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Breach of fiduciary duty and bad leaver provisions
In a recent case (Keystone Healthcare Ltd v Parr  EWHC 1509 (Ch)), the High Court considered complaints by Keystone (a healthcare employment agency) against one of its former directors, Mr Parr. The court held that Mr Parr had breached his fiduciary duties to Keystone and was liable to the claimants under bad leaver provisions for the difference in the amount they paid for his shares and the amount that would have been paid had the claimants known of the breach. This article will consider key aspects of the decision and identify relevant take-away points.
The court case
Keystone was owned and run by Mr and Mrs Ward and Mr Parr. A shareholders' agreement had been entered into between these individuals (Shareholders’ Agreement). When read alongside Keystone’s articles of association, the documents provided that the shareholders would be entitled to acquire a “bad leaver’s” shares at a 50 per cent discount.
Mr and Mrs Ward bought out Mr Parr’s shares in Keystone at a high premium under a share purchase agreement (SPA). Mr Parr then set up another company, Medipro Recruitment Limited (Medipro) in direct competition with Keystone, along with two other individuals: Ms Whitehurst (Keystone ex-employee) and Mr Reynard (Keystone IT consultant), misused confidential information belonging to Keystone to divert custom away from Keystone to Medipro and acted in breach of restrictive covenants which he had entered into under the SPA and the Shareholders’ Agreement.
When Mr and Mrs Ward discovered this, they brought proceedings to recover part of the price they had paid to Mr Parr under the SPA. The court held that on the facts this was a clear case of breach of fiduciary duty, going well beyond lawful competition following resignation. Once Mr Parr knew that Mr and Mrs Ward were going to buy him out, he proceeded to make preparations for setting up a competing business, including, obtaining business from those clients who Mr Parr believed would be receptive to an approach by undercutting Keystone on rates. He was therefore seeking to acquire for himself Keystone’s opportunity to carry on doing business with those clients and those workers. He did so in the full knowledge that he was subject to post-departure restrictions under the Shareholders' Agreement and would be accepting similar restrictions under the SPA. Keystone was therefore entitled to an account of profits or to damages at its election for breach of fiduciary duty.
In addition, as Mr Parr was a director, and hence a fiduciary, he had been under a duty to report his own wrongdoing to Keystone. As a result of his failure to report his own wrongdoing, Mr and Mrs Ward had been unable to summarily dismiss him under his employment agreement and as a result of this, they had not been able to purchase Mr Parr’s shareholding compulsorily at a 50% bad leaver discount (they had instead paid a premium). Mr Parr was therefore liable for the difference between what he had been paid for his shares and what the shares would have been valued at with the 50% bad leaver discount.
Key take-away points
Taking preparatory steps to compete with a company after resignation whilst still a director does not automatically involve a breach of duty. However, taking steps which go beyond preparation, could leave a director open to a claim, especially where those steps are contrary to the interests of the company.
The courts are willing to uphold bad leaver provisions. Bad leaver provisions are often included in a shareholders’ agreement or a company’s articles of association to disincentivise certain conduct by a shareholder (e.g. fraud, gross misconduct, voluntary resignation during the early years of a company’s incorporation) by providing for the remaining shareholders acquiring the leaver’s shares at a discount (often the subscription price paid or nominal value of the shares). They are often an area which is heavily negotiated. It is worth noting that when drafting leaver provisions, it is important to ensure such compulsory transfer provisions are not unenforceable as a penalty – they should not be out of proportion to the legitimate interests of the other shareholders. This is a question of fact and degree in each case, taking into account the circumstances in which the compulsory transfer provisions may be triggered and the price at which the shares can be purchased.