Tue, 08 Nov 2022
The Court of Appeal, in its decision in Mark Faulkner & Others v Vollin Holdings Limited & Others  EWCA Civ 1371 has taken a restrictive interpretation in respect of express duties of good faith. The Court cautioned against the adoption of formulaic rules and instead emphasised that what must lead any enquiry is a highly sensitive, fact specific analysis, beginning with a close examination of the context in which the good faith clause was initially agreed.
The Appellants were the majority shareholders and investors in Compound Photonics Group Limited [“CPGL”].
The Respondents, Mr Faulkner and Mr Sachs, were minority shareholders and directors in CPGL.
Clause 4.2 of a 2013 Shareholders’ Agreement contained a contractual duty of good faith in the following terms: “Each Shareholder undertakes to the other Shareholders and the Company that it will at all times act in good faith in all dealings with the other Shareholders and with the Company in relation to the matters contained in this Agreement”.
In 2016, after numerous funding rounds, the investors expressed a lack of confidence in Mr Sachs and a concern as to the “constitutional balance” of CPGL. Under pressure, Mr Sachs resigned. Later that year, following a series of antagonistic exchanges, Mr Faulkner, was forcibly removed as a director by a resolution passed under Section 168 of the Companies Act 2006.
Mr Faulkner and Mr Sachs contended that their removal as directors was a breach of the good faith clause contained at clause 4.2 of the 2013 Shareholders’ Agreement. An Unfair Prejudice Petition pursuant to Section 994 of the Companies Act 2006 was presented.
The Decision at First Instance
The High Court found that Mr Faulkner and Mr Sachs had been unfairly prejudiced. Having been “entrenched” as directors by CPGL’s Articles of Association and clause 4.2 of the 2013 Shareholders’ Agreement their removal from office was in breach of contract.
The Decision of the Court of Appeal
Providing, on the one hand, a detailed exposition of what ought to be considered, and on the other, making it clear that one size does not fit all when it comes to the interpretation of good faith clauses, the Court of Appeal unanimously overruled the decision of the High Court. Snowden LJ, giving the only Judgment of the Court, held that the 2013 Shareholders’ Agreement did not have an entrenching effect. The roles of Mr Faulkner and Mr Sachs were not a contractual right and their removal as directors did not breach the duty of good faith provided for by clause 4.2.
In his analysis of past cases, Snowden LJ discouraged what he described as the “formulaic” approach to interpretation such as that in Unwin v Bond  EWHC 1768 (Comm) where minimum standards of good faith were described as –
- Acting honestly;
- Faithfulness or fidelity to the parties’ agreed common purpose;
- Fair and open dealing; and
- Regard to the interests of the party to whom the duty is owed.
Snowden LJ expressed concern that the application of formulaic principles, such as these, might detract from the Court’s ability to examine the context in which a specific good faith clause had been introduced and to interpret it accordingly.
In considering the Unwin standards, the Court observed as follows –
- Honesty, and the other Unwin standards, are concepts from which good faith derives. The duty of good faith goes beyond just a duty to act honestly, and also includes a duty not to act in bad faith. That is, a prohibition on "conduct that reasonable and commercial people would regard as commercially unacceptable, but not necessarily dishonest". However, a finding of dishonesty will not automatically mean that a duty of good faith has been breached.
- The requirement to be faithful to the parties’ agreed common purpose does not apply to a shareholders' agreement in the absence of express wording to the contrary. In the instant case, the 2013 shareholders' agreement did not create a valid agreement to entrench Mr Faulkner and Mr Sachs because it did not include an obligation on the shareholders to not vote to remove the directors.
- Fair and open dealing is typically taken to refer to procedural fairness. In the instant case, the majority shareholders were not under any procedural duty with respect to director removal beyond that set out in sections 168 and 169 of the Companies Act 2006; and
- There was no duty of good faith requiring the majority shareholders to "have regard to the interests of the [minority shareholders] in some undefined way over and above any requirements that would be imposed on shareholders to have regard to the interests of the Company".
In interpreting express good faith clauses, the Court will not enforce an absolute duty of honesty, or necessarily find dishonesty conclusive, but will take into account the original purpose of the contract and the surrounding circumstances. Accordingly, parties entering into contracts with such clauses ought to be aware that, notwithstanding the Court of Appeal’s detailed and lengthy Judgment, there remains a relatively high degree of ambiguity as to what good faith means in a contractual context.