Tuesday, August 4, 2009

Corporate Opportunities: A "Scope of Business" Exception?


A couple of weeks ago, Corporate Law and Governance highlighted a decision of the Court of Appeal in O’Donell v. Shanahan, reasserting the strictness of a director’s fiduciary duties.

A leading decision on the point of the director’s fiduciary duties was Regal (Hastings) v. Gulliver, [1942] 1 All ER 378, where the duties were held to extremely strict. The principles – bearing a relationship with the no-conflict rule, the no-profit rule, and the corporate opportunities doctrine – were affirmed in several later cases, notably, Phipps v. Boardman, [1966] 3 WLR 1009, and Industrial Development Bank v. Cooley, [1972] 2 All ER 288. The principles were stated to be so strict, in fact, that Professor Gower observed in his work that the decisions had led to an equitable principle being stretched to inequitable ends. Effectively, under a set of English cases following the strict approach, it was held that if a director uses an opportunity (a “corporate opportunity”) which comes to him in the course of his duties for private benefit, he must account to the company for the profits he makes. This much is eminently in keeping with first principles – where the Courts stretched the equitable principle to inequitable results was when they expanded the meaning of “corporate opportunity” to include even those instances when the opportunity was out of the line of business of the company. In Regal itself, it was stated that the question of the bona fides of the directors was irrelevant. It was also held that the fact of the opportunity not being ‘open’ to the company was no defense. The decision suggested that a mere theoretical possibility of a conflict of interest was enough to attract the rules.

Arguably, several later cases mitigated the rigour of rules, beginning with Island v. Umunna, [1986] BCLC 784, and Queensland Mines, [1978] 18 ALR 1. In the latter case, the Privy Council stated that what mattered was the practical possibility of a conflict of interest, and not a mere theoretical chance of conflict. As recently as 2007, the Court of Appeal noted (in Foster Bryant Surveying v. Bryant) Professor Gower’s criticism of Regal. An arguable case can be made out, then, that the ‘newer’ English approach has been to water down the inequities which could result from Regal. In particular, it appears possible to argue that if an opportunity is outside the practical scope or line of business of a company, it will not be treated as a corporate opportunity.

This watering down also appeared to be in consonance with the practice in other jurisdictions. In the United States, particularly, as early as in Guth v. Loft, (1939) 5 A.2d. 503, it was held that directors would be disallowed from making use of an opportunity only when the opportunity (a) was one which the company had the financial capacity to undertake, (b) was in the line of business of the company, and (c) was of practical importance to the company.

Coming back to the latest decision in O’Donell, however, the Court of Appeals resurrects the strictness of the test. It elaborately discusses Regal, without any mention of any watering down. Further, it was held: “The authorities relating to directors' accountability not only do not support the ‘scope of business’ exception in relation to the 'no profit' rule, they are contrary to it. They show that the principle is a rigorous one…” Thus, the Court expressly rejects the ‘line of business’ exception. Presumably, English law has returned to the position when an equitable principle has resulted in an inequitable result. The reasons for this return are not clear, either on principle or on precedent.

So what exactly are Indian Courts likely to do in such cases? Whether the strict British approach will be adopted by Indian Courts is difficult to say. In the few instances where the corporate opportunity doctrine has come up before Indian Courts, the position has not been entirely clarified. Illustratively, among the recent decisions which talk about Regal are the following:

1. The Company Law Board in Kishor Kundan Sippy v. Samrat Shipping, [2004] 118 Comp Cas 472 (CLB), adopted the American position which gives more latitude to directors. On appeal, in [2004] 120 Comp Cas 681 (Bom), Khanvilkar J. of the Bombay High Court expressed some reservations about the use of American decisions on the point. On further appeal, the Division Bench (Gokhale and Devdhar JJ.) in a decision reported in (2006) 6 Comp LJ 74 (Bom), however held that American decisions on the point “are … definitely apposite”.

2. Regal has been referred to by the Supreme Court in Sangramsinh Gaekwad, [2005] 123 Comp Cas 566 (SC), but the Court distinguished that judgment without offering an opinion on its correctness.

3. In Dale and Carrington, [2004] 122 Comp Cas 161 (SC), however, the position in Regal was taken to be “well-settled”, but without any discussion of the issue.

It remains to be seen whether the recent developments in the UK will have an impact on the Indian position. The American approach appears to be more pragmatic than the English one. Difficulties may arise in the American position if it is left to the individual director to decide whether or not an opportunity is within the scope of business of the company. But, if an objective standard can be adopted on that question, that difficulty can perhaps be precluded.

2 comments:

Mihir Naniwadekar said...

I would like to thank Mr. Umakanth for his suggestions on this post.

Also, the Foster Bryant case mentioned in the post is available at the following link:

http://www.bailii.org/cgi-bin/markup.cgi?doc=/ew/cases/EWCA/Civ/2007/200.html&query=foster+and+bryant&method=boolean

The case contains a useful summary of the English decisions on the point.

sathish said...

Dear Mihir,

I just bumped into this post now and I must appreciate that you have summarized the issue well. You are right that there were two lines of cases: 1st starting with Regal Hastings v Gulliver which took strict approach and the 2nd starting with Island Export v Umunna followed by British Midland Tool v Midland Tooling, Balston Ltd v Headline Filters, Shepherd Investment v Walters, Foster Bryant v Bryant etc which took more pragmatic approach. But, curiously, O’Donell v. Shanahan case does not refer to the any of the 2nd line of cases at all..!!!