Tuesday 18 November 2008

Is the HBoS deal illegal?

Walk with me here, I've not quite got this pinned down, but I think I'm on the way.

I've already mentioned Hornby's £60,000 per month deal with Lloyds TSB if the deal goes through, and the very strange conditions in the Implementation Agreement. For the avoidance of doubt, Andy Hornby is a director of HBoS.

You see, I thought to myself "I wonder what the legal parameters are for directors?" What are they allowed to do, what is expressly forbidden, what is common law because of custom and repute, and so on. So I pondered where the best place to find such information would be. It came to me in a flash - my old mate Victor would know!

A fine man is Victor, there it is in glorious technicolour (I know, but I'm not American):

As a director, you have several duties:
To act in good faith to promote the success of the company for the benefit of its members. You must also have take into consideration employees, suppliers, customers, the environment and the community.
To carry out your duties with reasonable care and skill. Higher standards may be expected from executive directors who are responsible for an area in which they have a specialist or professional qualification.
To make sure that there is no conflict of interest and duty.
Not to benefit from a third party by reason of your being a director, or by doing or not doing something.
Not to act with intent to defraud creditors or for any other fraudulent purpose.
To carry out the statutory obligations imposed by the Companies Act 2006 and other legislation.
There's more in there, but this will do for a start. You'll note that directors should take into account, amongst other things, the community - that would be Edinburgh and Halifax primarily for HBoS.

More importantly, perhaps, is that duty to ensure that there is no conflict of interest (like writing your company into an impossible-to-escape Implementation Agreement), and the requirement not to benefit from a third party by reason of your being a director (surely a future sinecure is as important as anything else in this consideration?)

Then there's that requirement to be honest (not fraudulent) and to carry out the statutory obligations. In search of the truth, I set off on the long journey into the Companies Act 2006. I did so with some trepidation, considering just how much of a horrible beast the 1985 Act was, but it did not in any way prepare me for the full trauma of the 2006 Act - 1300 sections (that's not a typo, it's 1,300) and 16 schedules.

"Away an no be daft" I thought, and continued to peruse my extensive library (some people call it the internet) - I went to the obvious shelf (just above the flask of tea and the marmalade sandwiches), and peered in at the Companies House Guidance Booklets - pretty dry except for the bit in the Directors and Secretaries guidance which says:
A director’s general duties to the company are, for the first time, set out in the Companies Act 2006 but the relevant provisions are being commenced in two stages. Most of Chapter 2 of Part 10 of the 2006 Act (General duties of directors) was commenced with effect from 1 October 2007, but the sections relating to the duties to avoid conflicts of interest, not to accept benefits from third parties, and to declare an interest in a proposed transaction or arrangement with the company (and related provisions) will be commenced with effect from 1 October 2008. The general duties of directors were previously contained in case law. See the Department of Business, Enterprise & Regulatory Reform website www.berr.gov.uk for further details.
You can imagine how I felt.
If these provisions were not commenced until October 1st this year then there is a court argument to be had (let's not call it a legal argument, it's more like theatre) about whether the provisions should apply in this case, and you'd have to know a bit more about when the deals were offered and accepted than we currently do. We know, for example, that the Hornby deal was made public in early November, but when was it made?

I trudged off round the library shelves, pausing to move the economics textbooks into the fiction section, and found myself staring at the hallowed pages of the International Financial Law Review. Would it have anything on UK directors? Indeed it did. The information was much the same except for this titillating little piece:
A director (including a former director) must "avoid a situation in which he has a direct or indirect interest that conflicts or may conflict with the interest of the company". Directors are currently under a similar common law duty and can avoid liability for breach by obtaining the members' consent.
So it was a common law breach before it became a statutory breach - unless Hornby asked the shareholders for permission first. It's not definitive, though, and so it was back to the 2006 Act and started reading:
An Act to reform company law and restate the greater part of the enactments relating to companies; to make other provision relating to companies and other ...
And so it went on until I reached page 138 and the chapter on the general duties of directors where we find that the duties are based upon the common law rules and equitable principles and should be read as such.

A few specifics are often delicious:
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.
Like not be working for both sides of a takeover.
176 Duty not to accept benefits from third parties
(1) A director of a company must not accept a benefit from a third party conferred by reason of—
(a) his being a director, or
(b) his doing (or not doing) anything as director.
Would a £720,000 a year job with a third party count as a benefit? You can see how the case stacks up. Then this happens:
178 Civil consequences of breach of general duties
(1) The consequences of breach (or threatened breach) of sections 171 to 177 are the same as would apply if the corresponding common law rule or equitable principle applied.
(2) The duties in those sections (with the exception of section 174 (duty to exercise reasonable care, skill and diligence)) are, accordingly, enforceable in the same way as any other fiduciary duty owed to a company by its directors.
It's a civil wrong rather than a criminal wrong, so shareholders have to sue. The deal breaks the law because Hornby's actions in accepting a third party benefit run exactly counter to the law. Further, the duty to exercise independent judgement as imposed by Section 173 is an obligation not to fetter the exercise of their powers of discretion - as the Implementation Agreement does.
See Boulting versus the Association of Cinematograph, Television and Allied Technicians from 1963.
Shareholders should be able to interdict the takeover in order to have the case examined properly. Derivative Proceedings are examined in section 265 and onwards. A shareholder can also petition the court under section 994.

Personally, I'm off to read the HBoS articles of association and then, just for a laugh, I'll read the Lloyds one.


Scott @ loveandgarbage said...

Mr C - if you weren't so rude to commercial lawyers that leave comments on your posts then you might have been saved a lot of legwork. Anyway, since you mentioned the agreement in your post the other week I've trawled a bit of conflict of interest material, because the point you raised seemed a bit odd. Anyway I went back to source for the legislation - including the original joint Law Commission report that led to the provisions in the first place (that's on-line http://www.scotlawcom.gov.uk/downloads/rep173.pdf and as readable as these things get).

The position in s 175 (1) of the 2006 Act is a codification of the common law, hence old cases could be used in interpreting the new provision. The leading case here is Aberdeen Railway Co v Blaikie Bros [1854] 1 Macq 461 where a company managed to pull out of an agreement because its chairman was also a managing partner of the other contracting party. His dual role stuffed the contract. However, since then the general duty has been watered down by companies making express provision in their articles or government watering it down through the Companies Acts or the model Articles of Association produced - the latest watering down is that s 175 (4)(b) allows a conflict to be authorised by the board (if permitted by the company constitution - most do), and 175 (5) and (6) set the procedural hoops. Also s 177 gives a duty to those interested in the deal to declare that interest (Although s 177 (6)(b) is a bit odd here and seems to suggest that you don;t even have to declare our interest in some cases).

The actions of the directors can stymie the shareholders (see s 180 (1)) because if the directors have authorised it then the shareholders can't intervene (unless the Articles provide otherwise).

So, even if it looks a bit iffy - it's dependent on what has been agreed by the board - this may come to nothing. It's the economic arguments that will make the difference here.

As for the obligation in the duties to take the community interest into account most company lawyers view that as window dressing. Section 170 sets out who the duties are owed to, and the minister when the bill was going through indicated that where any of the factors in s 172 conflicted directors should take their own "good faith business decisions" to promote the success of the company Comm D 11 July 2006 cols 591 - 3.

I appreciate this comment is rather longer than the comments you prefer. It has no jokes, and it suggests that your legal hunt may have been in vain. Still better luck with the economic arguments.

Scott @ loveandgarbage said...

And PS

Fulham FC v Cabra Estates plc [1994] 1 BCLC 363 shows that directors can bind themselves if the original contract is assessed (at the time the contract is entered into) as being in the best interests of the company. This takes you back to the time of the original agreement in principle in assessing the best interests of the company but suggests s 173 may give a slightly better ground of challenge than ss 175 or 176. The no fettering rule as applied in Boulting (the case you refer to) is about nominee directors for specific shareholders - indicating they cannot act for the person nominating, but for the company as a whole.

Best wishes


Calum Cashley said...

Being rude to lawyers is one of the few true pleasures in life. I find myself surrounded by them, beset on all sides, and cannot work out for the life of me what their purpose is.

I didn't really take a long time to get through all the documents, I'm an excellent researcher and did it while I was hunting through something else (I can do such things with ease) but I was telling a tale and one must be entitled to a little padding in the seat cushion...

I am aware of the counter-arguments - they were in the links from my piece - but it was not and is not my intent to construct a case counter to the one which I wish to see succeed. That would, after all, seem a little counter-productive; let those who believe the counter argue their case if they are able.

The real buried treasure, of course,lies not in the Companies Acts but in the powers of "the Secretary of State" in the Enterprise Act of 2002. Brownie points for any lawyer who can spot the possibility (with the exception of m'learned friend whose advice has already been sought on this matter although he has so far declined to proffer an opinion).

Now, of course, that Darling has said he might take his ball home if he doesn't get his own way ("yeah, yeah, I'll just let the banks go down man, I don't care, they're only my constituents"), the battle may be destined to be fought out in the political arena.

That would be most unedifying and carry the risk of turning into a bloodbath - almost as bad as putting up with lawyers.

Scott @ loveandgarbage said...

"I am aware of the counter-arguments - they were in the links from my piece - but it was not and is not my intent to construct a case counter to the one which I wish to see succeed. "

Ah!. you see Mr C that's what lawyers are for. Anticipating the counter-arguments and then showing why they do not apply to a particular case.

From the omissions in the comments above you'll therefore see where your best argument lies! Had a quick look at Len Sealy's book today (one of the top academic company lawyers). He stresses that the whitewash procedure is not generally applicable to all of the directors duties. And there must be a reason for that omission (it could be argued) and there lies the root of any challenge.



PS if you do a similar bit of digging on the Mortgage Rights Act to that you've done for this stuff(although it will require you to get into the conveyancing hinterland because the guides produced here do not reflect the wording of the legislation) you'll discover that it's full of inadequacies (not least its anglicised short title). That was the crux of the point I tried to make the other week - some aspects of the problems would be fairly easily remedied. When your lot have the levers of power such reform would be welcome to those that work in the sector (especially when it looks like the original enactment didn't take account of the reforms made to the English legislation to address inadequacies shown up by case law, despite warnings at the time that the wording was too opaque given the typical nature of Scottish standard securities). For me just because it's Scottish doesn't mean it's better - when you're reforming you take your lessons from anywhere that does it a bit better because they're dealing with the same policy problems.

cheery toodle


Calum Cashley said...

I'll come back to mortgage stuff later - I have to argue with an old chum about it first, he emailed me and I've not had a chance to respond.

He's a lawyer, though, so he'll be used to it.