A recent English law case raises an important question for company directors: is honestly believing that you are doing the right thing enough?
The case, Saxon Woods v Costa, concerns directors’ decision-making and the meaning of acting in a company’s best interests. At the time of writing, the case is awaiting judgment from the Supreme Court.
The background to the case
A private company had several shareholders who had entered into a shareholders’ agreement. One clause said, in essence, that they would work together to sell the company by the end of 2019.
Several potential buyers came forward, but no sale took place. One shareholder argued that this was because the chairman had blocked each proposed deal.
The chairman’s defence was that he genuinely believed waiting would ultimately produce a better deal and a higher price for everyone. On that basis, he argued that he had been acting in the company’s best interests.
Section 172 of the Companies Act 2006 requires a director to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.
This is a key provision in the Companies Act and is frequently referred to by corporate lawyers. However, as this case demonstrates, its practical interpretation can be extremely difficult.
Lawyers will often include wording similar to the following in company board minutes:
“Having considered the transaction and related matters, and having considered the provisions of section 172 of the Companies Act 2006, the directors noted that the matters considered were in the best interests of the company.”
Is an honest belief enough?
One of the questions for the courts was whether it is enough for a director to believe honestly that they are doing the right thing, even if, by an objective measure, they are not.
Imagine the directors of millions of SMEs having to consider the legal niceties surrounding this point every time they make an important commercial decision. No, I cannot imagine it either.
In Saxon Woods v Costa, the High Court found that the chairman genuinely believed he was doing the right thing. That may seem sensible.
However, the Court of Appeal disagreed. It said that a director’s conduct must also be honest when judged against the standards of ordinary, reasonable people. A director’s subjective belief may not, by itself, provide a complete defence.
The Supreme Court must now decide which approach is correct. The two sets of barristers have reportedly produced more than 80 pages of legal submissions between them.
Why does this matter to SME directors?
This case involves tens of millions of pounds, so its factual background may feel far removed from the day-to-day concerns of most SMEs. However, the legal issues are still relevant.
There are two particularly important points for directors and business owners.
1. “I thought it was best” may not be enough.
A director’s judgment may be measured not only against what they personally believed, but also against what a reasonable person would think they were doing and why. This is not an easy distinction to understand or apply.
2. Shareholders’ agreements are important.
In this case, the shareholders had a written agreement that referred specifically to the sale of the company. Where a company has several shareholders, what has—or has not—been recorded in writing may become crucial if a disagreement arises.
Paper trails matter. SME directors are unlikely to walk around with section 172 constantly in mind. They are more likely to be concerned about securing the next order, managing raw material costs, dealing with staff sickness and protecting cash flow.
The idea that directors regularly ask themselves whether they are promoting the success of the company in a way that a reasonable person would recognise as honest is, in practical terms, unrealistic.
A practical piece of advice
There is a practical reason for keeping even a brief record of why an important decision was made.
It is not about proving that you know the law. It is about being able to demonstrate, if the decision is ever questioned, that you considered the relevant issues and had a genuine commercial reason for taking the course you chose.
“We considered two offers and accepted the lower one because the buyer was financially stronger and we were concerned about the payment of deferred consideration.”
A short board note or email recording that reasoning may prove extremely valuable later.
Practical takeaway: when making a significant business decision, record what was considered, why the decision was made and how it was expected to benefit the company.
Law, business and common sense
I am interested to know whether directors in other jurisdictions have to navigate similarly complex issues and what advice they are given.
I often suggest that curiosity and common sense are useful guides for directors facing legal and commercial problems. However, this may be one of those situations where common sense alone does not provide a clear answer.
I recently heard someone suggest—not in a flattering way—that business growth in the UK and USA is often held back by lawyers, whereas growth in many other countries is driven by engineers and others who understand how their businesses operate.
What do you think? Does the law provide directors with necessary protection and accountability, or has decision-making become unnecessarily complicated?
This article is intended as a general discussion of directors’ duties and decision-making. It should not be treated as legal advice relating to any particular company, transaction or dispute.