Directors’ duties (diversion of corporate opportunity) – Drylandcarbon decision

Last month, Radich J delivered a very long decision in what was obviously a keenly contested dispute affecting the Drylandcarbon joint venture.

Ultimately, the judgment applies a number of well-known and long-established principles relating to the diversion (by a director) of a corporate opportunity for their own personal benefit.  But the background to this case is quite complicated.  No doubt this, coupled with the quantum involved, is part of the reason for the length of the proceedings and judgment.

Background

At a high level, well-known company director Anthony Beverley conceived the idea that ultimately took shape as a forestry and carbon credit venture.   

The concept was a forestry vehicle that was established to help firms generate carbon credits through establishing forests on marginal land.  Mr Beverley developed the model and, in 2017, brought the concept to the parties who were to become his JV partners (who were the principals of Wellington-based investment bank, Lewis & Tucker). 

Whilst the vehicle for the JV was a limited partnership, the structure supporting it included a holding company (Holdco), a holding company which owns the Drylandcarbon General Partner and associated management company.  Ownership of these entities was divided 50/50 between the JV parties – being Mr Beverley and his wife and the interests of the principals of Lewis & Tucker.

Initially, Mr Beverley was to be the chief executive of the management entity and be paid a salary. 

The concept was immediately successful and attracted a number of NZX-listed companies as cornerstone investors with carbon fund contributions of over $100 million.

But tensions soon emerged between the JV parties soon after launch, about a series of management matters – and by 2021, Mr Beverley had been pushed out of his management role.

After Mr Beverley’s removal, the JV partners set up a new fund, using the same concept and staff – and with many of the same corporate investors.

Proceedings

At a high level, the proceedings brought by Mr & Mrs Beverley fell under two headings:

• a derivative action on behalf of the Drylandcarbon companies, alleging that his JV partners misused company information; and
• an oppression claim under section 174 of the Companies Act, claiming that he and his wife had been unfairly treated as shareholders of Holdco.

The defence was quite complicated.  In simple terms, the defendants argued for a silo approach – that the Drylandcarbon companies were a series of SPVs (single-purpose vehicles), contractually limited to one fund.

Diversion of corporate opportunity – a primer   The building blocks that identify the restriction on directors are found in some quite old, and quite well-known cases.  Together, they map out a fundamental principle that directors owe fiduciary obligations to the companies they direct and so should not divert (to themselves or anyone else), a business opportunity that they should only have pursued for the company.  The policy underpinning is said to have been reinforced by a UK Supreme Court decision earlier this year, Recovery Partners GP Ltd v Rukhadze.

Outcome

The judge rejected the defence case.  He said that the silo approach did not correspond with the evidence, which included the JV’s early planning documents and correspondence which showed the parties’ expectation of multiple funds.  At the conclusion of the judgment, he also listed many (evidential) examples of what he referred to as clear fiduciary breaches – that led to the conclusion that the profits from the new fund opportunity were made from or out of the JV partners’ positions as directors of Holdco.

Consequently, the judgment found that the JV partners, owed a continuing fiduciary duty – and couldn’t simply take the opportunity (the next fund or funds) for themselves.  And by replicating the structure and using the same staff and information, they had breached that duty.

The judgment also found that the JV partners’ breaches, and the removal of Mr Beverley as a director from the business, were conducted in a way that (using the language of the oppression remedy in section 174 of the Companies Act) – was oppressive, unfairly discriminatory and unfairly prejudicial.

From this platform, the judgment found that profits from the new fund were derived from those breaches and must be accounted for to Holdco.  This was added to calculations of the fair value of the JV – which led to an order for the JV partners to buy out the Beverley’s 50% stake in Holdco for $12.135m.

Interestingly, the judgment noted that there is no need for the court to order that a constructive trust be put into place:  it simply exists.

Rejecting the defence arguments, Radich J ruled that the new fund was a corporate opportunity of the JV (and therefore Holdco) – and that there is no requirement that the opportunity “belonged” to the original JV vehicle (Holdco), or that the JV vehicle (Holdco) was “actively pursuing” the opportunity.

Instead, it is enough if the opportunity is “sufficiently connected” to the director’s role.  There is a sufficient connection if the director accesses or pursues an opportunity by using their position as a director.  But even if they had not used their position in this way, there may still have been a sufficient connection – where a director pursues an opportunity that falls within the scope of the company’s business.  As Radich J noted, the rule is “intentionally draconian”.

By using their position as directors of the JV vehicle (Holdco) to set up the new fund, with an identical corporate structure, the JV partners had used their positions as directors of Holdco to transfer staff, approach existing investors, and market the new fund by leveraging the success of the original fund.

The defence argued that the companies that were formed as part of the supporting structure for the original fund were SPVs, and only intended to be used for [that] single fund.  Whilst accepting that a director has a defence if they can show there was an agreement that a company was a SPV formed to pursue a single opportunity, and not future opportunities, the judge found that this was not the case for Holdco.  That is, Holdco, the holding company for the JV, was not limited in this manner – even if the General Partner and the management company were restricted as SPV entities.  Therefore, it was a breach of duty for the JV partners (as directors of Holdco) to pursue the corporate opportunity of forming a new fund.

Consequently, the judge found that the JV partners were required to account (to Holdco) for the profits they made from the new fund – less an allowance (15%) for the costs of establishment of the new fund.  The figure of $12.135m was reached after considering extensive, and widely divergent, expert evidence on valuation.

Concluding comments

Subsequent media reports indicate that there is still some work to do on the final settlement outcome.  As the judgment notes, this may mean that the parties are able to reach agreement on a practical settlement mechanism, such as payment out of future cashflows from the new fund.

The decision is a very stark (and expensive) reminder of the ‘draconian’ duties owed by company directors not to divert company opportunities to themselves. 

The judgment concludes with a summary of principles on the [fiduciary] duty to account for profits and then a series of finding.  From this, a handful of points are relevant:

• there was no need to demonstrate that the new fund was a corporate opportunity (of Holdco) that belonged to /was being actively pursued by the company;
• instead, it was sufficient that a reasonable person looking at the facts and circumstances would think there is a real sensible possibility of conflict – which will generally be the case when profits are derived from or otherwise sufficiently connected to the director’s (fiduciary) role; and
• in a directorship context, that means where a director has profited from an opportunity that they accessed or pursued using their position as director, including by using company information.

For more information, please do not hesitate to contact me.