UK: Joint ventures and directors’ duties under English law

Introduction

All directors are obliged to comply with certain duties and, for directors of joint venture companies, the application of those duties can be complex. This complexity arises because a director may have been appointed by one of the joint venture partners or because the JV agreement imposes additional restraints on how such director can act. The consequences of breaching directors’ duties are potentially severe and can result in directors facing civil or even criminal sanctions.

This note considers the source of those duties and how directors can practically comply with them – all within the context of a joint venture company.

To whom are duties owed?

When considering any of the duties we summarise, it is crucial to remember that those duties are owed to the company and not, directly, to anyone else.

In relation to JV companies, it is common for shareholders to have the right to appoint one or more directors to represent their views on the board. However, any such nominee must never forget that they owe their duties primarily to the company not to the nominating shareholder. This can put the director in a difficult position and below we identify likely flashpoints and how best to manage those situations.

Statutory duties

The UK Companies Act 2006 imposes seven general duties on all directors. We set these out below with some particular issues for directors in the JV context to note:

Section 171 – to act within powers

This duty is comprised of two parts. The first part requires directors to act in accordance with the company's constitution (being its articles and certain members’ resolutions) and the second part requires them to exercise their powers for the ‘purposes’ for which they are conferred. The courts have held that this power should not be used to influence the balance of control over the company, whether as between the directors and shareholders, or between shareholders themselves. Other examples of ‘improper’ purposes are acting to protect a director's own position, to make matters difficult for a particular shareholder, or to influence the outcome of a general meeting.

JV Issue: Directors need to be aware of the prohibition to exercise powers for an improper purpose even where the de facto conflict arising from a director being nominated by a shareholder has been approved.

Section 172 - to promote the success of the company

A director must act in the way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and, in doing so, the director must have regard to a non-exhaustive list of six statutory factors. The decision as to what constitutes the "success" of the company and what will "promote" the company's success is one for the directors' judgement in good faith, so business decisions remain matters for directors rather than the courts. Interestingly, recent ICSA guidance describes Section 172 as ‘the overriding duty’.

JV Issue: a director appointed by a shareholder must promote the company’s success for the benefit of all its members not the self-interest of their appointing shareholder.

The parties to a joint venture should therefore consider whether it is appropriate to allow a shareholder and/or their appointed director to vote where there is a clear conflict, whether certain conflicts may be authorised and the adjustments to quorum requirements which may need to be made where shareholders/directors are not permitted to vote. It may also be worth considering whether to appoint any independent directors to the board of the joint venture company as an independent director may be helpful in combating uncertainty arising from a conflict situation as well as having the potential to reduce the possibility of the board becoming deadlocked.

Section 173 - to exercise independent judgment

Whilst Section 173 requires directors to exercise independent judgement, the duty is not infringed if a director acts in accordance with an agreement the company has entered into that restricts the future exercise of discretion by its directors, or in a way authorised by the company's constitution.

JV Issue: This duty appears to mean that a director cannot agree with an appointing shareholder to vote at board meetings in a particular way (even if voting in that way would not otherwise be a breach of duty to the JV company) as by doing so, the director would be failing to exercise independent judgment. However, the Companies Act expressly provides that the duty is not infringed by a director acting in accordance with an agreement properly entered into by the company that restricts the future exercise of the director's discretion or in a way authorised by the company's constitution. This duty is therefore usually modified by the articles or joint venture agreement (JVA), thereby enabling directors appointed by a party to the JV to act in accordance with the wishes of that party if required, without being in breach of the duty to exercise independent judgment.

Other common provisions in JVAs are also relevant here: for example, JVAs usually specify which matters require board or shareholder approval. Abiding by those approval levels will not put individuals at risk of breaching the Section 173 duty as they will be acting in accordance with an agreement to which the JV company is a party. Similarly, JVAs sometimes include provisions specifically enabling non-conflicted directors or shareholders to direct decision-making on behalf of the JV company where another shareholder is interested in a particular transaction (for example, where one of the shareholders plans to enter into a supply agreement with the JV company). Again, this will not mean that the JV directors are failing to exercise independent judgement.

Section 174 - to exercise reasonable skill, care and diligence

The effect of Section 174 is that there is a minimum standard of skill and care to be exhibited by all directors, regardless of their experience or qualifications, i.e. an objective test. However, that minimum standard will be raised if a director has particular knowledge, skill or experience as then the director can reasonably be expected to meet a higher standard, so there is also a subjective element. In addition, the minimum standard of skill and care is determined by reference to the functions carried out by that director in relation to the company. So, a finance director would be expected to meet a higher minimum standard in relation to financial matters than, say, the legal director, even if those matters were being considered by all the directors at a meeting of the board.

JV Issue: The subjective element of the expected skill level should be borne in mind in a joint venture context where a shareholder wishes to appoint a particularly experienced individual or an expert in a particular field to be a director.

Section 175 - to avoid conflicts of interest

Section 175 imposes a positive duty on directors to avoid actual and potential conflicts of interest. This duty is objective – the fact that a director may not appreciate that they face a conflict of interest, and/or may be acting in good faith, does not provide a defence to a claim for breach of duty under Section 175. Whilst the Companies Act does provide a statutory mechanism whereby a situational conflict can be authorised by the board, this does not mean that the director is absolved of their other general duties – including the duty to promote the company for the benefit of its members as a whole under Section 172.

JV Issue: Conflicts can arise where a director of a JV company has been appointed by a particular shareholder with a view to protecting (or enhancing) the interests of that shareholder. That director must not allow the relationship with the appointing shareholder to interfere with their overriding duty to act in the way they consider most likely to promote the success of the JV company for the benefit of its members as a whole. In other words, the director cannot safeguard the interests of the appointing shareholder to the detriment of the JV company.

In practice, as mentioned in the context of Section 172, the JVA and articles will usually contain provisions to facilitate dealing with conflicts, including specifying whether, and in what circumstances, directors are allowed to participate in proceedings or vote on matters in relation to which they have another interest. Quorum provisions may also be adjusted to avoid problems achieving the quorum, and some matters may have to be put to a shareholder vote rather than a board vote.

Section 176 - not to accept benefits from third parties

Section 176 imposes a duty on a director not to accept benefits from third parties which are conferred by reason of being a director or for doing or not doing anything as a director (unless it could reasonably be regarded as unlikely to give rise to a conflict of interests because it is, for example, de minimis). It’s worth noting that, unlike conflicts under Section 175, there is no statutory mechanism to enable the other directors to authorise the acceptance of a benefit.

JV Issue: The Companies Act makes clear that a salary paid by a joint venture party to an employee who it nominated as a director of the joint venture company is not caught by this prohibition.

Section 177 - to declare an interest in a proposed transaction or arrangement with the company

Under Section 177 CA 2006, a director is under a statutory duty to declare (both the nature and extent of) their interest in prospective transactions or arrangements with the company. This is different to the Section 175 duty as it is concerned with transactional rather than situational conflicts.

JV Issue: There may be situations in a JV context which give rise to both a Section 175 (situational) conflict and a Section 177 (transactional) conflict. For example, where an individual holds directorships of both the JVCo and the shareholder entity and subsequently JVCo and the shareholder entity propose to enter into a supply or other contractual arrangement.

Duty of confidentiality

In addition to the duties codified by the Companies Act, all directors owe a common law duty of confidentiality to the company. This duty overlaps with the codified duties to promote the success of the company and to avoid conflicts of interest.

JV Issue: In a joint venture context this means that, even where a director is appointed by a particular shareholder, the director should not, without the authority of the company, disclose to that shareholder any confidential information relating to the company which has been gained as a director of that company.

Directors will clearly obtain a significant amount of information relating to the JV company. They are entitled to receive notice of, and attend, board meetings and they can also inspect and take copies of the records of the company (including minutes of meetings).

It is therefore usual for the board and shareholders of a JV company to agree in advance what categories of information can be passed to that shareholder by its nominated director. This is generally provided for in the JVA and articles so as to ensure that a JV director can pass confidential information to the appointing shareholder without that director breaching the confidentiality duty, with the appointing shareholder itself being under an obligation to keep that information confidential.

Impact of JVAs

It is not just the statutory and common law duties that directors of a JV company need to be aware of. It is critical that directors of JV companies have a working knowledge of the terms of the JVA (and articles). These documents contain provisions dealing with how directors are appointed and removed, how board meetings should be conducted, areas of delegation, (for example, to specialist committees or to an executive team) and which matters require board or shareholder approval or shareholder approval.

The JVA is likely to include further constraints on the directors (who will need to operate within and abide by particular approval levels, for example) but, on the upside, should also include flexibilities to enable the JV company to operate notwithstanding some of the restrictions the statutory duties would otherwise impose on the JV directors (such as the ability to share information or deal with conflicts as described above).

Shadow directors

A shadow director is a person in accordance with whose directions or instructions the directors of a company are accustomed to act. Traditionally, the courts have held that shadow directors can be liable for insolvency-related offences such as wrongful trading but that they were not subject to the same duties (statutory and common law) as a ‘full’ (de jure) director. However, recent case law indicates that a shadow director may, in certain circumstances be bound by these duties.

JV Issue: Fortunately the Companies Act explicitly provides that a parent company will not be regarded as a shadow director of a subsidiary simply because the directors of JVCo are accustomed to act in accordance with its directions so a majority shareholder in a JV will not be expected to have regard to the general duties (although it could in the context of duties as applicable during an insolvency situation). However, an individual director of that shareholder does run that risk and care should therefore be taken that directions are given by the board (not an individual director) of the shareholder company and that such individual director clearly does not exert personal influence or control over the JVCo’s affairs.

Distressed companies

A recurring theme is the obligation for a director to promote the company’s success for the benefit of all its members rather than the self-interest of their appointing shareholder. That duty is caveated in a situation where a company is in financial difficulties. Once the company is likely to become insolvent the directors must start to consider, and act, in the interests of the company’s creditors rather than the company’s shareholders. Once the company is actually insolvent those creditors’ interests become paramount.

JV Issue: For directors of JV companies who are experiencing financial difficulties it is crucial that they are aware of this requirement and take appropriate advice and action – even if the result of acting in the creditors’ interests is not aligned with the interests of the shareholder who nominated that director.