Disclosure and the Director’s Fiduciary Duty of Loyalty: Item Software v (UK) Ltd v Fassihi [2005] 2 B.C.L.C. 91

Posted: November 6, 2006

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Introduction
Where a director breaches his duty to the company by making a secret profit, company law provides a simple solution in the form of an action for damages in which the director is called to account for any profit made. Where a director takes steps to make a secret profit in circumstances where the company sustains damage, but where the director does not succeed in making that secret profit the remedy for the company was, prior to the Court of Appeal decision in Item Software, less clear cut. It is now clear that a claim based on a fiduciary duty of loyalty will provide that remedy.  

The Facts
In this case the facts, as opposed to the law, were relatively straightforward. The business of the claimant, I Ltd, was the distribution of software products for a company, A Ltd. I Ltd’s managing director was D and its sales and marketing director was F, the defendant. F’s employment contract expressly provided that he should not use confidential information belonging to I Ltd for his own purposes. In 1998 I Ltd started to negotiate more favourable terms for its distribution contract with A Ltd while, at the same time and unbeknown to D, F made secret approaches to A Ltd with his proposals to establish his own company to take over the distribution contract. There was no explanation provided in the reported decision for such an obvious breach of duty in circumstances where it was highly likely that D would discover the breach. In any event, F encouraged D to press A Ltd for improved terms but, because I Ltd insisted in the negotiations on terms that A Ltd was not prepared to accept, the latter terminated the contract by giving 12 months’ notice. I Ltd later discovered F’s misconduct and he was summarily dismissed. I Ltd then brought proceedings against F alleging that he was in breach of duty as a director and as an employee in seeking (a) to divert the contract to his own company (the diversion claim); (b) pressing D to take a hard line in the negotiations in order to improve his own chances of obtaining the business for himself (the sabotage claim); and (c) in failing to disclose to I Ltd his own wrongdoing (the disclosure claim).  

Decision at First Instance
The judge at first instance (reported at [2003] 2 B.C.L.C. 1) found that the cause of the failure of negotiations was I Ltd’s insistence on terms that A Ltd found unacceptable and he did not find that D would have negotiated any more cautiously if F had not pressed him to seek those better terms. Consequently he rejected the diversion and sabotage claims and, because there was no appeal against that part of his decision, there was no opportunity for the Court of Appeal to examine that conclusion further. However, the judge did find that F was in breach of duty in failing to disclose to I Ltd his own wrongdoing, and added that “it is highly probable that had F disclosed what he had done, this would indeed have changed D’s attitude to the negotiations radically … I have little doubt that D would have been severely shocked by F’s conduct and that this would have led him to accept [A Ltd]’s proposal instead of indulging in the further brinkmanship which caused [A Ltd] to lose patience and serve notice of termination” [35]. The judge held that F’s misconduct gave rise to a “superadded” duty of disclosure because he was involved in the negotiations, and his contractual obligations of fidelity and care required him to disclose important information known to him which was relevant to those negotiations. He held that F was in breach of his duties both as an employee and as a director, and that I Ltd was entitled to recover from him damages for breach of that duty suffered as a result of the termination of the contract. The trial had been on liability only and consequently a further hearing on damages was required. F appealed against that decision, as well as against a decision on apportionment of salary which is outside the scope of this commentary. He was, interestingly in the context of a commercial dispute, represented by the Bar Pro Bono Unit.