Duty of Good Faith

Duty of Good Faith

Speaker1: I’m very pleased to welcome Andrew Marsden as our next speaker. Andrew is a barrister and mediator and he specialises in and has a national reputation for resolution of disputes between shareholders. And he’s been practicing in that field for nearly 30 years. And he’s the founder of Commercial Chambers in Bristol, where I have spent the vast majority of my professional career as well. So another Bristol boy. Andrew, pleased to see you. He’s he’s ranked in the first tier by Chambers and the Legal 500. And interestingly, on his on his CV here, it says his other interests include boxing, skiing and cognac. And cheeky David Jacobs has written in brackets, presumably not all at the same time. And so looking forward very much to hearing what you have to say about a duty of good faith between shareholders. So thank you. Over to you, Andrew.

Speaker2: Thank you very much. Yes, certainly. The the boxing and the cognacs don’t mix well.

Good afternoon to all of you. As you’ve heard, my name is Andrew Marsden and I’m a company and commercial barrister and my specialist field of expertise is in the resolution of disputes between persons who are in business together, whether that be through the medium of a limited company, a limited liability partnership, or indeed through a traditional partnership. This is a field in which I have practiced for nearly 30 years. And over that time, I think it’s fair to say that I’ve handled hundreds of these disputes. My practice is a specialist one but the variety of matters that I have to consider is seemingly endless. Certainly the nature of the underlying businesses involved in cases that I handle is very varied indeed. I’ve been instructed in cases that have ranged from those involving the conduct of oil exploration to the ownership of racehorses, nursing homes and the professional practices of doctors, vets, accountants, lawyers, as well as the sale and supply of all manner of goods and services. That variety in the underlying businesses is, in itself, interesting presenting, as it does, an opportunity to glimpse into many different worlds. But that’s not the only interest that the nature of my specialist practice holds for me. One other fascinating aspect is the seemingly consistent evolution, as you’ve heard, of the legal principles applicable in this area today.

What I want to talk to you about is one such recent development in this area that I think is likely to become of increasing importance in practice. That development is the increasing judicial recognition, as I see it, of a duty of good faith owed as between persons in business together, whether they conduct that business through the medium of a limited liability company or a limited liability partnership.

Of course, such a duty of good faith has long been recognised as existing between those in business together through the medium of a traditional partnership. But the existence of a duty of good faith as between the participants in a limited company or between the members of a limited liability partnership is certainly of more recent origin.

At the very outset. I think I should stress that what I’m talking about here is the recognition of such a duty as between participants in closely owned ventures. I’m talking about enterprises which are owned and run by a limited number of people. Often, but by no means always, those people may even be members of the same family. These are frequently limited companies or limited liability partnerships characterised as having a quasi partnership nature where the shareholders or members also participate in the conduct of the business and affairs of the company or the limited liability partnership concerned. What I’m not talking about here are widely owned ventures such as those operated through quoted companies, for example, companies where the ownership is held widely and the conduct of the business of that venture is entrusted to others. Here it seems to me very difficult to see how duties of good faith might be said to exist between the shareholders. No, what I’m talking about here are large or small undertakings with relatively limited ownership and where those owners participate in the conduct and management of the business concerned.

It’s in the context of those types of enterprise that I want to consider three questions or issues. The first is when a duty of good faith may be owed between the shareholders or members. The second is what any such duty of good faith might require from those shareholders or members. And the third is, as I see it, the growing importance of the recognition of and reliance on a duty of good faith in claims under sections 994 to 996, which make up Part 30 of the Companies Act 2006. Those being, of course, claims for relief from alleged unfairly prejudicial conduct of the affairs of the company or the limited liability partnership.

Again at the outset of this talk, I think it’s important to recognise that the relationship between shareholders and a limited company or between members of a limited liability partnership is largely a contractual relationship. Their relationship is governed by the terms of the relevant memorandum and articles of association and by the terms of any separate private shareholders’ agreement or members’ agreements. Those documents, of course, represent contracts between the shareholders or members. Even if there is no written shareholders’ agreement in place there may still exist an oral agreement or understanding between the participants and that oral agreement or understanding may again represent an essentially contractual relation between the participants.

Now, historically, the courts of England and Wales were not prepared to imply a duty of good faith as between contracting parties. So, in the absence of an expressed contractual provision, a contracting party did not have a duty to act in good faith and so was not required to act in good faith towards other contracting parties. It was often said that if a person held a contractual right he might exercise that right for good reason, for bad reason or, indeed, for no reason at all.

The position in civil law jurisdictions was and is markedly different. There’s a duty to act in good faith in the exercise of legal rights was generally widely recognised.

Then in 2013, Mr. Justice Leggatt, now Lord Leggatt of the Supreme Court, whose views should therefore be treated with corresponding respect, challenged that orthodox view with his decision in the case of Yam Seng v International Trade Corp [2013] EWHC 111. In that case, Mr. Justice Leggatt held that, where the relevant contract was “relational” in character, a court might well be prepared to imply a duty of good faith owed between the parties to that contract. In very broad terms. The rationale behind the implication of a duty of good faith seems to be the recognition that trust and confidence is key to such long lasting relationships, and good faith is required to maintain that trust and confidence.

A shareholders’ or members’ agreement, particularly one between persons whose relationship might be characterised as one of quasi partnership, might, in my view, be said to be perhaps a paradigm example of a “relational” contract. Indeed, the courts have now shown themselves to be willing to imply a term requiring the parties to a shareholder’s agreement to act in good faith towards one another even where the relevant shareholder’s agreement does not expressly seek to impose such a duty.

It will be interesting to see how far the courts might be prepared to go in recognising the existence of a duty of good faith between persons in business together where that relationship cannot be said to be one of quasi partnership nature.

Quite surprisingly, in my view, the courts have even been prepared to imply a duty of good faith in appropriate circumstances where a written shareholders’ agreement existed that was professionally drawn up with the assistance of lawyers and where the parties chose not to include an expressed duty of good faith. They’ve also been prepared to imply a duty of good faith in circumstances where the relevant, professionally drawn up contract contained an explicit entire agreement clause.

Now the importance of this in practice is that where a duty of good faith is either expressly provided for in a shareholders’ agreement or a member’s agreement or it is to be implied into a shareholders’ agreement or members’ agreements, a breach of that duty may involve unfairly prejudicial conduct of the relevant company’s affairs, contrary to the interests of the parties to that agreement such that a victim of that conduct might be afforded relief under section 994 of the Companies Act 2006.

So the question that arises is this; what does fulfilment of the duty of good faith require from the shareholders in a company or the members of a limited liability partnership? In particular, what behaviour is likely to be considered as amounting to a breach of an express or implied duty of good faith such that it might constitute unfair and prejudicial conduct of the affairs of a company or limited liability partnership?

Well, on one level, it might be said that establishing a breach of a duty of good faith might require the demonstration of bad faith. That is certainly what traditional textbooks on equity, such as Snell, would suggest. However, that observation is a bit circular to be particularly helpful in practice but it does, at least to my mind, suggest a subjective element to the establishment of a breach of duty of good faith. In other words, it suggests an approach that might require the demonstration of an actual wrongful motive or at least an ulterior motive on the part of the perpetrator.

In the same case, Mr. Justice Leggatt emphasised that the requirements of a duty of good faith were sensitive to the context in which that duty was owed. Relying on the decision in the Royal Brunei Airlines v Tan case [1995] 2 AC, 378, Mr. Justice Leggatt held that the requirements of a duty of good faith did not depend on a party’s own perception of whether particular conduct was improper but on whether the conduct concerned would be regarded as commercially unacceptable by reasonable and honest people. So his decision itself seems to suggest, at least to me, that what is required is an objective assessment of whether a party to a contract has fulfilled any duty of good faith owed to the other parties.

What has been the approach of the courts as to the nature of good faith owed in the context of a relationship between shareholders and a company or as between members of a limited liability partnership?

Well, the first substantial judicial consideration of the content of a duty of good faith between shareholders appears to have been that in a case which has already already been referred to, the Re Coroin Ltd case, [2013] EWCA CIV 781. That was a case concerning an expressed contractual duty of good faith owed between shareholders and a limited company. The Court of Appeal indicated that the duty of good faith involved an obligation to act honestly. That was the natural meaning of the particular clause in the context of that particular case. The interpretation given to the clause in that case seems to me to be a rather subjective one. The expressed good faith clause in the context of that case did not suggest or require that an objective test should be applied to it. Moreover, the Court of Appeal seemed to be of the view that in the particular circumstances of that case, a lack of good faith required conscious bad faith. In other words, in that case, mere negligence or oversight was not sufficient to amount to a lack of good faith as it was required by the clause the parties had chosen to use in their shareholders’ agreement.

Two recent first instance decisions have, however, suggested that a much more objective test of good faith might be adopted in other circumstances. Both of these decisions are decisions of courts junior to that in the Coroin case and so they should have considered themselves to have been bound by the decision in that case. But, in each of these cases, the court of first instance seems to me to have been able to differentiate the cases before them from that in the Coroin case and, indeed, to have gone further than the Court of Appeal was prepared to do in the Coroin case.

In these cases, the courts have certainly provided further guidance as to what is required to demonstrate a breach of a duty of good faith. They’ve also, it seems to me, applied a much more objective assessment of whether there has been an absence of good faith in breach of a clause requiring good faith to be exhibited.

The first of these cases is Unwin v Bond [2020] EWHC 1768. Once again, this case concerned an express duty of good faith. In other words, a duty of good faith required by the terms of the particular shareholders’ agreements. In this case, it was accepted that in dismissing the petitioner from his employment, the respondent had not been improperly motivated by a desire to obtain the petitioner’s shareholding, chiefly pursuant to bad leaver provisions, but rather was motivated by a genuine desire to preserve the business of the company. In other words, the Court was seemingly persuaded that there had not been actual, subjective, bad faith on the part of the respondent. Nevertheless, the court held that the extent of a contractual duty of good faith depended on the context in which it was owed. Very much in line with the Coroin case.

The court also identified that the duty of good faith was made up of a number of potentially overlapping elements. Those elements were said to include requirements to act honestly and not for an ulterior purpose. Those elements seem to me to be of an essentially subjective nature.

However, most importantly, in the context of this talk, the court also held that acting in good faith required the parties to, and I quote, “act fairly and openly, taking into account the other shareholders’ interests as well as their own.” It is this observation as to the requirements of good faith that seem to me to import a more objective assessment as to whether there has been a breach of a duty of good faith.

The court concluded that there was no need to show dishonesty or even an improper purpose behind the actions said to be in breach of the duty of good faith; rather a breach of a duty of good faith might occur in circumstances where one shareholder had simply not dealt fairly and openly and had not had regard for the other’s interests when dismissing him from his position as an employee.

The second recent case that I want to draw your attention is Faulkner v Vollin Holdings Ltd [2021] EWHC 77. In that case, it seems to me that the Court perhaps has gone further still. Here, a director appointed by the minority shareholder was removed from office by the majority shareholder. That removal was clearly effective as a matter of law. However, it was held to have involved, again, a breach of an express contractual duty of good faith imposed by the terms of the relevant shareholders’ agreement.

The judge determined that whilst the majority shareholder clearly had the power to remove the director, the expressed contractual duty of good faith required that the majority shareholder, in exercising that power, was bound to act with “fidelity to the bargain he had struck with his fellow shareholders.” That phrase, again, seems to me to invoke a more objective analysis as to the nature and extent of the bargain that has indeed been concluded between the shareholders as it’s expressed within the shareholders’ agreement and the memorandum and articles of association.

It also seems to require the courts to determine objectively whether or not a shareholder has acted in a manner consistent with or contrary to that bargain.

In the Faulkner v Vollin Holdings case, the court also went so far as to identify the duty of good faith as requiring a shareholder to consider and act in accordance with all relevant factors and even in accordance with due process. Those observations, again, seem to me to accord more with the objective standards one might expect to be required of public officers or bodies in an administrative law context. It certainly goes well beyond the purely subjective assessment as to whether there has been good faith or bad faith.

So the decisions in Unwin v Bond and Faulkner v Vollin Holdings Limited certainly suggest to me a potentially much broader scope to an expressed or implied duty of good faith and a more objectively assessed content to the duty recognised.

I understand the decision in the Faulkner v Vollin Holdings case is currently subject to appeal; so we’ll have to wait for that and for further decisions from the courts to see whether a narrower more subjective or a broader more objective approach will prevail. We’ll have to wait, I think, for further clarity as to the circumstances in which either a narrower subjective or broader objective approach is to be preferred.

In the interim, however, it seems clear that these days more and more shareholders’ agreements and limited liability partnership agreements that one comes across in practice express provisions requiring the parties to act in good faith towards one another. Similarly, it appears that even when no duty of good faith is expressly provided for in the terms of a shareholders’ agreement or members’ agreement, the courts are more readily prepared to imply a duty of good faith in appropriate circumstances into these essentially “relational” contracts.

With this adoption of a seemingly more objective assessment as to the content and satisfaction of duties of good faith in the context of shareholders’ agreements and limited liability partnership agreements. Those drafting such agreements may wish to think carefully as to whether to include clauses imposing duties of good faith.

Indeed, in light of the increasing prevalence of the implication of duties of good faith into shareholders’ agreements, particularly where they may be characterised as of a quasi partnership nature or in circumstances which may be characterised as of a quasi queasy partnership nature, the legal advisers involved may even want to consider excluding a duty of good faith that might otherwise exist between the parties. However, the viability of any such excluding clause may have to be looked at very closely in light of the restrictions as to enforceability of clauses that do seek to limit or exclude liability.

So to conclude. Certainly I think you can anticipate that petitions for relief under section 994 of the Companies Act 2006 are going to more regularly rely on alleged breaches of an express or implied duty of good faith. However, given the notoriously high costs involved in such proceedings, I still think it would be a brave litigant who pursued a claim for relief solely on the basis of an alleged breach of a duty of good faith and, particularly, on the basis of an alleged breach of a duty of good faith that he contended should be implied in the circumstances of his case.

Thank you very much. I hope you found that short talk of interest. I’ll now hand back to David who I think is also the next speaker and I think the title for the next talk, if I’m right, David, is “Fights, Fallouts and Fails”.

Speaker1: Yes, it is. Andrew, thank you very much indeed for that presentation. That was extremely clear. That gave some very clear and important messages for practitioners to consider, for example, whether to expressly exclude or include duties of good faith and if so, what sort of duties. And I would describe that presentation as a work of scholarship given the state of flux which we seem to be in the middle of in relation to “relational” contracts and implied duties of good faith. I remember reading the Lufthansa case with some relief because that’s how I felt that the law in this area had not yet reached a stage of settled clarity. And I thought, phew, I’m not as thick as I thought I was. But that was extremely interesting. So thank you very much indeed, Andrew. Thank you.