INVEST 360 LIMITED AGAINST KEVIN PARK
SHERIFFDOM OF GRAMPIAN HIGHLAND AND ISLANDS AT ABERDEEN
[2017] SC ABE 34
A356/15
JUDGMENT OF SHERIFF W H SUMMERS
In the cause
INVEST 360 LIMITED
Pursuer
Against
KEVIN PARK
Defender
Pursuer: Shand;
Defender: McDiarmid;
Aberdeen, 24 May 2017
The sheriff, having heard parties in debate and having resumed consideration of the cause, Repels the first plea-in-law for the defender; Sustains the second plea-in-law for the defender to the extent of excluding from probation the pursuer’s averments in Article 5 of condescendence at page 10 of the Closed Record, line 33 reading “…exercise independent judgment and…”, and excluding from probation the passage of the pursuer’s pleadings in Article 5 of condescendence at page 11 reading “...173 and…” ; Quoad ultra repels the second plea in law for the defender; Sustains the fourth plea-in-law for the defender to the extent of excluding from probation the first three sentences of Article 4 of condescendence reading “At a point in 2010, the Defender made payments from the Pursuers to SCL in the sum of £1865. This was not authorised by the Board of Directors. It was made without the knowledge of the Board of Directors”; Allows parties a proof of their respective averments; Reserves meantime the question of expenses arising from the diet of debate of 9 May 2017; Appoints parties to be heard in relation to expenses and further procedure on 8th June 2017 at 10am.
NOTE
Introduction
[1] The pursuer company in this action sues a former Director for payment of the sum of £47,685. The pursuer avers that the defender paid these sums to a company with which he was associated in breach of the fiduciary duties he owed to the pursuer.
[2] I heard a debate in the action on 9 May 2017. In the course of the debate, I was invited for the defender to exclude certain averments from probation and in consequence, to dismiss the action. Failing that I was invited simply to exclude certain averments from probation.
Background
[3] The pursuer company was established to invest in property. It was established by three individuals. Those were Mike Duthie, Andrew Dudek and the defender. Each of the three was a Director of the company. The defender was a director from the point of incorporation until 23 September 2014.
[4] The three individuals did not take their shares in the pursuer in their own names. Rather the shares in the pursuer were held by companies in which the Directors had an interest. Michael Duthie’s shares were held by Michael Duthie Limited (“MDL”). Mr Dudek’s shares were held by ASD Investments Limited (“ASD”). The defender’s shares were held by Sunnyside Group Limited (“SGL”).
[5] It was agreed between the Directors that Mr Dudek and the defender would be paid by the pursuer for work that they did on behalf of the company. It was agreed that any sums due to the defender for work that he did for the company would be paid to Sunnyside Consulting Limited (“SCL”). SCL is a subsidiary of SGL.
[6] This action concerns sums that were paid to SCL on behalf of the defender. Two separate sums are involved. The first is a sum of £1,865 which it is averred was paid by the pursuer to SCL in 2010. The second is a sum of £47,685 which it is said was paid by the pursuer to SCL in August 2014 shortly before the defender resigned as a Director of the pursuer. When the action was raised the sum sued for was £47,685. That sum has never been amended. The Record No. 15 of process incorrectly refers to the sum being sued for as £49,550.
[7] The pursuer avers that the defender authorised payment of these sums to SCL in breach of his fiduciary obligations as a Director of the pursuer. Two broad lines of argument were advanced for the defender at debate. It was argued in relation to the sum of £47,685 that the pursuer had not pled a relevant case. It was argued in relation to the smaller sum of £1,865 that any entitlement the pursuer may have had to recover that sum has been extinguished by the operation of prescription.
Pleadings
[8] The Record extends to some 13 pages. The pursuer’s averments comprise some six pages of detailed averments. Many of those have no relevance to the issues arising from debate.
[9] The pursuer does not aver that the defender was not entitled to be paid for work that he did for the company. The position on record is that agreement in principle had been reached that the defender was entitled to be paid something and agreement was reached in principle that payment could be made to SCL. It is averred by the pursuer there was never any agreement in relation to the amount to be paid. The pursuer avers that the position was quite the opposite. The sums said to be due to the defender were set out in invoices rendered by SCL to the pursuer. It is averred that issue was taken with the sums sought by the defender. The pursuer avers that the defender was repeatedly asked to substantiate the sums that he sought. The pursuer goes on to aver that the defender was told that he should not make payment of these invoices without the agreement of his fellow directors. It is averred that he agreed to that but proceeded nonetheless to authorise payment of the invoices.
[10] The pursuer avers at the beginning of Article 3 of condescendence:-
“SCL rendered invoices to the Pursuers for the period 31st December 2008 to 30th June 2014. Mike Duthie received those invoices on or around 15th August 2014. The invoices had been backdated to cover the period between December 2008 and June 2014. The invoices totalled £47,685. These invoices purported to be for remuneration on behalf of the duties carried out by the Defender. The rate charged was £600.00 plus VAT. The pursuer did not authorise the payment of the invoices ....”.
[11] The pursuer goes on to aver in Article 3 towards the bottom of page 4 of the Record:-
“Explained and averred that the pursuer had in place a procedure for payment of invoices, such as those issued by SCL. The procedure involved submitting an invoice to another Director for authorisation; that Director would review and then authorise an invoice for payment where appropriate. The pursuer consistently applied that procedure for all Directors…”.
[12] Further in that Article the pursuer avers:-
“At no point were any of the SCL invoices approved. In terms of the Pursuer’s Article of Association the Directors are not automatically entitled to any remuneration. The pursuer’s Articles of Association adopt the regulations contained in the Table A …... The Pursuers did not at any time determine by ordinary resolution that the Defender would receive remuneration at a rate of £600 + VAT per month……..with reference to the email dated 7 July 2014, the Defender made proposals as to how the remaining company funds should be distributed. The proposals included payment to the defender in the sum of £7,856 in repayment of a Director’s loan, MDL in the sum of £4,538.82 in repayment of shareholder’s loan, payment to the company’s accountant in the sum of £1,448 and the disputed invoices to SCL. Mr Duthie approved the Defender’s proposals, save the disputed invoices to SCL. Mr Duthie’s reply email requested independent verification of the disputed invoices. That was not provided ….... The pursuer has repeatedly requested that the Defender provide a detailed breakdown of the time spent on performing duties for the pursuer and a justification of the proposed fee rate……”.
[13] At the beginning of Article 4 of condescendence it is averred-
“At a point in 2010, the defender made payments from the pursuer to SCL in the sum of £1865. This was not authorised by the Board of Directors. It was made without the knowledge of the Board of Directors.”
[14] From the beginning of Article 5 of condescendence it is averred on behalf of the pursuer:-
“The defender used his position as a Director of the pursuers to make payment to SCL without the authorisation of the other Directors. In acting in the manner condescended upon the Defender breached the fiduciary duties which he owed to the Pursuers. ………..The Defender had a duty to act within his powers, by acting in accordance with the Company’s constitution and only exercising powers for the purpose for which they were conferred. In a meeting between the Defender, Mr Duthie and Mr Dudek on or around 12 November 2007, the defender proposed that the Pursuers would pay for his additional services by payment to SCL. It was agreed between the three Directors that the proposal to pay SCL was acceptable but that the rate would be quantified at the market price for the duties which were undertaken…... Further explained it was agreed at the meeting on or around 12 November 2007 that any payments proposed by SCL would require the approval of one other Director…….. Mr Duthie agreed that compensation should be made in respect of the time spent by the Defender for duties carried out on behalf of the Pursuers. Mr Duthie stated in his email that the defender should implement the proposal but that a monthly analysis of the time the Defender spent undertaking the said duties would be required. The Defender did not provide this. During the said telephone conversation it was agreed that the proposed remuneration would follow the same approval and quantification procedure as applied to the other Directors. On or around 31 July 2014, Mr Duthie emailed the Defender stating that “In the past [the Defender] approved and paid invoices submitted by [Mr Dudek]” and wanted to apply the same rigour and control that had been agreed. The Defender replied to that email on or around 31 July 2014 and stated that he “totally agree(s) that we have to apply the same governance and procedures to Sunnyside invoices as we did to [Mr Dudek’s]” ......It was agreed between the Pursuers’ Directors that SCL’s proposed fee would require to be approved by the Pursuers’ Directors before payment was made. The Defender proceeded to make payment to SCL, knowingly without the required approval. By doing so the defender breached his duty to act within his powers. Reference is made to Section 171 of the Companies Act 2006. The Defender was a Director of both SCL and the Pursuers. The defender was noted on SCL invoices as the “Sales Person”. The Defender had duties to exercise independent judgment and avoid conflicts of interest. In this sense he had a duty to act in the best interests of the company as a whole and not to represent the interests of just one shareholder. By making the said payments to SCL, which is wholly owned by SGL, the Defender was representing the interests of just one shareholder. As a Director of both SCL and SGL, the Defender had a direct interest in the transaction which conflicted with the interests of The Company. In acting in this way, the defender breached his fiduciary duties. Reference is made to sections 173 and 175 of the Companies Act 2006….”.
[15] The defender responds in detail to all of the averments made against him. His response to the allegations made in relation to acting without authority is to be found in Answer 3. His position is that steps were being taken to wind up the company and agreement had to be reached in relation to the distribution of the company’s remaining funds. The defender avers –
“Following email correspondence between the Defender and Mr Duthie during August 2014, the Defender and Mr Duthie still had not reached a resolution. The Defender discussed the situation with the Pursuer’s bank account manager ….. The Defender was concerned that the financial affairs of the Pursuers required to be dealt with and the company wound up in short order so as to avoid further fees in respect of filing annual accounts. He therefore decided to proceed with the proposal and issued the proposed sum to SCL”.
Submissions for the defender
[16] The solicitor for the defender advanced three arguments in support of the defender’s first and second pleas in law and one in support of the fourth plea. The first three arguments related to the invoices totalling £47,685. In relation to the payment by the defender of those invoices the argument proceeded broadly on the basis that the pursuer’s case was predicated on the defender having breached the fiduciary duties set out in section 171, 173 or 175 of the Companies Act 2006 (“the Act”). It was submitted that on the basis of the pursuer’s averments, no breach of any of those sections was made out. It was submitted the averments for the pursuer did not give the defender fair notice of the case against him. It was submitted the averments should not be admitted to probation and the action should be dismissed. The fourth argument in support of the defender’s fourth plea in law was directed at the averments relating to payment of the smaller sum of £1,865. That was a straightforward argument based on the provisions of section 6 and schedule 1 to the Prescription and Limitation (Scotland) Act 1973.
[17] The first argument advanced on behalf of the defender related to the case taken by the pursuer under section 171 of the Act. Section 171 reads:-
“A director of a company must –
a) act in accordance with the company’s constitution, and
b) only exercise powers for the purposes for which they were conferred.”
[18] The argument was simply that on the basis of the pursuer’s averments, no case was made out under section 171(a) of the Act. It was recognised that the pursuer made averments in relation to an agreement reached between the defender and his fellow Directors not to make payments to SCL without the agreement of those other Directors. It was said that even if those averments are proved that does not amount to a breach of section 171(a). It was argued that it was not a breach of a fiduciary duty owed to the company to breach any agreement reached with fellow Directors in relation to payment of these sums. That might be a breach of the separate duty to promote the success of the company but that was not pled. It was submitted on behalf of the pursuer that in terms of the company’s constitution, the defender was entitled as a Director to authorise payments in the manner in which it was averred he had done in this case. It was submitted that any agreement with fellow Directors did not, and could not, affect that entitlement. In relation to section 171(b) it was said that there were no averments in relation to powers being conferred for a particular purpose. No fair notice was given of any case under section 171(b). In that regard I was referred to Eclairs Group Ltd v JKX Oil and Gas Plc [2015] UK SC71 at paragraphs 19 and 41 to 43. That case involved analysis of the “proper purpose rule”. It was said that case was authority for the proposition that there should be averments in relation to the purpose for which any power is conferred.
[19] In relation to the section 171 argument it was submitted that I should exclude from probation the averments in Article 5 of condescendence at page 10 of the Record, lines 29 to 31. The averments appear at paragraph [14] above. The averments read:-
“By doing so, the defender breached his duty to act within his powers. Reference is made to section 171 of the Companies Act 2006”.
[20] The second argument advanced on behalf of the defender related to the pursuer’s case taken under section 173 of the Act. The relevant part of the section 173 for these purposes reads:-
“173(1) A Director of a company must exercise independent judgment.”
[21] Again, on behalf of the defender it was submitted that there were no averments on Record in relation to the defender not exercising independent judgment. I was referred to Fulham Football Club Limited and others v Cabra Estates Plc 1992 WL 895734. That was an example of a case in which it was argued Directors had failed to exercise independent judgment by entering into an agreement which fettered the future exercise of their discretion. It was submitted on behalf of the defender that there were no averments in this case of such fettering of discretion nor were there any other averments from which it might be inferred that the defender had somehow failed to exercise independent judgment.
[22] It was submitted on behalf of the defender that it cannot be the case that by virtue only of being a Director of two separate companies that a Director can be said to have failed to exercise independent judgment. There must be averments of some other facts.
[23] In relation to the section 173 argument it was submitted that I should exclude from probation the averments in Article 5 of condescendence at page 10 of the Record, line 33 reading “….exercise independent judgment and..” and the reference on the following page to section 173 of the Act. Again, the averments appear at paragraph [14] above.
[24] The third argument advanced on behalf of the defender related to section 175 of the Act. The relevant parts of section 175 read:-
“Section 175 Duty to avoid conflicts of interest
(1) A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.
(2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity).
(3) This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.
(4) This duty is not infringed –
(a) if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or
(b) if the matter has been authorised by the Directors ..”
[25] The simple proposition on behalf of the defender in relation to this argument is that s175 does not apply because of the operation of section 175(3). It was submitted that the duty to avoid a conflict of interest did not apply in the present circumstances because this case involved “... a transaction or arrangement with the company”. It was submitted that instead, the relevant sections of the Act are section 177 and section 182. Section 177 deals with the Director’s duty to declare proposed transactions or arrangements and section 182, with the Director’s duty to declare an interest in existing transactions or arrangements. It was submitted, in any event, that neither section 177 nor section 182 could apply because in each case there was an exclusion of the section in relation to declaring an interest to the extent that the other Directors were already aware of it.
[26] It was submitted that section 175 applied to all transactions or arrangements with the company and not simply to transactions or arrangements between the company and the Director.
[27] In relation to the section 175 argument, I was invited to exclude from probation the averments in Article 5 commencing “The defender had duties...” at page 10, line 32 to the passage ending in “… Companies Act 2006” at line 4 of page 11”. Again, I have shown those averments at paragraph [14] above.
[28] It was submitted on behalf of the defender that if I sustained each of the arguments in relation to section 171, 173 and section 175 and excluded from probation the offending averments, no relevant case would remain and I should dismiss the action. In the event that I found in favour of the defender only in relation to some of the arguments, I should exclude the relevant averments from probation.
[29] The fourth argument on behalf of the defender was the prescription argument. That related to the averments relative to the separate sum of £1,865 referred to at the beginning of Article 4 of condescendence. Those averments relate to a payment made at some point in 2010 which it is said was not authorised by the Board. Those averments were introduced to the pleadings by adjustments in December 2016. That was more than 5 years after the payment was supposedly made. I have set out the averments at paragraph [13] above.
[30] In support of this argument, I was referred to the Prescription and Limitation (Scotland) Act 1973. I was referred to section 6(1) and (2) of the 1973 Act to schedule 1, paragraph 1(d) to section 6(3) and to section 11(1). It was submitted that for the purposes of paragraph 1(d) of schedule 1 to the 1973 Act the obligation this action was concerned with was an obligation to make reparation for breach of duty. Section 6(1) of the Act provides (read short) that if after the appropriate date an obligation to which the section applies has subsisted for a continuous period of 5 years without a relevant claim having been made…, then the obligation shall be extinguished. For the purposes of section 6(3) of the Act, the “appropriate date” is to be determined having regard to the date when the obligation became enforceable. By reference to section 11(1) of the Act, that is the date on which the loss occurred. It was submitted that any entitlement the pursuer might have had to recover this sum had been extinguished by the operation of prescription. I was invited to sustain the defender’s fourth plea-in-law to the effect of excluding the averments in relation to that sum from probation. There were no averments on the basis of which the pursuer could try to make a case under section 11(3) of the Act to the effect that the pursuer was not aware of the loss on the date on which it had occurred.
Submissions for the pursuer
[31] The solicitor for the pursuer responded first of all to the argument taken in relation to the section 171 case. He referred me to Howard Smith Limited v Ampol Petroleum Limited [1974] AC 821 as an example of a case in which the Director’s exercise of power was attacked on the basis that it was not exercised for the purpose for which it was granted. He submitted that it was necessary to look at the exercise of powers by Directors within the context in which they are exercised and the matter of why powers are conferred might have to be investigated. It was submitted that in terms of section 171 of the Act the Directors must act in accordance with the company’s constitution. That incorporated the provisions of the relevant Companies Act. The powers had to be exercised in accordance with the relevant legislation and in particular in accordance with sections 170 to 177 of the Act. I was referred to the averments for the pursuer in Article 3 at page 5 of the Record and Article 4 at page 9. It was submitted that those averments taken alongside the other averments made on behalf of the pursuer set out a relevant case. Fair notice was given to the defender of the case that was taken against him.
[32] It was submitted that the defender had not acted within the terms of the company’s constitution because he had acted in breach of the provisions of the Act. It was said that the defender had not exercised his power to settle invoices for the purpose for which it was conferred. The purpose of the power to authorise settlement of invoices was to allow the company to operate properly. It was not a blank cheque. The purpose it was said was to pay invoices properly due and properly authorised by other Directors. It was said that by failing to adhere to the restriction imposed by his fellow Directors the defender had acted ultra vires and in breach of section 171.
[33] In relation to the section 173 case, the solicitor for the pursuer again referred to the averments on Record. It was submitted that at all times the defender was a Director not only of the pursuer but also of SCL. It was said that by proceeding to authorise payment of the invoices in those circumstances he had not exercised independent judgment. It was submitted that the defender had failed to exercise independent judgment because he had not acted independently.
[34] In relation to the section 175 case, the solicitor for the pursuer supported a different interpretation of section 175(3). His submission was that read in context, section 175(3) plainly related to a transaction or arrangement involving the Director and the company. It did not apply to other transactions or arrangements with the company. The transaction or arrangement with which this action was concerned was not a transaction or arrangement between the Director and the company. It was a transaction or arrangement between SCL and the company. To that extent the exclusion of section 175 by section 175(3) did not operate. Section 175 applied and the defender had clearly acted in a situation where there was a conflict of interest.
[35] I was referred to McMenemy v Dougal 1960 SLT (Notes) 84 and in particular the oft-quoted passage of Lord Guest “In my view a Record should not be subjected to the careful and meticulous scrutiny devoted to a conveyancing Deed. The matter must be looked at broadly with a view to ascertaining whether the defenders having given fair notice of the case which the pursuers intend to prove...” It was submitted that reading the pleadings as a whole, fair notice was given to the defender of the case the pursuer intended to prove. It was submitted that there was no requirement to look a section 177 or 182 of the Act even for the purposes of interpreting section 175(3).
[36] In relation to the prescription argument, the solicitor for the pursuer reminded me that the action had been raised in 2015. He accepted that the adjustments in relation to payment of the sum of £1,865 were introduced in December 2016. He appeared to recognise that there would be a requirement on the part of the pursuer to rely on section 11(3) and referred me to averments at Article 3 near the beginning of page 5 “Mr Duthie, at no point prior to 15 August 2014, knew that the company accounts, which were prepared on the instruction of the defender alone, showed a balance due to SCL.” It was submitted that those averments were sufficient to enable the pursuer to take a case under section 11(3) of the 1973 Act. The solicitor for the pursuer recognised that the sum sued for in the writ was £47,685. The sum sued for in the Record is stated as £49,550. It was said that change had been made by adjustment.
Decision
[37] The Companies Act 2006 represented a comprehensive codification and restatement of the existing law. Sections 170 to 177 of the Act represented a restatement of the duties incumbent upon company Directors. It is specifically provided by section 170(3)-
“The general duties are based on certain common law rules and equitable principles as they apply in relation to Directors and have effect in place of those rules and principles as regards to duties owed to a company by a Director”.
It is provided by subsection (4)-
“The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.”
[38] For the purposes of the debate in this action, the solicitor for the defender did not seek to argue that the defender was entitled to act as he had done. Rather the submission insofar as it related to the Director’s duties was confined to specific criticism of the pleading of the pursuer’s case under section 171, section 173 and section 175. It was submitted that some of those did not apply and in relation to others that the pursuer had failed to make sufficient averments to give the defender fair notice of the case which it was intended to take.
[39] When looking at Directors’ actions against the backdrop of the duties incumbent upon Directors, there will, in some cases, be overlap between certain duties. Particular actions of a Director might be said to breach more than one of the fiduciary duties. There was a concern when the 2006 Act was introduced that the strict codification of Directors’ duties might lead to inflexibility. This case is an example of difficulty arising from that inflexibility. Having said that, while I applaud the intellectual athleticism involved in formulating the arguments for the defender I do not agree with the main thrust of those arguments.
The section 171 argument
[40] Section 171(a) requires a Director to act in accordance with the company’s constitution. That involves acting in accordance not only with the Memorandum and Articles of Association but also the relevant provisions of the Companies Act. It was submitted by the solicitor for the pursuer a Director might fail to act in accordance with the company’s constitution for the purposes of section 171 of the Act by failing to comply with the duty incumbent upon him in terms of section 172 of the Act. That argument seems on the face of it to be well founded but it does not answer the criticism of a failure to give fair notice. If that is the pursuer’s case it needs to be set out clearly in averment and it is not.
[41] The position is different in relation to s171(b). The criticism of the pursuer’s s171(b) case was that it was said that there were no averments in relation to powers being conferred for a particular purpose. It was submitted no fair notice was given of any case under section 171(b). I do not agree. In my opinion the pursuer’s averments are sufficient to set out and give fair notice of a case of an alleged breach of section 171(b) of the Act.
[42] The defender, as a Director of the pursuer, plainly had authority in terms of the company’s constitution and the legislation to authorise payment of invoices. This case concerns invoices rendered to the company in respect of work allegedly undertaken by the defender. The pursuer makes detailed averments throughout the Record in relation to those invoices and to the discussions that took place between the defender and the pursuer’s Directors in relation to settlement of those invoices. Insofar as it was within the defender’s power to settle those invoices, it is specifically averred on behalf of the pursuer that power was curtailed. It is averred that power was curtailed by agreement at the meeting on 12 November 2007 “…that any payments proposed by SCL would require the approval of one other Director”. It is averred the power was curtailed by the arrangement that the pursuer had in place for payment of such invoices. The pursuer further avers that as recently as July 2014 the defender agreed “We have to apply the same governance and procedures to Sunnyside invoices as we did to [Mr Dudek’s]”.
[43] The power to settle these invoices was conferred upon the defender. It was curtailed in the interests of the proper organisation and management of the pursuer’s affairs. The pursuer avers that the defender authorised settlement of these invoices without securing the agreement of one other Director. The pursuer avers that was in flagrant disregard of the procedures that were in place within the company.
[44] Powers may be conferred on different Directors for different purposes. Powers may for example be conferred on a Financial Director for purposes different from powers conferred on a Technical Director. Different powers may be conferred on different Directors depending on their roles. To ascertain the extent of powers conferred on any director and the purpose for which powers were conferred it may be necessary to look not only at the company’s constitution but also at other things. Those might include any service contract and any agreement between directors in relation to their roles and responsibilities. It follows that in considering whether powers are exercised for the purpose for which they were conferred, regard must necessarily be had to any curtailment of a directors powers and the purpose of such a curtailment. The pursuer makes detailed averments as to the curtailment of the defender’s powers and the reason why those powers were curtailed. If the pursuer’s averments are established at proof, it cannot be said that the defender exercised his power to authorise settlement of invoices for the purpose for which that power was conferred and curtailed. It seems to me for that reason the pursuer has sufficient averments on record to prove a case under s171(b).
[45] If I am wrong in that view there is another reason why the pursuer’s case should be allowed to proceed to proof. I was referred to Eclairs Group Ltd v JKX Oil and Gas plc but I was not referred to the most relevant passages. The “proper purpose rule” is discussed in paragraphs [14] and [15] of Lord Sumption’s judgement.
“The proper purpose rule has its origin in the equitable doctrine which is known, rather inappropriately, as the doctrine of “fraud on power”. For a number of purposes the early Court of Chancery attached the consequences of fraud to acts which were honest and unexceptionable at common law but unconscionable according to equitable principles….The important point for present purposes is that the proper purpose rule in not concerned with excess of power by doing an act which is beyond the scope of the instrument creating it as a matter of construction or implication. It is concerned with abuse of power, by doing acts which are within its scope but done for an improper reason.”
[46] The pursuer makes detailed averments about what it is alleged the defender did. The pursuer sets out in detail why it is said the defender acted with an improper reason. In essence that is paying himself without the agreement of his fellow directors and shareholders. What is averred for the pursuer, if proved, would amount to a breach of s171(b) by the defender exercising his power to authorise settlement of invoices for an improper reason. The averments give fair notice to the defender of the case pled against him and should be admitted to probation.
The section 173 argument
[47] In my opinion there is some force in the defender’s submission in relation to the case pled by the pursuer under section 173 of the Act. There are no averments on Record as to the specific respect in which it is said the defender failed to exercise independent judgment. There are no averments of fact from which that might be inferred. It is not enough for the purposes of section 173 simply to aver that at the same time as he was a Director of the pursuer the defender was also a Director of SCL. Failing to exercise independent judgment is not the same as failing to act independently. A Director might fail to act independently in the sense of having a conflict of interest (as the pursuer avers the defender did here), while at the same time exercising independent judgment in deciding to act in that way. I have excluded from probation the pursuer’s averments in relation to the section 173 case.
The section 175 argument
[48] In relation to the section 175 case, I agree with the interpretation of section 175(3) urged upon me by the solicitor for the pursuer. Section 175(1) is the section dealing with conflict of interest. Section 175(3) provides “This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company”.
[49] As a starting point I should observe that if that subsection were taken to apply to any “….transaction or arrangement with the company” it seems to me that it would exclude any number of transactions in which a Director might be thought to have a conflict. In my opinion, that subsection is intended to relate to transactions or arrangements involving the Director and the company.
[50] I take the view not least of all because of the structure of section 175 in general. Section 175(1) starts by referring to “A Director of a company ..” Section 175(2), without making any reference to a Director, provides “This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity)”. Although there is no mention in that subsection of a Director, s175(2) plainly applies to the actions of a Director. It seems to me that s175(3) falls to be interpreted in the same way.
[51] In my opinion s175(3) will be engaged (and the s175 duty will not apply) if a Director enters into a transaction or arrangement with the company. It will not be engaged (and the s175 duty will apply) if another entity, whether associated with the Director or not, is engaged in a transaction or arrangement with the company.
[52] Dealing particularly with the payment of the invoices which is the subject of this action, if that was a “transaction or arrangement” for the purposes of s175(3) then it was not a transaction or arrangement involving the Director. It was a payment to SCL.
[53] On that basis, it does not seem to me that the exclusion of section 175 generally brought about by section 175(3) has any application. The pursuer makes clear and detailed averments in relation to the alleged conflict of interest between the company and the Director. Those averments are sufficient for enquiry.
[54] Beyond that, I should also record for the sake of completeness that I am not satisfied that the payment of invoices in the manner averred by the pursuer is, “…a transaction or arrangement with the company”. The pursuer avers that invoices were rendered by SCL to the pursuer for services rendered to the pursuer by the defender. The defender as a Director of the company authorised payment of those invoices. The pursuer avers that he did so in breach of his fiduciary duties. The act that is complained of is the authorisation by the defender of payment of the invoices without prior approval of another Director. I am not satisfied that is a “transaction”. Typically a transaction would involve one party providing goods or services in consideration of payment. In some respect a transaction would be bilateral. The act of the defender complained of is not a “transaction” for the purposes of section 175(3). Similarly I am not satisfied this is an “arrangement”. Typically an arrangement in this context would be an agreement with someone to do something. The act of the defender complained of is not an “arrangement” for the purposes of section 175(3). Again, for that reason it does not seem to me that section 175(3) has any application.
[55] For the sake of completeness I should deal with the other argument advanced for the defender. It was submitted on behalf of the defender that even if a case had been pled under section 177 or section 182 that would have been irrelevant. It was said to be irrelevant because of the provision of sections 177(6) and 182(6) to the effect that a Director need not declare an interest in a transaction or arrangement under the section – (b) “if, or to the extent that, the other Directors are already aware of it ..” I do not agree with that. As a starting point I am not satisfied that the defender making the payment as he did was a transaction or arrangement. What is complained about is the defender’s act of authorising payment of the invoices. That notwithstanding, it is averred that the other directors were not aware of the payment being authorised so the exclusion under either s177(6) or s182(6) would not apply.
[56] Throughout the pleadings the pursuer makes detailed averments in relation to the defender failing to act in the best interests of the pursuer. Those averments are to be found in particular in Article 5 of condescendence at pages 10/11. The defender was required to act consistently with the duties incumbent upon him as a Director of the company. One of those duties is the general duty contained in section 172(1) of the Act and that is the duty specifically “…to act in a way he 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 have regard (amongst other matters) to – (f) the need to act fairly as between members of the company”. The pursuer’s averments suggest that in exercising the power to settle these invoices the defender did not act consistently with that duty. It might be thought that what is averred would more readily be characterised as a breach of the fiduciary duty to promote the success of the company provided by section 172(1) of the Act rather than the breach of any other duty, but that is not averred.
The prescription argument
[57] Finally, in relation to the prescription argument, I have no hesitation in preferring the submission for the defender. On the basis of the pleadings and the procedure in the action to date it is clear that no steps were taken to recover the sum of £1,865 until adjustments were introduced into the pleadings in the action in December 2016. By that time, more than 5 years had elapsed since the obligation to make reparation had arisen. There are no sufficient averments to enable the defender to prove a case under section 11(3) of the Act. The right to recover the sum of £1,865 has been extinguished. I have excluded from probation the averments relating to that sum. I have not reduced the sum sued for in the record because it is misstated.
Conclusion
[58] The arguments advanced on behalf of the defender have met with limited success. To the extent that those arguments have been successful I have excluded averments from probation. I have fixed a hearing in relation to expenses and further procedure.