For Directors Setting up a Competing Business, What Is a Step Too Far?

At what point do the steps a director takes to establish a competing business before resigning become unlawful? In the recent case of Cheshire Estate & Legal Ltd v Blanchfield & Ors,¹ the Court of Appeal considered whether two directors of a company were in breach of their fiduciary and statutory duties when they took preparatory steps to set up a competing business prior to resigning their offices.

Background

Thomas Oliver Blanchfield and Mark Montaldo (B and M, the respondents, along with MTCC Solutions Limited) were appointed as directors of (and also engaged as consultants to) Cheshire Estate & Legal Limited (CEL), a corporate firm of solicitors specialising in financial mis-selling and fraud claims.

In January 2023, the respondents tendered their resignations. Following the resignations, CEL discovered that B and M had taken preparatory steps to set up a new law firm (MTCC Solutions Limited). The preparatory steps included registering a trade name for the new venture, incorporating a corporate entity to conduct the new venture (of which B and M were directors), seeking professional indemnity insurance for the new company, applying to the Solicitors Regulation Authority (SRA) to register the new company, and entering into discussions with several litigation funders (including a funder the respondents previously had negotiations with on behalf of CEL).

In February 2023, CEL commenced proceedings alleging that the respondents had acted in breach of their fiduciary duties as directors and were in breach of contract, and that the respondents had conspired with MTCC to injure CEL by unlawful means. CEL sought injunctive relief, an account of profits, or equitable compensation and damages. During the hearing of the injunction application, the parties reached agreement that, among other things, interim injunctions should be in place until trial.

At the trial, the High Court determined, among other things, that the majority of the preparatory steps had not ‘crossed the line’ or otherwise put B and M in a position of conflict that amounted to a breach of their fiduciary duties. The High Court was also of the view that CEL was not entitled to the injunctive relief it sought.

CEL appealed that decision, seeking to overturn the judge’s findings of liability for breach of fiduciary duty and breach of contract with the ultimate aim of seeking damages for those alleged wrongs.

The Court of Appeal Decision

On appeal, Lord Justice Phillips made clear there was no basis for CEL to challenge any aspect of the High Court’s ruling and provided further clarification on when preparatory steps may constitute a breach of fiduciary duty.

While CEL had abandoned its pursuit of injunctive relief by the time of the appeal, the Court of Appeal was clear that the judge at first instance had been ‘plainly right’ to refuse it, noting that the judge had found that: (i) there was no evidence that B and M had solicited clients or customers of CEL or threatened to do so; (ii) CEL’s business model (and one-off nature of claims they handled) meant the risk of the respondents soliciting existing clients was less of a concern; (iii) the respondents had surrendered or no longer had access to any confidential documentation or information; and (iv) there was no allegation that the respondents had started to trade or that CEL had lost clients or suffered an interrupted workflow.

The Court of Appeal also observed that whether preparatory actions, short of active competition, are consistent with a director’s fiduciary duty to the company is highly fact-sensitive in every case and that even an irrevocable intention to compete does still not necessarily mean that merely preparatory steps are unlawful. Endorsing the position taken in previous cases, the Court of Appeal noted there is a spectrum of preparatory steps that could be taken, from merely deciding to set up a competing business (which would be lawful) to actively soliciting customers of the company and carrying on the trade of a competing business (which would be unlawful).

Having noted those principles, the Court of Appeal determined that there was no basis on which the first instance judge’s conclusions could be overturned. The Court of Appeal found that the judge’s conclusion that there was no breach of duty had been reached through a thorough review of the facts on the basis of extensive evidence. In this regard, the Court of Appeal noted that : (i) the steps taken were entirely preparatory to trading, which would not start until six months after the respondents resigned; (ii) the venture might not have proceeded until the SRA’s response to the registration application in January 2023; (iii) the respondents resigned shortly thereafter; and, (iv) in the meantime, the respondents had faithfully served CEL.

Comment

The Court of Appeal’s decision demonstrates that cases of this nature are ultimately highly fact-dependent. Factors that a court will likely take into account when assessing the lawfulness of a director’s conduct in such a case will include:

• Whether there was an irrevocable intention to compete
• Whether the steps the director has taken affected their ability to serve their appointing company faithfully, honestly, and to the best of their abilities 
• How advanced the preparatory steps were (i.e., whether the plans were at a very early stage, where there is a chance the steps taken could have been unsuccessful or steps had already been taken to solicit customers and business)

For directors, the Court of Appeal’s decision provides helpful discussion around what may be permissible preparatory steps to take when considering future opportunities or otherwise preparing for a subsequent role albeit in a very fact specific context. More generally, while the Court of Appeal acknowledged that arguments regarding restraint of trade considerations should not trump directors’ fiduciary duties to their engaging entities, the decision reflects the point that there are broad exploratory steps directors can take before deciding to terminate their appointments without necessarily falling foul of their fiduciary obligations. Of course, any preparatory steps directors take will need to be carefully considered in light of potential conflicts of interests that may arise and the need to avoid “crossing the line” into activities which would amount to a breach of their obligations (for example, the active solicitation of employees or customers of the business).

For companies seeking to mitigate the risk of directors taking steps to launch competing businesses, it would be helpful to consider what alternative levers they can pull to discourage this (rather than solely relying on directors’ fiduciary duties). For example, companies can offer incentive awards that lapse or are otherwise forfeited if the director takes any steps to set up a competing venture (or joins a competing venture) or, alternatively, include carefully considered explicit post-termination restrictive covenants in the director’s terms of appointment. Introducing or relying on these alternative methods would offer companies stronger grounds for bringing a claim against directors or otherwise discouraging directors from setting up competing ventures.

^[1] [2024] EWCA Civ 1317.

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