nominee directors and insolvent companies

8/13/2019 Nominee Directors and Insolvent Companies

1/9


2/9

02 S L A U G H T E R A N D M A Y

JULY 2011 Nominee directors and insolvent companies

The difficulty for nominee directors arises becauseeven though they are treated like other, non-special

interest directors, there is usually an expectation thatthey will act with some awareness of their appointorsinterests. This can range from a mere expectation ofloyalty to legal duties owed to the appointor, thoughmore than the mere appointment is required to createsuch duties.4

Nominee directors are de jure directors of thecompanies to whose board they have been appointed.They are not a distinct class of directors and they owethe same duties to the company as other directors

do whilst, at the same time, representing, throughexpectation of loyalty or legal duty, the interests oftheir appointor. This can create difficulties in carryingout their duties as directors. The next section willbriefly outline those duties most likely to be affectedby a directors dual status as nominee to his appointorand fiduciary to the company.

DIRECTORS DUTIES AND ISSUES FACED BY

NOMINEE DIRECTORS

Conflict of interest

In Bray v Ford5Lord Herschell described the rule againstconflicts of interests as the inflexible rulethat aperson in a fiduciary position is not, unless otherwiseprovidedallowed to put himself in a positionwhere his interest and duty would conflict. The ruleapplies with equal force where a directors duty tohis appointor and the duty to the company conflict.Section 175 CA 2006 now puts this rule on a statutoryfooting, stating that a director of a company must

avoid a situation in which he has, or can have, a director indirect interest that conflicts, or possibly mayconflict, with the interests of the company.

The rule against the conflict of interest has thepotential to make every appointment of a nomineedirector uncomfortable. It would be most unusual fora nominee director to not be subject to at least anexpectation of loyalty towards his appointor. In many

4

Re Neath, also known as Hawkes v Cuddy [2009] EWCA Civ 2195 [1896] AC 44, 51 (Lord Herschell)

situations, the nominee director will be an employeeor even an officer of the appointor and for that reason

be subject to legal duties to his appointor. Given thatthe duty against conflicts of interests is expressed asa duty to avoid a situation in which a conflict, director indirect, may occur, this puts the whole concept ofnominee directorship into question.

Independent judgment

A fiduciary, including a nominee director, must avoidfetters on his discretion and must reach his decisionindependently.6Section 173 CA 2006 states that adirector of a company must exercise independent

judgment.

Clearly, a prior agreement with an appointor to votea certain way would violate this duty. However, itis easy to see how this duty can cause problems toeven the most conscientious nominee director. Theinterests of his appointor will be on his mind andthe expectation of loyalty, perhaps combined with arealistic commercial expectation that he will lose hisappointment if he votes against the interests of hisappointor, can all be said to affect the independence of

his judgment.

Promote the success of the company

Lord Greene MR said in Re Smith & Fawcett7thatdirectors must exercise their discretion bona fide inwhat they consider not what the court may consider is in the interests of the company and not for anycollateral purpose. This has now been codified insection 172 CA 2006: A director of a company mustact in the way he considers, in good faith, would bemost likely to promote the success of the company for

the benefit of its members as a whole In doing so,the director must have particular regard to a numberof factors listed in section 172(1).

The interest of the company is not a particularly well-defined concept and the reformulation to successof the company for the benefit of its members doeslittle to clarify it. However, it is well-settled that theinterest and success of a company has to be assessed

6

Selangor United Rubber Estates v Cradock [1968] 1 WLR 15557 [1942] Ch 304, 306


3/9



from the perspective of the shareholders, present andfuture. There is some debate as to how far the list of

factors in section 172(1) CA 2006 amends this but itremains clear that preferring the interest or successof a particular shareholder or a particular stakeholderviolates the duty in section 172. This is clear partlybecause the equality of members is one of the factorslisted in section 172(1).

It is easy to see how a nominee director can strugglewith fulfilling the requirements of the duty to act inthe best interests of the company, to promote itssuccess, when his appointor approaches him with a

particular interest that the appointor wishes to further.How far the director can take those interests intoconsideration when discharging his duty under section172 CA 2006 is the key question in the next sectionwhere the approach to directors duties in the contextof nominee directors will be analysed.

THE LAWS APPROACH TO THESE DUTIES IN THE

CONTEXT OF NOMINEES

Conflict of interestThe width of section 175 CA 2006 may lead to theconclusion that the mere acceptance of a directorshipby a nominee violates the duty to avoid conflictsof interest. However, the law has taken a differentpath and has generally allowed nominees to takedirectorships. This is for a number of reasons.

First, section 175(4)(a) CA 2006 states that the dutyis not infringed if the situation cannot reasonably beregarded as likely to give rise to a conflict of interest.

This means that even though the appointment ofa director may cause the possibility of a conflict ofinterest there is no breach of duty where an actualconflict is not reasonably likely. In many cases ofnominee directorships this will be the case, particularlywhere the nominee director is the nominee of a soleshareholder, or the director of a number of groupcompanies. Interests are unlikely to diverge in thosecases.

Secondly, section 175(4)(b) CA 2006 allows a director

to act in circumstances where there would otherwisebe a conflict of interest where the other directors

have authorised the matter. Such authorisationshould be sought where there is some doubt about

the alignment of interests between appointor andcompany so as to prevent any suspicion of a conflictfrom arising.

Thirdly, section 180(4)(b) CA 2006 provides that ifthe companys articles authorise certain conflictsof interest, nothing done in accordance with thosearticles violates section 175. This is a useful provisionfor joint venture companies, for example, where thearticles of the joint venture company are purposelydrafted to accommodate the fact that the parent

companies will wish to appoint nominee directors tothe board of the joint venture company.

Lastly, the courts have been willing to overlook the factthat the duty is to avoid the possibility of a conflictof interest and have instead focused on the actionsof the director. A director is not expected to resign orstep aside when a conflict arises between the interestsof the appointor and the interests of the companybut is, instead, expected to prefer the interests of thecompany. This is an onerous task.

It follows from this analysis that a nominee directorwill rarely be affected by the duty to avoid conflictsof interest in section 175 CA 2006. Instead, the focuswill be on the exercise of his powers where the courtswill inquire whether he acted in the interest of thecompany or, in violation of his duties, preferred theinterests of his appointor.

Independent judgment

Selangor United Rubber Estates v Cradock8illustrates

the potential for nominee directors to violate theirduty to exercise their judgment independently. In thiscase, two directors of a company acted on the expressinstructions of their appointing shareholders, assumingthat their primary duty lay with their appointor.Unsurprisingly, the court found that this amounted toan abdication of responsibility and the directors couldnot be said to have exercised their judgment at all, letalone independently.

8 Note 6


4/9



One way to protect nominee directors is to providein the articles of association of the company that the

director may act in accordance with his appointorswishes. Section 173(2)(b) CA 2006 provides that theduty to exercise independent judgment is not infringedby the nominee director acting in a way authorisedby the companys constitution. This section wasintroduced with nominee directors in mind.9


Even if any potential conflict of interest can be dealtwith through authorisation or otherwise and if thenominee director has constitutional authorisation to

take into account the wishes of his appointor, thereis still the overarching duty to promote the successof the company, to act in its best interest. This is aparticularly important duty in the context of nomineedirectors because, by definition, they represent asectional interest in the company, be it shareholder,creditor or employees, whose interests may differ fromthe interests of the company as a whole.

The interest of the company and the success of thecompany is defined in terms of benefit accruing to

the shareholders, present and future, as a whole. Thisremains the case even with the inclusion of a list ofstakeholder interests in section 172 CA 2006.

It follows that it is illegitimate for a nominee directorto undertake to a majority shareholder that he will notuse his powers unless the interests of the company andthe majority shareholder coincide.10The interest of thecompany cannot be equated to that of the majority.

However, nominee directors are, in practice, granted

some discretion because the requirement undersection 172 is that the director, in good faith, considersthat the action promotes the success of the company.The test is, therefore, subjective. Lord Greene MR inRe Smith & Fawcett11placed great emphasis on thatpart of the test that determined that it was for thedirectors, not the court, to determine what is in thebest interest of the company.

9 Answer by the Solicitor General, HC Official Report, SC D (CompanyLaw Reform Bill), 11 July 2006, col 601.

10

Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 61411 Note 7

Despite the subjective nature of the test, a director willhave failed his duty if no reasonable director could, in

good faith, have considered his decision to promotethe success of the company. Re Southern CountiesFresh Foods12illustrates that there is an objective limitto the directors discretion.

TO WHAT EXTENT CAN THE NOMINEE DIRECTOR

TAKE INTO ACCOUNT AND ACT IN THE INTERESTS

OF HIS APPOINTOR?

It is clear that a conflict of interest can be managed

and even authorised and that the duty to exerciseindependent judgment can be adjusted through thecompanys constitution. The foregoing discussionalso showed that the overarching duty to act in thebest interest of the company remains and that thecompanys interest cannot be equated to that of astakeholder. It follows that the key question facedby the nominee director is the extent to which hecan take into account and further the interests of hisappointor in making his decisions as a director of thecompany.

The traditional or absolutist13approach has been toacknowledge that nominee directors are a commercialreality and are in a difficult position but to insist uponthem exercising their powers subject to the sameduties as other directors without being able to takeinto account the interests of their appointor. LordDenning illustrates this well when he said there isnothing wrong in [having nominee directors]. It isdone every day. Nothing wrong, that is, so long as thedirector is left free to exercise his best judgment in the

interests of the company.

14

Scottish Co-operative v Meyer15exemplifies thistraditional approach. CWS, the majority shareholder ofST&M, appointed the majority of the directors to theboard of ST&M. The other directors were the minorityshareholders in the company. CWS operated acompeting business to ST&M and aimed at destroying

12 [2008] EWHC 2810 (Ch) at [53]13 Ahern, Note 3, p.12914

Note 1, 626 (Lord Denning)15 [1959] AC 324


5/9



ST&Ms viability. The nominee directors did nothingto prevent this. The court found this to be an example

of oppression of the minority and CWS was orderedto purchase the shares of the minority.16In the courseof his judgment Lord Denning said that as soon asthe interests of the two companies were in conflict,the nominee directors were placed in an impossibleposition they probably thought that as nomineesof [CWS] their first duty was to [CWS]. In this theywere wrong.17Even though the directors were not heldpersonally liable in this case, Lord Denning was in nodoubt that in preferring the interests of the appointorthey placed themselves in breach of duty. Despite

recognising that their position was impossible, LordDenning was in no mood to make their position easierthrough recognising the commercial expectation thatnominee directors at least consider the interests oftheir appointor. The interests of the company have tobe the sole determining factor in the decision makingprocess of any director.

In Kuwait Asia Bank v National Mutual Life18the PrivyCouncil confirmed that in exercising their duties asdirectors of a company nominee directors had to

ignore the interests and wishes of their appointor.19

A bank was beneficially interested in a New Zealandmoney broker and had appointed two directorswho were also employees of the bank. The moneybroker had gone into liquidation and the depositors,unsecured creditors, claimed against the shareholdersin a claim similar to that in Scottish Co-op. The claimfailed, but the Privy Council repeated the positionthat nominee directors owed their duty only to thecompany and could not take into account the interestsof their appointor.

This approach has rightly been criticised as toostrict.20Statements such as Lord Cullens in DawsonInternational plc v Coats Paton Plc (No 1)21thatdirectors have but one master, the company simply

16 Under section 210 Companies Act 1948. Today, such an action wouldfall within the unfair prejudice provisions in section 994 CA 2006.

17 Note 15, 366-7 (Lord Denning)18 [1991] 1 AC 18719 Ibid, 222.20 Ahern, Note 3; Crutchfield, Nominee Directors: the law and

commercial reality, [1991] Company Lawyer 13621 [1989] BCLC 233 at 243

ignore the commercial reality faced by nomineedirectors. Lord Dennings approach, which recognises

that commercially nominees are bound to takeaccount of their appointors wishes but then refusesany legal recognition of this, is unworkable. This is notto say that the nominee director should not ignore theappointor where there is an actual conflict of interest,but it is unacceptable that the nominee must alwaysdisregard the interests of his appointor.

The impracticality of this traditional approach is, tosome extent, recognised in more recent case lawwhich emphasises that a nominee director can take

into account the interests of his appointor so long ashe does not prefer that interest over the interest ofthe company if there is a conflict. Ahern terms thisthe corporate primacy approach.22Ultimately, thedirector will only be able to further his appointorsinterests to the extent that there is congruence ofgoals between the appointor and the company,although it must be emphasised that much dependson the directors subjective assessment of thatcongruence. As Ahern points out, conceptually, thedistance between this and the absolutist approach is

small.23

This corporate primacy approach is well representedby Jacobs Js judgment in the Australian case of ReBroadcasting Station 2GB.24The 60% owner of abroadcasting company appointed directors to theboard of that company. The nominee directorsrefused to give any details of negotiations with thebroadcasting authority to the other directors. As inScottish Co-operativethe claim was by the minorityshareholder for oppression by the majority. Jacobs J

rejected the idea that nominee directors could nottake into account the interests of their appointors.Instead, he said, there would only be a violation ofthe directors duties if the directors would act inaccordance with their appointors wishes even if theywere of the view that their actions were contraryto the companys interests. This makes expressthe need for directors to prefer the interests of the

22 Ahern, Note 3, page 13123

Ibid24 (1964-1965) NSWE 1649


6/9



company but allows directors to act in the interestof the appointor where there is no conflict. Jacobs

J emphasised that this was so independently of anyshareholder agreement which might allow a nomineedirector to put the interests of the appointor first. Heacknowledged that this approach denies any rightin the company as a whole to have each directorapproach each company problem with a completelyopen mind, butto require this of each director isto ignore the realities of company organisation.25It follows that the difference to Lord Denningstraditional approach in Scottish Co-operativelies inthe extent to which the director needs to make up his

mind independently and without influence from hisappointor. On Jacobs Js approach, the director has toact in the interest of the company, as is required byLord Dennings approach. However, Jacobs J permitsthe director to come to the conclusion that he isacting in the interest of the company without a closepersonal analysis of the issues,26hence giving him thefreedom to follow his appointors wishes.

The English courts appear to prefer this approach overthe more traditional statements that the interest of

the appointor must play no role in the decision makingprocess. Re Neath Rugby Club27concerned an unfairprejudice petition under section 459 of the CompaniesAct 1985.28A company, N, was owned by H and C. Nowned a further company, O. C had been appointed asNs nominee on the board of O to protect and furtherNs interests. It transpired that C had put Os interestsfirst ahead of those of his appointor, N. Unsurprisingly,the Court of Appeal found that C had acted correctly.However, in the course of his judgment, StanleyBurnton LJ emphasised that a nominee director could,

without being in breach of his duties to the company,take the interests of his appointor into account,provided that he genuinely considered this to be inthe best interest of the company. This approach isalmost indistinguishable from that of Jacobs J in ReBroadcasting Station.

25 Ibid at p164826 Ibid at p166327

Note 428 Now section 994 CA 2006

Whilst there seems to have been a relaxation of thetraditional approach, it remains clear that even if a

director can take into account the interests of hisappointor, he must not prefer them over those of thecompany if there is a conflict of interest. It is for thisreason that a third strand of case law is of particularsignificance. A number of cases have pointed out thatdirectors duties can be amended to take into accountthe particular circumstances of nominee directors.It has already been seen that sections 180(4)(b) and173(2)(b) CA 2006 allow adjustments to the duties toavoid conflicts of interests and to exercise judgmentindependently through the companys constitutions.

A similar trend is discernible more generally inthe case law. Levin v Clark29is another decision byJacobs J. In this case, directors nominated to theboard of the company by a mortgagee were heldto be entitled to act primarily in the interests of themortgagee after a default by the mortgagor company.Jacobs J emphasised that the scope and content ofthe fiduciary duty to act in the best interest of thecompany depended on the circumstances of each case.In particular, the question was what the interest of thecompany was. In circumstances where a mortgagee

appointed a director to represent his interests on theboard of the company, the interest of the companymight best be served if that director acts in the interestof the mortgagee in the case of a default.30

The best interpretation of this paragraph is not that adirector may prefer the interests of his appointor overthose of the company he serves. Instead, it should beread in the way suggested by Warren J in Re SouthernCounties Fresh Food.31He emphasised that directorsduties, including the duty to act in the best interest of

the company, are capable of being attenuated with theunanimous agreement of the shareholders.32However,Warren J seems to have intended to put someroom between the English cases and the Australiancases when he said that the strictness of the noconflict and no profit rules are well established inEnglish law whatever flexibility might be seen in the

29 [1962] NSWR 686, referred to in Re Southern Counties Fresh Food[2008] EWHC 2810 (Ch) at [60]

30 Ibid at p70031

Note 2932 Ibid at [64]


7/9


8/9



members of the company that made concessions tothat member but offered little to the other members.

This happened in circumstances in which the companywas insolvent and would be wound up within 21 days.One of the directors was appointed by the memberwho would benefit from the settlement. Leslie CosminQC, sitting as Deputy High Court Judge, found that theinterested director could still vote on the resolutionbecause the articles of Limehouse expressly providedthat a director with an interest in a board resolutionwas entitled to form part of the quorum for themeeting and could vote on any resolution.39However,he then continued that even when the articles

permitted a director to vote on a resolution in whichhe was interested, such a provision did not relieve himof his general duty to exercise his power to vote ingood faith in the interests of the company. This reflectsthe position as previously discussed. A conflict may beauthorised, but the duty to promote the success of thecompany remains.

It followed that the nominee director in ColinGwyer was required to act in the best interest of thecompany, not in the best interest of his appointor.

However, Leslie Cosmin QC then referred to Liquidatorof West Mercia Safetywearand said that where acompany was insolvent or of doubtful solvency or onthe verge of insolvency and the creditors money wasat risk, the directors, when carrying out their duty tothe company, have to consider the interests of thecreditors as paramount and take those into accountwhen exercising their discretion. The test, he said, waswhether an intelligent and honest man in the positionof the director concerned could, in the whole of theexisting circumstances, have reasonably believed that

the transaction was for the benefit of the companybut that in considering the benefit of the company thedirector must have been capable of believing that thedecision was in the interest of and for the benefit ofthe creditors.40In the event, it was not possible to givea positive answer to this question in the circumstanceswhere all claims against the member were given upfor very little concessions from that member. Theresolution was void.

39

Ibid, at [60]-[69]40 Ibid, at [75]

In short, on an insolvency or on the verge of aninsolvency the directors have to act in the interests

of the creditors rather than in the interests of theshareholders as a whole. The interest of the companyis, in reality, the interest of the existing creditors.

The effect of that on nominee directors was evident inColin Gwyer itself. The remainder of this chapter willoutline these effects in more detail.

Conflict of interest

The analysis of the directors duty to avoid conflicts ofinterest does not change in any substantive manner

because of the companys insolvency. The directorcontinues to be estopped from acting when there is aconflict of interest, unless the conflict is authorised,either by the directors under section 175(4)(b) CA2006 or by the articles under section 180(4)(b) CA2006. Leslie Cosmin QC in Colin Gwyer made clearthat such authorisations survive the insolvency of acompany and are not affected by the fact that the dutyto promote the success of the company is now subjectto the duty to act in the benefit of the creditors.

Independent judgmentColin Gwyershows that the court will investigatewhether a director has exercised his judgmentindependently from ulterior purposes. In the caseitself, Leslie Cosmin QC found it difficult to believethat the directors could have exercised their judgmentindependently, particularly in the case of one of thedirectors who did not inform himself properly as tothe settlement offer. However, there is again nothingto suggest that the duty to exercise independentjudgment is affected by the insolvency of the company.


The biggest impact on directors duties is felt inrelation to the duty to act in the best interest of thecompany. The principles identified earlier in relationto nominee directors in general should continue toapply in relation to nominee directors of insolventcompanies. However, the fact that the duty topromote the success of the company makes place for aduty to act in the interest of the creditors changes theeffect of those principles.


9/9

Nominee directors and insolvent companies

Slaughter and May 2011

This material is for general information only and is not intended to provide legal advice.For further information, please speak to your usual Slaughter and May contact.

JULY 2011

slp30.indd711

As seen before, the nominee director of a shareholdermay take into account the interests of his appointor

when these interests overlap with those of thecompany or when the shareholders have agreed thatthe nominee may consider those interests. In neithercase can the director act in a way that is contrary tothe success of the company, however. In an insolvency,the director has to act in the best interests of thecreditors, in a way that is likely to achieve the bestresult for the creditors. Practically, this means thata nominee director will rarely be able to considerthe interest of his appointor because the interestsof the creditors are likely to diverge fundamentally

from those of the appointor shareholder in a waythat the interests of a (solvent) company and itsshareholders would not diverge (in many cases). Evenif the nominee director is authorised by the articlesto consider the interests of his appointor there isno scope for preferring that interest over that ofthe creditors. The duty to act in the interest of thecompany continues to rule supreme only that theusual equation of the interest of the company with theinterest of its shareholders has been replaced with adefinition in terms of the interest of the creditors.

A creditor may also have an interest in appointinga nominee director to a company on the verge ofinsolvency.41In that case, the nominee director maywish to act in the interests of his creditor appointorseeking to maximise the return to that particularcreditor. The considerations for that nominee directorwill be similar to those faced by the nominee directorappointed by a shareholder. The duty to act in theinterests of the creditors is, like the duty to act in theinterests of the company, one to act for the benefit

of all the creditors as a whole and to not prefer theinterests of one particular creditor.

In this context, attention should also be drawn to therules against the preferential treatment of creditorsunder the Insolvency Act 1986. Under section 238of the Insolvency Act 1986 (IA 1986) transactionsentered by a company at an undervalue are voidable.

41 E.g. see the facts of Levin v Clark, Note 29

A similar effect befalls transactions that prefer onecreditor over another under section 239 IA 1986. These

provisions are plainly relevant to a creditor appointednominee director in addition to the general duty totreat all creditors equally that follows from the duty toact in the best interest of the creditors as a whole.

CONCLUSION

Nominee directors face a difficult conflict. On the onehand, the commercial reality of their position requiresthem to take into consideration the interests of their

appointor. On the other hand, the law requires themto act exclusively in the interests of their companyand to do so with independent judgment and withoutconflicts of interests. The law has taken cognisanceof the obvious difficulties here, although early casesdid not go beyond pronouncements to the effect thatnominees were placed in an impossible position. Inmore recent cases, English law has begun to acceptthat nominee directors can take into account theinterests of their appointors so long as this interestdoes not conflict with the interests of the company, so

long as acting in the interests of the appointor is alsomost likely to promote the success of the company. Arecognition that fiduciary duties, including directorsduties, are context sensitive and can be amendedby beneficiary, in this case shareholder, consent hasfurther helped the position of nominee directors. Ininsolvency cases, nominee directors have to be awareof these principles and, in particular, have to be awarethat the interests of their appointing shareholders andthe companys creditors are likely to diverge. Nomineedirectors appointed by creditors need to be aware

that their first duty is to the creditors as a whole.English law continues to place great emphasis on theimportance of a directors duties to his company. Anyrelaxation that allows the director to consider theinterests of his appointor must be seen in this lightand subject to the paramount duty to act in the bestinterests of the company.

nominee directors and insolvent companies

Documents