Corporate update: the latest corporate law developments December 2022

Express duty of good faith – context is key

In Re Compound Photonics Group Ltd [2022] EWCA Civ 1371, the Court of Appeal has given a restrictive interpretation of an express duty of good faith owed by company shareholders under a shareholders’ agreement. When giving its judgment, the Court confirmed the importance of context when defining the precise scope of express good faith obligations and rejected the formulaic application of general principles drawn from previous cases.

Facts

The case concerned an appeal from a High Court decision where two minority shareholders of Compound Photonics had been found to have suffered unfair prejudice resulting from their removal from office as directors of the company (the Nominee Directors). One Nominee Director had been “forced” to resign, whilst the other had been removed by resolution of the majority shareholders under section 168 Companies Act 2006.

At the heart of the High Court’s decision was the finding that a shareholder’s agreement and the company’s articles of association amounted to a “constitutional settlement” amongst the shareholders that the Nominee Directors were entrenched in office as directors. If the majority voted in favour of removing them, or sought to obtain control of the board, this would be a breach of contract.

The articles of association included a provision preventing the board from voting to remove the Nominee Directors, but, importantly, the shareholders’ agreement did not include a comparable prohibition restricting how the majority shareholders could vote. The shareholders agreement did, however, include an undertaking that the shareholders would at all times act “in good faith” in all dealings with each other in relation to the matters contained in the agreement. The High Court held that this good faith clause “could not be broader” and required the shareholders to act “with fidelity to the bargain” they had struck – i.e. that the Nominee Directors would remain in office.

The majority shareholders appealed on the basis that the judge had interpreted the good faith provision far too widely.

Court of Appeal decision

The Court of Appeal unanimously allowed the appeal, overturning the decision of the High Court.

When giving its judgment, the Court noted that the High Court judge had, perhaps, applied principles derived from previous cases too rigidly. Although concepts advanced in other cases might prove useful when interpreting a particular contract, it was not appropriate to apply them in a formulaic way in every case. A good faith clause – like any other contractual provision – should be interpreted in the context in which it is used.

The Court concluded that an express duty of good faith will consist of a “core” duty of honesty. Depending on the contractual context, it may also include a duty not to engage in conduct that could be characterised as bad faith – i.e. conduct that reasonable and honest people would regard as commercially unacceptable, but not necessarily dishonest. Any further obligation must be capable of being derived by interpretation or implication from the contract.

The Court particularly referred to the concept of “fidelity to the bargain” as relied on by the High Court when making its decision. This concept originated in US law and was developed in New South Wales in the context of an implied duty of good faith. There was no legal basis for automatically incorporating that concept into an English law contract containing an express duty of good faith. Even where an obligation of fidelity to the bargain exists, it should only operate in relation to the common purpose and aims of the parties as objectively ascertained from the terms of the contract.

As for the bargain that the shareholders had reached, the Court of Appeal did not consider that the shareholders had agreed for the Nominee Directors to be entrenched in their positions. If the parties had intended to restrict the rights of the shareholders (in this case, the right to vote to remove a director) the courts would expect this to be expressed clearly and directly, particularly in a professionally drafted agreement. The shareholder’s agreement contained no such express provision.

Comment

Although there is no general doctrine of good faith in English contract law, the parties to an agreement can expressly agree to act in “good faith” and it will then be for the courts to decide what those words actually mean. The decision in Re Compound Photonics helps to clarify what the duty entails but also, arguably, creates more ambiguity.

The decision confirms that the exact scope and nature of an express duty of good faith will be wholly dependent on the particular facts and circumstances existing at the time - there is no minimum standard applicable to all good faith clauses. Apart from importing a core duty of honesty (and possibly prohibiting bad faith conduct falling short of dishonesty) the parties should not assume that a duty of good faith will impose any additional obligations. The inherent uncertainty as to how the duty may be interpreted is problematic for all parties, though any uncertainty is likely to favour the party that is having rights enforced against it.

To mitigate against this uncertainty, the parties should, where possible, consider precisely what they will be expected to do (and not do) when under a duty of good faith and state this clearly in the contract. Particular care should be taken to explicitly note when parties are agreeing to give up existing rights (such as voting or other decision-making rights) or where parties are expected to follow particular procedures in specified circumstances.

Court considers contents of buyer's warranty claim notice

In TP ICAP Ltd v NEX Group Ltd [2022] EWHC 2700 (Comm) the High Court refused to strike out a buyer’s claim for breach of certain warranties in a share purchase agreement despite the seller’s arguments that the buyer’s notice of claim failed to comply with the specific requirements of that agreement.

Facts

The case involved the £1 billion pound acquisition of a voice broking company. The agreement contained certain warranties from the seller including that none of eight named individuals were aware of any investigation against a director of the target group which would have a material adverse impact on the target’s business.

After completion, the buyer discovered that a Frankfurt prosecutor was in fact carrying out an investigation into a named director of the target. So the buyer sent notice of a warranty claim to the seller.

The sale agreement said that the buyer’s notice of warranty claim had to state “in reasonable detail the nature of the [claim] and, if practicable, the amount claimed”.

The seller asked the court to strike out the buyer’s claim, arguing that the buyer’s notice of claim was invalid because:

• the buyer had failed to state which of the eight named individuals had been aware of the investigation into the target’s director; and
• the buyer had failed to state that the investigation would have a material adverse impact on the target.

Decision

The court disagreed with the seller and refused to strike out the buyer’s claim.

The judge reviewed the case law relating to unilateral notice provisions, noting that the construction and meaning of such a notice must be approached objectively: the issue was how a reasonable recipient would understand the relevant notice.

Where a clause expressly required a notice to state certain information, that information must be included in order for a notice to be valid, even if it was something that the recipient already knew. But, in this case, the clause did not specify the exact information that a notice must contain. It was much more widely drafted, simply requiring the buyer to state things “in reasonable detail”. The judge said that in this case what was reasonable would depend on all the circumstances and that would include what the seller, as recipient, already knew.
The judge said that requiring a notice to state which individuals were aware of the investigation went beyond what was required by the specific clause in the agreement. That clause did not say that those individuals had to be identified in the notification. The seller argued that the purpose of the requirements in the notification clause was to give the seller sufficient information to enable it to make appropriate enquiries, gather evidence and deal with the claim. But the judge did not see that including the names of the individuals would add to the commercial certainty or purpose of the notification.

In relation to the impact of the notified claim on the target’s business, again the judge said there was nothing in the notification clause that required the buyer to set this out in its notice. According to the judge, adding such a statement would do little more than repeat the text from the relevant clause which would not advance any of the commercial purposes for giving notice.

Comment

This is the latest case where a seller has sought to contest a buyer’s claim for breach of warranty not by disputing the merits of the actual claim itself, but instead by challenging the validity of the buyer’s notice of that claim. Whilst the specific requirements of each clause will turn on the interpretation of the words used, buyers would be well advised to include as much information as possible to avoid an otherwise valid claim failing on a technicality.

This case was simply a preliminary application to strike out the buyer’s claim. As the judge noted, whether the investigation complained of actually gave rise to a good claim, and whether that claim was of sufficient worth and impact on the target, were all matters to be determined at a trial of the claim’s merits rather than to be considered as part of the notification process.

Updated practice note on electronic execution of documents published 

The Law Society and the City of London Law Society (CLLS) have published an updated version of their practice note on the “Execution of a document using an electronic signature.” The practice note, which was originally published in July 2016, sets out principles to help determine whether contracts entered into in a business context, and executed using an electronic signature, have been validly executed under English law. It has now been updated to reflect developments since 2016, including the Law Commission’s 2019 report on electronic execution of documents, changes in practice adopted by HM Land Registry, HMRC and others, and the widespread use of e-signing platforms – a practice that was greatly accelerated during the Covid-19 pandemic.

The publication of the updated practice note acts as a timely reminder of the importance of complying with established legal principles when executing documents, even when those documents are being signed using modern technology. Some of those principles, and the main changes made to the practice note, are highlighted below.

Types of electronic signature

The practice note confirms that electronic signatures are valid for English law purposes, but whether a particular document has been validly executed using an e-signature will depend on whether the relevant legal principles have been followed. Electronic signatures identified in the practice note include:

• typing a name into a contract;
• pasting a picture of a signature into a document;
• signatures generated by an e-signing platform (including an electronic copy of the signatory’s wet-ink signature); and
• signing a name on a touchscreen (using a finger, pen or stylus).

Remote signings

The updated practice note confirms that where an e-signing platform is used to obtain signatures, the principles set out in the Law Society and CLLS’s note on execution of documents at a virtual signing or closing (Mercury Procedures) must still be observed. This means that it remains important in relation to deeds that:

• any signature, and its attestation, forms part of the same physical document when the deed is signed;
• the signed document is a discrete physical entity; and
• the parties should sign an actual existing authoritative version of the document.

The practice note points out that using an e-signing platform, where the entire final version of the document is uploaded, should make it more straightforward to comply with these requirements. The individuals organising the signing process are advised to still obtain appropriate authorisations from the signatories to implement the dating and delivery of the relevant documents.

Witnessing a deed

A deed will be validly executed by an individual if they sign it in the presence of a witness who attests the signature. Similarly, a company can validly execute a deed in several ways, one of which is for a director to sign on the company’s behalf, again in the presence of a witness who attests the signature.

To attest a signature, the witness must:

• be present;
• see the document being signed by the executing party; and
• sign a statement in the document stating that it has been signed by the executing party in their presence as a witness.

The updated practice note now confirms that the witness should be “physically present” when the signatory signs and it is not acceptable for the witness to view the signing through some form of live video link. This means that, regardless of what form of e-signature is being applied, the witness must be in the same room as the signatory, or at the very least, be able to see the signatory through a window (as was common when social distancing was required during the Covid-19 pandemic).

Although not specifically referred to in the updated practice note, the identity of a witness could also impact on the validity of any attestation. As detailed in the Law Society’s Q&A on electronic signatures (January 2021), a party to a deed may not act as an attesting witness for another signatory to that deed. Also, although there is no statutory requirement for a witness to be “independent”, it will always be preferable for the witness to not be a family member of the signatory or otherwise interested in the transaction. An “unbiased” witness will have more credibility in court than a witness who is closely related to the signatory.

Common seal

The updated practice note confirms that the safest course for a company formed under the Companies Acts is not to use an e-seal when executing documents and not to substitute an e-seal for its corporate seal. This is because an electronic seal would not be engraved, as is required for a corporate seal under the Companies Act 2006, and anyone who authorises the use of a seal which is not engraved is committing a criminal offence. In practice, very few companies now use a corporate seal.

Implications of the E-commerce Directive and the Trade and Co-operation Agreement (TCA)

Both Article 9 of the E-commerce Directive 2000/31 and Article 205 of the Brexit-related TCA, identify types of contract that may not benefit from the protective provisions in those Articles supporting the use and validity of electronic signatures. (These include, for example, contracts transferring rights in real estate and contracts governed by family or succession law.) This leaves open the risk that an electronically signed, English law governed agreement that falls into this category of contracts, may not be enforced by the courts of a member state in certain circumstances.

The updated practice note advises parties who are entering into these types of contracts to consider taking advice to check whether the relevant local law supports the e-signing of those contracts.

First published in Accountancy Daily.