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Beware of the Little-Known Sting in the Tail of Directorship Status

Senior Executives who are also directors need to be aware of additional obligations that continue to apply after termination of their employment and resignation of their directorship.

The majority of Senior Executives who are considering leaving their current role are aware of the restrictive covenants in their contracts of employment, which can seek to prevent them from competing and/or soliciting or dealing with clients, and/or poaching or engaging with fellow employees of their employer.

In fact, many have carefully negotiated the restrictive covenants in their contracts of employment to try to ensure that they have as few restrictions as possible placed on their actions when they leave.  However, very few are aware of the duties and obligations which they continue to owe to their employer after termination of their employment, if they were also a director of their employer or any of its group companies.

Whilst it is generally the rule that a director, including a de facto director, ceases to be subject to the general duties owed by a director under the Companies Act 2006, Section 170 (2) (a) of that Act states that a person who ceases to be a director continues in certain respects to be subject to the duty in Section 175 (duty to avoid conflicts of interest) as regards the exploitation of any “property, information or opportunity”of which they became aware at a time when they were a director.

The recent case of Burnell v Trans-Tag Ltd [2021] EWHC 1457 (Burnell case) has highlighted the importance of remembering such continuing duties once employment/directorship terminates, and has widened the impact of such duty.

In this case, the High Court held that a former investor, CEO and de facto director of a company had breached the duty to avoid conflict of interest situations, notwithstanding that all the relevant acts on his part had occurred after he had ceased to be a director.

A de facto director owes the same fiduciary duties to the company as if they had validly been appointed as a statutory director. There is no one definitive test for whether an individual is a de facto director, the question is whether they were part of the corporate governance system of the company and whether they assumed the status and function of a director so as to make themself responsible as if they were a director. Whilst it may be difficult to determine with certainty when such a person ceases to be a de facto director, in this case, that date was determined as the last date on which there was any evidence of Mr Burnell purporting to act as a director and being treated by others as acting in that capacity.

Prior to the Burnell case it was clear that a director would fall foul of the duty not to act in conflict with their former employer should their resignation have been prompted or influenced by a wish to acquire for themself (or their new venture) any maturing business opportunities available to the former employer, and where it was their position with that company, rather than a fresh initiative that led to the opportunity which they later appropriated. However, the Burnell case has removed the requirement for there to have been some connection between the resignation and a maturing business opportunity. Now there needs to be no such intention at the point of resignation. Therefore, if at the point of resignation, a director had no intention to depart and exploit any property or information of the company, if such property or information or opportunity is in fact exploited this could amount to a breach of duty, provided that the “property, information or opportunity” is one that the director became aware of when they were a director.

By way of example:

Tom, an employee and director of Accounts & Co leaves to work for Numbers & Co, a direct competitor. His resignation was purely motivated by a wish to move to a different region.  When he was at Accounts & Co he acted for Newco and was aware that they needed a valuation of their business and they had asked Accounts & Co to provide a quote for the work.

When Tom started at Numbers & Co, as he had no restrictive covenants preventing him from acting for Accounts & Co’s clients, Tom contacted Newco and pitched for the work.

This work is likely to be found to be a maturing business opportunity for Accounts & Co, of which Tom became aware owing to his position at Accounts & Co. Should Tom obtain the work, Accounts & Co could bring a claim against him for breach of his continuing duty to avoid conflicts of interest as regards the exploitation of any “property, information or opportunity” of which he became aware at a time when he was a director, and may claim an account of profits and/or consider injunctive relief.

Practical points to note

It is important to fully consider the implications of becoming a director of a company or being held out as a director. Frequently, being asked to be a director is seen to be a privilege and often the position is accepted with very little thought given to the wider ramifications of being such an office holder. It is likely that following the Burnell case, many employees who are also directors will be caught out by this judgement and its effect on the interpretation of S170 (2) (a) of the Companies Act, with the resultant possible stress and cost of defending a claim for an account of profits and/or an application for injunctive relief to prevent them from acting in respect of a maturing business opportunity.

For Senior Executives who had based their business plan on their ability to take existing client work to their new employer, this could result in double trouble, as they could find themselves on the receiving end of a claim from their previous employer, whilst simultaneously losing the support of their new employer, when it becomes clear that the business plan on which the offer of employment was based will not deliver the immediate income expected.

When Senior Executives are considering a move, the duty to avoid conflicts of interest as regards the exploitation of any “property, information or opportunity” which they became aware of as a director, even after ceasing to hold the office of a director, needs to be considered  side by side with discussions around the enforceability of restrictive covenants (if any),  to ensure that there are no unpleasant surprises once they have landed in their new role.

If you are a senior executive or founder considering a strategic move, with questions arising from this alert, or for specific legal advice on particular circumstances, please contact Senior Consultant Elizabeth McEneny or Partner Merrill April, both of whom specialise in contentious and non-contentious employment and partnership issues, including director’s duties and shareholder issues.

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CM Murray LLP is ranked in Band 1/Tier 1 by Chambers and Partners and Legal 500, with ”a reputation that can’t be beaten for senior executive work” (Legal 500 UK 2021). Merrill April is “fast-thinking, forward-thinking and responsive” (Legal 500 UK 2021).