In a recent decision, the Court of Appeal considered the issue of whether directors of a company were in breach of their fiduciary and statutory duties by taking preparatory steps towards setting up a competing business prior to resigning as directors.
The court’s decision highlights that not all preparatory steps by directors of a company to set up in competition amount to a breaches of the fiduciary and/or contractual duties owed. However, caution must still be exercised to make sure such actions do not 'cross the line' rending them unlawful. In this article we explore this case in detail and provide insight on the outcome.
The two defendant’s had resigned from their positions as directors of a law firm (the claimant). Following their resignations, it was discovered that the defendants had been taking preparatory steps over the course of several months to set up what would become a competing law firm.
The defendants’ conduct included registering a trading name, seeking professional indemnity insurance, opening a bank account and setting up a website for the new business, as well as applying to the Solicitors Regulation Authority to register the new firm. The defendants also had discussions with several litigation funders in respect of their new firm, including a funder with which the defendants had previous dealings in their capacity as directors of the claimant company.
The claimant commenced proceedings against the defendants, alleging that they had acted in breach of their fiduciary duties as directors and that they were in breach of contract. The claimant further alleged that the defendants had conspired to injure the claimant by unlawful means.
The claimant applied to the court seeking an injunction against the defendants, as well as either an account of profits or equitable compensation and damages.
The claimant sought to restrain the defendants from providing any services or products of a type provided by the claimant, or promoting or raising funding for any such business, for a period of 12 months, often referred to as ‘springboard relief’. The claimant referred the judge to a clause in the defendants’ consultancy agreements which provided that each of the defendants must not, for 12 months after termination, supply or solicit to supply any services in competition with the claimant to anyone with whom they had material dealings with during their employment.
In response, the defendants argued, amongst other things, that the claimant had not suffered any losses as a result of the their actions and therefore could not expect to recover compensation or damages. Furthermore, the defendants argued that no injunction should be granted.
The trial judge ruled in the defendants’ favour, finding that the preparatory steps taken by them had not 'crossed the line' or otherwise breached their fiduciary duties to the claimant. The judge held that the steps taken by the defendants wouldn't have affected the their ability to serve the claimant faithfully, honestly and to the best of their abilities.
The defendants did not intend for their new firm to trade until the end of their contractual notice period and, in respect of the litigation funder with which the claimant had previously undergone negotiations, on the balance of probabilities the litigation funder no longer represented a business opportunity to the claimant irrespective of the defendants’ actions, as the claimant had entered into an exclusive arrangement with another funder. As a result, there was no real possibility of conflict arising out of the defendants’ dealings with the funder.
In respect of the injunctive relief sought, the judge accepted that the restriction contained in the defendants’ consultancy agreements was lawful and enforceable, but held that there was no evidence of the defendants having solicited customers of the claimant.
Importantly, the judge also made a point that the claimant’s business by nature handled one-off claims, such that repeat custom was not a feature of its business model. The judge therefore held that solicitation of existing clients with whom the defendants had previously dealt was, in any case, not a real concern.
The trial judge dismissed each element of the claim and ordered the claimant to pay the costs of the proceedings.
The claimant appealed, seeking to overturn the trial judge’s decision. The claimant claimed that the defendants’ actions went well beyond legitimate conduct and that the claimant had indeed suffered reputational damage.
Unsurprisingly, Court of Appeal found that, as the defendants’ actions were not known to the claimant or the public at the time so this argument was 'without merit'.
In respect of the alleged breach of the defendants’ fiduciary duties, the Court of Appeal relied on a previously ruling which held:
'… an intention by a director of a company to set up business in competition with the company after his directorship has ceased is not to be regarded as a conflicting interest … nor is the taking of preliminary steps to investigate or forward that intention so long as there is no actual competitive activity, such as, for instance, competitive tendering or actual trading, while he remains a director.' (emphasis added)
The appeal was dismissed and it was made clear that the previous approach from the court on this topic had been 'too dogmatic' - merely preparatory steps are 'not necessarily' unlawful.
This judgment is a reminder that merely taking preparatory steps to set up a potentially competing business is not necessarily going to amount to a breach of fiduciary or contractual duties. However, that line may be crossed if the defendant strays beyond taking merely preparatory steps, particularly if those steps demonstrate some degree of trading.
Where that line is drawn is not always clear. Our dispute resolution team has significant experience in pursuing and defending injunctions and damages claims arising out of restraining competing conduct. If you would like to discuss please contact Liam Tolen or Helene Hauskeller.
