with statute appears to have softened. While this has the effect of potentially permitting a "highly technical breach" – a stance which directors may welcome as practical – it removes from the process the certainty that companies previously enjoyed that all directors are putting company interests first.

New approach

Evidence of the new approach by the courts is the recent Court of Appeal decision – Fairford Water Ski Club v Cohoon & Ors – in which a company director successfully appealed against the first instance decision that he had failed sufficiently to disclose his conflict of interest since, at the time of his disclosure of interest, the final terms of the proposed contract had not been established nor the board satisfied that the proposed net fee payable was justifiable.

The company in question ran a members' club allowing access to a lake and surrounding land owned by the company. A director of the company, Mr Cohoon, also ran a water-ski school business at the lake. A management agreement was entered into between the company and the school in 2007. Ten years later, when new directors joined the company, they alleged that Mr Cohoon had failed to disclose his interest in that management agreement to the company under section 317 of the Companies Act 1985 (the applicable legislation in 2007, repealed and replaced from 1 October 2008 by s177(1) of the Companies Act 2006).

The company's articles reflected the provisions of section 317 and provided that: "A director who is in any way, whether directly or indirectly, interested in a contract or proposed contract with the company shall declare the nature of his interest at a meeting of the directors". Having made such a declaration, a director was permitted to vote on the contract and to count towards a quorum.

At first instance, the judge found there had been a breach of section317. Although at a board meeting early in the negotiations about the agreement, Mr Cohoon's potential conflict of interest had been noted, the extent of his interest was not known at that stage because fees had not been agreed; and the conflict was not declared again at a board meeting five months later to discuss the negotiated terms of the agreement. In reaching his decision, the judge found that it didn't matter that the company had been aware of Mr Cohoon's interest in the school throughout the relevant period. The company was entitled to claim back fees paid under the management agreement over the 10-year period of around £350,000.

Court of Appeal's view

In allowing the appeal against the first instance decision, the Court of Appeal made some important observations about how section 317 works, many of which are also applicable to the working of section 177 of the Companies Act 2006:

• The section covers a wide range of interests and potential interests and the nature of the disclosure required will vary depending on the context of the case. If an interest is "clear and obvious", very little may need to be disclosed. What is required is a clear declaration of the nature of the director's interests so that the board is "fully informed of the real state of things" (Gray v New Augarita Porcupine Mines Ltd [1952] 3 DLR 1).
• The declaration must be made at a board meeting so that the interest is an item of business at a meeting of the directors – declarations outside of board meetings don't count.
• Disclosure can be made before the contract is entered into (and before the terms of the contract have been finally agreed) but should be made before the contract is concluded.
• If there are to be a series of board meetings to consider a proposed contract, disclosure must be made at the first meeting but doesn't have to be repeated at each subsequent meeting.
• Only a general notice of interest need be given. In particular, the Court of Appeal confirmed that "because the negotiation of any such contract may lie in the future, there is no question of any need for disclosure of its terms or the amount of any payment, let alone that it represents value for money".
• Section 317 is intended to ensure that an interest is disclosed – not that a contract is in the company's interest.

Based on the above principles, the Court of Appeal found that sufficient disclosure had been given here. The nature of Mr Cohoon's interest had been understood and sufficiently disclosed at the first board meeting. There was no need for the final fee to be disclosed.

Osborne Clarke comment

As noted, because of the timing when the interest first arose, this case fell to be considered under the 1985 Companies Act, whereas since 1 October 2008, the situation has been governed by section 177 of the Companies Act 2006 instead.

Two important differences between the two Acts were noted by the Court of Appeal: 1) it is now possible under the 2006 Act to give notice other than at a board meeting; and 2) there is now an express provision that disclosure is unnecessary if the other directors are already aware of the interest (or reasonably ought to be).

Had the 2006 Act applied to the management agreement, there would therefore have been even greater scope for Mr Cohoon to argue that he had not breached the duty to disclose his interest. Indeed, the argument may not have arisen at all and it may be that this development in the law motivated the Court of Appeal in its application of the repealed legislation.

This case demonstrates that the protection offered to companies on this issue is limited. There is no need for directors to provide an independent valuation of their interest in order to have complied with their obligation to disclose its nature.

At the extreme end of the scale, where a director is not acting in good faith in the best interests of the company (or, under the 2006 Act, promoting the success of the company), there will be remedies available to the company (such as injunctions or damages claims). In the majority of cases, however, the requirement to declare an interest, (as this case demonstrates) may, in practice, end up being little more than a formality.