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April 2007 - Conflicts of interest. Legal Developments by Lewis Silkin LLP.

More articles by this firm.

We will be examining conflicts involving property and property transactions in this briefing, using some real examples from recent cases. To some extent, this brings together areas that we have considered in other articles in this series, but we think that it is interesting to look specifically at conflicts that arise in the property context and, in particular, the issues for solicitors and directors.

Solicitors

Rules of conduct for property-related transactions

The new Law Society rules on conflicts of interest and confidentiality came into force on 25 April 2006.

In outline, Rule 16D states that a solicitor must not act if there is an actual conflict (or a significant risk of a conflict) between the interests of two clients or of a client and the solicitor; save where either the ‘common interest' exception or the ‘competing for the same asset' exception apply and provided the clients have given informed consent and it is ‘reasonable' to act (for a more detailed analysis of Rule 16D, see Mark Lim's briefing on the new rules in IHL145, p41-45).

Rule 16D applies equally to conveyancing and other property and mortgage-related transactions. However, such property transactions are one of the most common situations where a solicitor can act for two clients whose interests do, or at least could potentially, conflict. As such, property transactions provide good examples of the first exception to Rule 16D and, indeed, Rule 6 of the new rules clarifies exactly when a solicitor can act. It is worth stressing that Rule 6 does not soften the application of Rule 16D for conveyancing solicitors.

Rule 6(2): Acting for seller and buyer
  • A solicitor must never act for both seller and buyer without the consent of both parties, or where the seller is a builder or developer, or where a conflict of interests exists or arises.
  • A solicitor might otherwise be able to act for both seller and buyer, but only in very limited circumstances (ie where the value of the transaction is no more than £10,000; where the only advice to the buyer is mortgage advice; where the parties are established clients; or where there is no other conveyancer available in the locality).

The exceptional circumstances in which a solicitor might be permitted to act for both seller and buyer are therefore quite rare, and the solicitor's overriding duty is still to refuse instructions, or to step down, where a conflict of interest actually arises.

Rule 6(3): Acting for lender and borrower on the grant of a mortgage
  • A solicitor must never act for both lender and borrower if a conflict of interests exists or arises, or if the mortgage is an ‘individual' mortgage at arm's length.
  • A solicitor may act for both lender and borrower on the grant of a ‘standard' mortgage, provided that one or other of the parties instructs the solicitor to carry out work from only a limited number of specified activities (such as making for the lender standard legal enquiries relating to the property, and reporting the replies). A mortgage is a ‘standard mortgage' where it is provided on standard terms by a lender whose activities consist largely of mortgage lending.

Again, the extent and detail of Rule 6(3) means that a solicitor's ability to act for both buyer and lender in practice is very limited and where the solicitor believes they are permitted to act for both, the scope of the retainer with each client must be similarly (and clearly) limited, as was demonstrated in the case of Mortgage Express Ltd v Bowerman & Partners (see below).

The Regulation Review Working Party of the Law Society has recently proposed that Rule 6(3) should be lifted in the context of commercial property transactions, effectively making real or potential conflicts of interest the only bar to a solicitor acting for both borrower and lender.

Directors

A quick refresher on the law

At common law, a company director owes a fiduciary duty to the company to act honestly and in good faith in the best interests of the company and to the exclusion of their own personal interests.

Additionally, a company director owes various supplementary/specific statutory duties, namely:

  • a duty to declare at a directors' meeting any interest in a contract the company proposes to enter into (s317 of the Companies Act 1985); and
  • a duty to first obtain authority in general meeting before the company enters into a substantial transfer of property with a director or a company in which a director has an interest (s320 of the 1985 Act).

For the purpose of ss320 and 322 (penalties) of the 1985 Act, a transfer is substantial if it has a value in excess of £100,000 or 10% of the company's assets (subject to a de minimis of £2,000). A transfer of real property will therefore almost invariably fall within the ambit of these provisions.

If a director breaches these rules, the director will be liable to make restitution to the company, which may mean transferring the relevant property to the company and/or accounting for any profit made.

Statutory and common law problems

Many cases of directors breaching their fiduciary duties involve property. A few recent examples are set out in the boxes on the facing page and above. In addition to providing real life applications of the rules, they raise the following points of interest:

  • The breach of duty can arise whether one or other parties immediately realises a profit from the venture. In Duckwari (see below), there was a transfer of property at cost price. There nevertheless arose a conflict of interest, and not just because the director in question had reserved for himself a 50% stake in any development profit subsequently realised by the company.
  • Third parties who knowingly participate in the arrangements that constitute the breach of duty will be fixed with the breach and will also be made accountable to the company by way of return of the property and/or damages - see Wrexham FC below.
  • Often, the first time someone seeks to undo a transaction that was carried out in breach of the statutory requirements is when the company becomes insolvent, at which point an administrator or liquidator will be looking very carefully at the details of past dealings - again, see Wrexham FC.
  • A director can act in good faith but still find themselves in a position that unquestionably conflicts with their duties as a director - see Bhullar below.
  • A director can be in breach of fiduciary duty by exploiting an opportunity discovered outside of their role/capacity as director. For example, in Bhullar, two directors fell out with the company over a property investment opportunity they had discovered not through their roles as directors of the company, but because they had passed a ‘for sale' sign outside the building in question. Acting in the interests of the company can sometimes mean doing so to the exclusion of a director's own interests.
  • A conflict may also arise notwithstanding that the company had no ability to pursue the project itself. The Wrexham FC case is a good example of this. A director who diverts a business opportunity away from the company deprives the company of the chance to decide whether it can pursue the opportunity itself. The director is then personally involved in making that choice for the company and so has two irreconcilable interests. The director might argue that the seller would (for its own reasons) have refused to sell the property to the company, so they were entitled to take the opportunity for themselves. In reality, the director is bound to do everything in their power to persuade the seller to deal with the company, if that was in its interests.
  • Where a director is found to have acquired real property in breach of their duty to the company, the usual remedy will be to convey the property to the company (with the usual financial adjustments) - see Bhullar and Wrexham FC.

Conclusion

It is widely recognised that directors (particularly non-executives) will have interests of their own outside the company. The general law of fiduciaries and the 1985 Act make directors accountable to their companies/shareholders for any advantage they might obtain as a consequence of their appointments.

In practice, the company may be willing to sanction such a transaction. In many such instances, the transaction will be to the company's advantage, and might not have been an option were it not for the information shared with the company by the director. This is what the well-advised director will seek to do.

Property related cases

Hilton v Barker Booth & Eastwood

Barker Booth & Eastwood (BB&E) obtained consent from Mr Hilton (their client and seller) to act for a prospective buyer. They failed, however, to disclose that the buyer was borrowing the deposit from them, and that he was a declared bankrupt and convicted fraudster. The buyer did not complete the transaction and Mr Hilton sued BB&E when his business collapsed. It was held that BB&E had irreconcilable duties of disclosure and confidentiality to its two clients and had acted in breach of duty by agreeing to act for both.

Mortgage Express Ltd v Bowerman & Partners

Bowerman acted for both the purchaser and Mortgage Express, a lender, on the purchase of a property valued at £199,000. Mortgage Express lent £180,000 with the property as security. In the course of the purchase, a partner in Bowerman discovered that the property was in fact worth less than £150,000. After the buyer defaulted on the mortgage, the property was sold for just £96,000 and Mortgage Express sued Bowerman for negligence in failing to disclose the new valuation information it had obtained.

The court looked at all the terms of the instructions from both buyer and lender, emphasising that this case would be decided on its own particular facts. It found that neither the instructions from Mortgage Express, nor Bowerman's ensuing duty to Mortgage Express, had been limited in any way. Bowerman thus had a duty to disclose to Mortgage Express any information that a solicitor would reasonably expect to be in the interests of the client.

In Re Duckwari Plc (No 2)

Offerventure Ltd was a private company owned by Mr Cooper and his wife. Among its assets was a development property which Mr Cooper offered to sell at cost price in 1989 to Duckwari Plc - a company of which he was also a director. The property was transferred subject to an ‘overage' agreement, under which Offerventure would be entitled to 50% of any profit arising from the land's future development.

It was clear on the facts that Mr Cooper had conflicting duties to Offerventure and Duckwari. Nevertheless, the transaction was completed without the consent of Duckwari's shareholders in general meeting, and so in breach of s320 of the Companies Act 1985 (the 1985 Act).

Duckwari subsequently defaulted on the loan that had funded the transaction, and the company sought restitution against Offerventure and Mr Cooper. The property element of this dispute then had a further part to play, as the property market collapsed soon after the transaction, leading to the property falling in value by £405,000.

In proceedings under s322(3)(b) of the 1985 Act, Offerventure and Mr Cooper were jointly held liable to indemnify Duckwari for the loss of value in the property resulting from the transaction. The only silver lining for the respondents was the Court of Appeal's finding that Duckwari could only claim losses arising directly out of the sale contract (the transaction carried out in breach of duty), and not arising out of its borrowing arrangements, which were not sufficiently connected.

Wrexham Association Football Club v Crucialmove Ltd

In this case, the administrators of Wrexham FC (the Club) successfully sought an order that Crucialmove held the freehold to the Club's ground on trust for it, on the basis that Crucialmove had acquired the property by virtue of a breach of duty by a Club director.

In very simplified terms, the facts were that two individuals, G and H, identified the football ground as ripe for development and they entered into a joint venture to pursue that development, which they would share 50:50. G became a director of the Club. The Club rented the ground from a brewery and G negotiated the purchase of the freehold from the brewery in the Club's name. H financed the purchase through Crucialmove. The Club declared that it held the freehold on trust for Crucialmove but the Club later transferred the freehold and surrendered its lease to the company.

Both at trial and in the Court of Appeal, it was found that G was in clear breach of his fiduciary duties to the Club. He became a director expressly to be able to exploit the opportunity in the ground and he negotiated the purchase of the freehold in the name of the Club to keep the price down. He declared a trust of the ground in favour of Crucialmove without any regard to the Club's interest and without seeking consent from the Club board or disclosing his interest in the matter. H was aware of these breaches and his knowledge was imputed to Crucialmove.

It was irrelevant that the Club could not have pursued the development opportunity itself as it was in financial difficulties.

Bhullar v Bhullar

Bhullar Bros Ltd was set up to acquire property for investment but when relationships between the two controlling families broke down it was agreed that the company would not acquire any new properties while the company was being wound down and the assets divided.

In the meantime, two of the directors (both from the same family) noticed that a ‘for sale' sign had been erected on a building next to the company's main investment property. Seeing an investment opportunity that might otherwise go to waste, they proceeded in good faith to buy it under the name of a separate company of their own, called Silvercrest. The remaining directors (and their family), felt that the Silvercrest directors had acted in a way that was unfairly prejudicial to their interests, and sought an order that the property be transferred to Bhullar Bros, to be divided with the rest of the assets.

The Court of Appeal restated two tests that had previously been applied to ascertain whether a director had - in breach of their fiduciary duty - acquired a ‘corporate opportunity' that could instead have been exploited by their company:

  • A director must not divert from the company a maturing business opportunity that the company is actively pursuing (the ‘maturing business opportunity' test); and
  • A director must positively make available to their company a business opportunity if:

    (i) it is in the company's line of business, or

    (ii) the director has been given responsibility to seek out particular opportunities such as that which they have identified.

Bhullar Bros had made a clear election not to pursue such opportunities. It thus seemed that the Court would have to decide whether the new opportunity was one that the directors should have made known to the company, in circumstances where it had expressed an intention not to take up such opportunities.

In its judgment, the Court focused instead on the directors' more fundamental duty to communicate to the company any information relevant to it. Regardless of the company's stated intentions, the individuals in question had to act at all times in the capacity of directors and had a duty to disclose to the company information that was in its interests.

Case references

Hilton v Barker Booth and Eastwood

(a firm) [2005] UKHL 8

Mortgage Express Ltd v Bowerman & Partners
[1996] 2 All ER 836

In Re Duckwari Plc (No 2)
[1999] Ch 268

Wrexham Association Football Club v Crucialmove Ltd
[2006] EWCA Civ 237

Bhullar v Bhullar
[2003] EWCA Civ 424

By Tim Reid, an associate in Lewis Silkin LLP's litigation department.

E-mail: tim.reid@lewissilkin.com.