Strand, London, WC2A 2LL
B e f o r e :
| ANTHONY KLEANTHOUS
|- and -
|(1) THEODOROS PAPHITIS
(2) MALCOLM STANLEY COOKE
(3) RICHARD EDWARD TOWNER
(4) IAN MICHAEL CHILDS
(5) RYMAN GROUP LIMITED (formerly CHANCEREALM LIMITED)
(6) RYMAN LIMITED
Mr Neil Kitchener QC and Mr Sam O'Leary (instructed by Mishcon de Reya) for the First Defendant
Mr Richard Snowden QC and Mr Ben Shaw (instructed by Reed Smith LLP) for the Second, Third and Fourth Defendants
Mr Michael Todd QC and Miss Mary Stokes (instructed by Ashurst LLP) for the Fifth and Sixth Defendants
Hearing dates: 5-8 July 2011
Crown Copyright ©
Mr Justice Newey :
"participate in or influence the affairs of [RGL] or any of its subsidiaries or seek or be entitled to any information in respect of the day-to-day management of [RGL] other than information available to all shareholders as prescribed by law".
i) A loan of up to £1.8 million should be made to Xunely to finance its acquisition of La Senza at an interest rate of 3% above base rate and with security over Xunely's assets;
ii) A guarantee should be given in respect of "the possible liability of La Senza to Suzy Shier Limited on terms to be agreed by the Board";
iii) A management agreement should be entered with Xunely on terms to be agreed.
The minutes went on to record that the board members present "confirmed that in their opinion the matters, having been discussed in detail, were of commercial benefit to [RGL]". However, in the course of submissions Mr Neil Kitchener QC, who appears with Mr Sam O'Leary for Mr Paphitis, accepted that Mr Childs had not been given notice of the 3 June "board" meeting and so that it could not have constituted a valid board meeting.
"Suzy Sher Equities [had] sold its 60 per cent controlling stake for a token pounds 1 to Xunely, a newly created company controlled by Theo Paphitis and his family, the owners of Rymans the stationers and Contessa Ladieswear".
The Financial Times referred in an article dated 18 June 1998 to "Financial support from a company associated with its prospective new owner" having enabled La Senza to continue trading.
"The Chairman [i.e. Mr Paphitis] confirmed that he had discussed with members of the Board the possible acquisition of La Senza by Chancerealm [i.e. RGL] but a decision had been reached that, in view of the extremely parlous financial situation of La Senza it would not be sensible to acquire that company and bring it with[in] the Chancerealm group. Whilst Mr Paphitis, having discussed a number of issues relating to that acquisition with Mr Ring and Mr Cooke, was confident that the situation could be turned round, if the financial figures of La Senza were incorporated in the Chancerealm Group profits at this time it would have a damaging effect on the Chancerealm Group profits notwithstanding that the shareholders' value in the Group is represented by the trading performance of each individual subsidiary. However in order to ensure that no reduction in Group profits (and hence perception of the Group's performance) occurred as a result of the introduction of La Senza into the Group it had been agreed that a special purpose company, owned by Mr Paphitis, should acquire the La Senza shares. However the activities of La Senza and its product, and outlets would be complementary to the products and outlets of Contessa (Ladieswear) Limited and benefits would accrue to the Chancerealm Group by the provision of management and administrative services (on an arm's length basis for which it would be properly remunerated) by La Senza and by the utilisation of surplus warehouse and office space at Hayes by La Senza (again for which La Senza would pay an arm's length fee).
The association would also result in increased buying power and probable resultant discounts and purchasing terms from suppliers, reduced overheads (because of shared facilities deliveries to outlets and so on) and for the relevant services it was proposed that La Senza would pay on an arm's length basis."
After recording that the board "had considered that it was in the interests of the company to enter into the arrangements relating to the loan and to the provision of the guarantee", the minutes stated:
"All those present confirmed their agreement with the above matters and it was noted that Richard Towner, who had expressed apologies for his absence from the meeting, had been present at the Board meeting held on 3rd June and had agreed with the various matters therein dealt with. Furthermore discussions had taken place between the Chairman, Mr Ring and Richard Towner with regard to the various issues now discussed at this Board Meeting and Mr Towner had expressed his agreement with them".
The minutes proceeded to record, among other things, that a form of loan agreement had been approved. They also stated:
"It was noted that in order to enable the auditors to La Senza Plc to sign off the Accounts for the year ended 31st January 1998, the Company had provided a letter confirming the discussions held with the Directors and advisers of La Senza Plc on 3rd June 1998 that the Company would provide or procure such financial support as is reasonable and necessary to enable La Senza Plc to continue trading".
"Xunely has entered into an agreement with Chancerealm [i.e. RGL] whereby Chancerealm has committed to lend to Xunely up to £1.8 million for the purpose of financing the Offer …. Furthermore, Chancerealm has guaranteed the performance by Xunely of the indemnity given by Xunely to Suzy Shier referred to above. It is proposed that Xunely and La Senza will enter into a management agreement with Chancerealm whereby Chancerealm will provide management services for the operation of the La Senza business".
The letter identified Mr Paphitis, Mr Cooke, Mr Towner and Mr Ring as directors of both Xunely and RGL.
"A short while ago I spoke with Theo [Paphitis] regarding press reference to the purchase of the La Senza Canadian Lingerie chain. I would appreciate any information you are able to provide on how this purchase effects the strategy of the Chancerealm [i.e. RGL] Group".
Replying on the following day, Mr Towner said:
"So far as concerns La Senza, the purchase was by Xunely Limited, a company wholly owned by Theo and I think that any queries as to how this relates to or affects the strategy of the Chancerealm Group were best directed at Theo".
Two days later, Mr Kleanthous wrote to Mr Paphitis enclosing a copy of Mr Towner's letter. In his letter, Mr Kleanthous said:
"Regarding his second paragraph [i.e. the passage from Mr Towner's letter quoted above], I should be interested in your comments. When I first learned about the purchase of La Senza a few months ago, I had assumed it was a Chancerealm deal since presumably La Senza is a similar line of business to Contessa".
Responding on 17 August, Mr Paphitis said this:
"Further to your letter dated 14 August 1998, I am somewhat surprised with the second paragraph since you and I have had 2 telephone conversations subsequent to the purchase of La Senza. At the time of the calls, I made the situation absolutely clear and explained to you that this was not purchased by Chancerealm Ltd and it was not a Chancerealm deal which you fully understood and accepted.
I am not going to labour on in order to remind you word for word about the conversation, or get involved in any lengthy correspondence to this end, but as always it will be a pleasure to get together with you should you wish, and answer any questions which you may have with regards to Chancerealm or La Senza face to face".
"After I read the press comment about the purchase of La Senza, I did raise the matter with you and, while I understood what you told me, it is not correct to say that I accepted the situation.
Indeed, given the similarity of this business with that of Contessa, I was keen to establish how you would propose to deal with the apparent conflict of interest".
Mr Paphitis does not appear to have replied. Neither does Mr Kleanthous seem to have pursued Mr Paphitis' suggestion of a face-to-face meeting.
"After careful consideration the directors concluded that:
(a) the negative effect on the Company's businesses of the Company bringing or continuing a claim against the Defendant Directors greatly outweighs any benefit to the Company by pursuing the claim; and(b) bringing or continuing the claim against the Defendant Directors would not promote the success of the Company".
"In summary, as set out in more detail below:
9.1 As directors of RGL and Ryman [i.e. RL], the Director Defendants owed fiduciary obligations to RGL and Ryman, which amongst other things required them not to use company assets for their own benefit or for that of associated companies and not to divert business opportunities from RGL or Ryman.
9.2 From about June 1998 onwards, the Director Defendants committed serious and fraudulent breaches of these fiduciary duties:
9.2.1 the Director Defendants diverted a substantial business opportunity (namely the purchase of the company and lingerie business, La Senza) away from RGL and Ryman in order to develop this opportunity for the benefit of Pahitis and his company Xunely (in which Cooke and Towner were also interested);
9.2.2 the Director Defendants used the assets of RGL and/or Ryman for their own benefit and/or that of Paphitis' company, Xunely, by procuring RGL and/or Ryman: (1) to make loans to Xunely in order to purchase La Senza; (2) to fund La Senza's activities after the acquisition, and (3) to provide a trade finance facility for La Senza;
9.2.3 the Director Defendants failed to disclose their own breaches of duty to the independent shareholder of RGL and/or Ryman, namely AK.
9.3 Paphitis (acting on his own behalf and for Cooke, Towner and Childs) deliberately concealed the wrongful conduct and breaches of duty from AK [i.e. Mr Kleanthous], being the independent shareholder of RGL and Ryman.
9.4 By reason of the said matters, the Director Defendants have made very substantial profits (in excess of £120 million) and have caused enormous loss to RGL and Ryman.
9.5 RGL and Ryman remain under the control of the Director Defendants who have refused to permit these companies to commence proceedings in respect of the wrongdoing committed by them.
9.6 By reason of the matters aforesaid, it is appropriate for this claim to be brought as a derivative action. RGL and Ryman are entitled to remedies against the Director Defendants including declarations of trust and/or an account of profits or equitable compensation."
The legal framework
Part 11 of the Companies Act 2006
"(a) give permission … to continue the claim on such terms as it thinks fit,
(b) refuse permission … and dismiss the claim, or
(c) adjourn the proceedings on the application and give such directions as it thinks fit".
"(2) Permission (or leave) must be refused if the court is satisfied–
(a) that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim, or(b) where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or(c) where the cause of action arises from an act or omission that has already occurred, that the act or omission–(i) was authorised by the company before it occurred, or(ii) has been ratified by the company since it occurred.
(3) In considering whether to give permission (or leave) the court must take into account, in particular–
(a) whether the member is acting in good faith in seeking to continue the claim;(b) the importance that a person acting in accordance with section 172 (duty to promote the success of the company) would attach to continuing it;(c) where the cause of action results from an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be–(i) authorised by the company before it occurs, or(ii) ratified by the company after it occurs;(d) where the cause of action arises from an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company;(e) whether the company has decided not to pursue the claim;(f) whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company.
(4) In considering whether to give permission (or leave) the court shall have particular regard to any evidence before it as to the views of members of the company who have no personal interest, direct or indirect, in the matter".
"(a) the likely consequences of any decision in the long term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company".
"s.263(2)(a) will apply only where the court is satisfied that no director acting in accordance with s.172 would seek to continue the claim. If some directors would, and others would not, seek to continue the claim the case is one for the application of s.263(3)(b)".
"In particular, under s.263(3)(b), as regards the hypothetical director acting in accordance with the s.172 duty, if the case seems very strong, it may be appropriate to continue it even if the likely level of recovery is not so large, since such a claim stands a good chance of provoking an early settlement or may indeed qualify for summary judgment. On the other hand, it may be in the interests of the company to continue even a less strong case if the amount of potential recovery is very large. The necessary evaluation, conducted on, as Lewison J observed, a provisional basis and at a very early stage of the proceedings, is therefore not mechanistic".
"[S]ection 268 [i.e. the Scottish equivalent to section 263] does not impose any threshold test in relation to the merits of the derivative proceedings. As we have explained, the Law Commission recommended that there should be no such test, partly in order to avoid the risk of a detailed investigation into the merits of the case taking place at the leave stage, and partly to avoid the drawing of fine distinctions based on the language of a particular rule. Section 268, and the parallel provision for England and Wales and Northern Ireland in section 263, do not depart from that recommendation. That is consistent with the nature of the factor to be considered under section 268(2)(b): it is possible to conceive of circumstances in which a director acting in accordance with section 172 might attach great importance to raising proceedings which were merely arguable, and of other circumstances in which a director might have sound business reasons for attaching little importance to raising proceedings which had good prospects of success."
The role of the Director Defendants
"Claimants to the trust fund, whether they be beneficiaries or strangers to the trust, should be allowed the maximum opportunity of being heard on the application consistent with the need to maintain confidentiality on matters which properly arise for consideration between the trustee and the court alone".
The merits of the proposed claim
"Stated comprehensively in terms of the liability to account, the principle of equity is that a person who is under a fiduciary obligation must account to the person to whom the obligation is owed for any benefit or gain (i) which has been obtained or received in circumstances where a conflict or significant possibility of conflict existed between his fiduciary duty and his personal interest in the pursuit or possible receipt of such a benefit or gain or (ii) which was obtained or received by use or by reason of his fiduciary position or of opportunity or knowledge resulting from it."
"A director may vote as a director in regard to any contract or arrangement in which he is interested or upon any matter arising thereout, and if he shall so vote his vote shall be counted and he shall be reckoned in estimating a quorum when any such contract or arrangement is under consideration and Regulations 94 to 97 in Table A [i.e. Table A in the Companies (Tables A to F) Regulations 1985] shall be modified accordingly".
Further, regulation 85 of Table A, which applied to RGL, was in the following terms:
"Subject to the provisions of the Act [i.e. the Companies Act 1985], and provided that he has disclosed to the directors the nature and extent of any material interest of his, a director notwithstanding his office –
(a) may be a party to, or otherwise interested in, any transaction or arrangement with the company or in which the company is otherwise interested;(b) may be a director or other officer of, or employed by, or a party to any transaction or arrangement with, or otherwise interested in, any body corporate promoted by the company or in which the company is otherwise interested; and(c) shall not, by reason of his office, be accountable to the company for any benefit which he derives from any such office or employment or from any such transaction or arrangement or from any interest in any such body corporate and no such transaction or arrangement shall be liable to be avoided on the ground of any such interest or benefit".
i) Absence of motive. Mr Cooke and Mr Towner do not appear to have acquired significant financial interests in La Senza until several years later, and Mr Childs never had any obvious reason to act otherwise than in the interests of the Ryman Companies;
ii) The board minutes. These seem to confirm that the Director Defendants had the interests of the Ryman Companies in mind in June 1998, and showing them to be "little more than window dressing" would not be an easy task;
iii) The Director Defendants have put forward a number of reasons for not wanting RGL to acquire La Senza but being prepared to support Xunely's acquisition of it. They echo to a considerable extent points made in the minutes of the 15 June 1998 board meeting (see paragraph 16 above).
"No period of limitation prescribed by this Act shall apply to an action by a beneficiary under a trust, being an action—
(a) in respect of any fraud or fraudulent breach of trust to which the trustee was a party or privy; or
(b) to recover from the trustee trust property or the proceeds of trust property in the possession of the trustee, or previously received by the trustee and converted to his use."
"The first covers those cases already mentioned, where the defendant, though not expressly appointed as trustee, has assumed the duties of a trustee by a lawful transaction which was independent of and preceded the breach of trust and is not impeached by the plaintiff. The second covers those cases where the trust obligation arises as a direct consequence of the unlawful transaction which is impeached by the plaintiff."
Millett LJ expanded on the distinction as follows (at 409):
"A constructive trust arises by operation of law whenever the circumstances are such that it would be unconscionable for the owner of property (usually but not necessarily the legal estate) to assert his own beneficial interest in the property and deny the beneficial interest of another. In the first class of case, however, the constructive trustee really is a trustee. He does not receive the trust property in his own right but by a transaction by which both parties intend to create a trust from the outset and which is not impugned by the plaintiff. His possession of the property is coloured from the first by the trust and confidence by means of which he obtained it, and his subsequent appropriation of the property to his own use is a breach of that trust …. In these cases the plaintiff does not impugn the transaction by which the defendant obtained control of the property. He alleges that the circumstances in which the defendant obtained control make it unconscionable for him thereafter to assert a beneficial interest in the property.
The second class of case is different. It arises when the defendant is implicated in a fraud. Equity has always given relief against fraud by making any person sufficiently implicated in the fraud accountable in equity. In such a case he is traditionally though I think unfortunately described as a constructive trustee and said to be 'liable to account as constructive trustee'. Such a person is not in fact a trustee at all, even though he may be liable to account as if he were. He never assumes the position of a trustee, and if he receives the trust property at all it is adversely to the plaintiff by an unlawful transaction which is impugned by the plaintiff. In such a case the expressions 'constructive trust' and 'constructive trustee' are misleading, for there is no trust and usually no possibility of a proprietary remedy; they are 'nothing more than a formula for equitable relief': Selangor United Rubber Estates Ltd v Cradock (No 3)  2 All ER 1073 at 1097,  1 WLR 1555 at 1582 per Ungoed-Thomas J."
While "the first kind of constructive trust was a creature of equity's exclusive jurisdiction," Millett LJ said, "the second arose in the exercise of the concurrent jurisdiction" (see page 410).
"There is no logical basis for distinguishing between an action for damages for fraud at common law and the corresponding claim in equity for 'an account as constructive trustee' founded on the same fraud. Section 21 of the 1980 Act can sensibly be limited to wrongs cognisable by equity in the exercise of its exclusive jurisdiction. It makes no sense to extend it to the exercise of its concurrent jurisdiction"
"There is a case for treating fraudulent breach of trust differently from other frauds, but only if what is involved really is a breach of trust. There is no case for distinguishing between an action for damages for fraud at common law and its counterpart in equity based on the same facts merely because equity employs the formula of constructive trust to justify the exercise of the equitable jurisdiction."
"I should note that, although the judgment in Gwembe (to which I was a party) proceeded on the premise that fraud was sufficient to bring the case within s 21(1)(a) (para 120), the ultimate decision may be better explained by reference to the alternative ground of fraudulent concealment: s 32."
Carnwath LJ then explained that section 21:
"is about deemed possession: the fiction that the possession of a property by a trustee is treated from the outset as that of the beneficiary. In the words of Millett LJ, the possession of the trustee is 'taken from the first for and on behalf of the beneficiaries' and is 'consequently treated as the possession of the beneficiaries'. An action by the beneficiary to recover that property is not time-barred, because in legal theory it has been in his possession throughout."
"(1) … where in the case of any action for which a period of limitation is prescribed by this Act, either—
(a) the action is based upon the fraud of the defendant; or(b) any fact relevant to the plaintiff's right of action has been deliberately concealed from him by the defendant; or(c) the action is for relief from the consequences of a mistake;
the period of limitation shall not begin to run until the plaintiff has discovered the fraud, concealment or mistake (as the case may be) or could with reasonable diligence have discovered it.
References in this subsection to the defendant include references to the defendant's agent and to any person through whom the defendant claims and his agent.
(2) For the purposes of subsection (1) above, deliberate commission of a breach of duty in circumstances in which it is unlikely to be discovered for some time amounts to deliberate concealment of the facts involved in that breach of duty."
"Paphitis' statement in the said letter that '[La Senza] was not purchased by Chancerealm Ltd and it was not a Chancerealm deal' amounted to deliberate concealment by Paphitis (on his own behalf and on behalf of Cooke, Towner and Childs) of the wrongful misuse of RGL (and/or Ryman) funds and the diversion of the La Senza Opportunity and misuse of assets."
Factors relevant to whether permission should be given
Section 263(2)(a) (whether a person acting in accordance with section 172 would not seek to continue the claim)
Section 263(3)(b) (the importance that a person acting in accordance with section 172 would attach to continuing the claim)
"A hypothetical director acting in accordance with section 172, and considering whether to commence legal proceedings, could ordinarily be expected to have regard to a range of factors, including the amount at stake, the apparent strength of the case, the prospects of securing a satisfactory outcome without litigation, the prospects of successful execution of any judgment, the likely cost of the proceedings, the disruption caused to the company's business, and potential risks to reputation and business relationships."
"To sum up, Simon [Lakin] and I find it very difficult to contemplate a situation in which the Companies bring a fraud claim (or continue the Derivative Claim) against their major shareholders and the other Defendant Directors. However, we believe it would have a devastating effect on the Ryman business for the following reasons:
(a) the Companies are likely to lose four of their most experienced directors. This in turn is likely to damage the trading performance of the RGL Group, staff morale and the reputation of the Companies;(b) replacing the Defendant Directors with candidates of similar skills and experience would be extremely difficult and, in the case of Theo Paphitis, impossible;(c) damaging the reputation of Theo Paphitis would mean damaging the reputation of Ryman, as Theo Paphitis' name is very closely linked to the Ryman brand. The RGL Group would no longer benefit from the considerable free publicity gained by its association with Theo Paphitis and the numerous business advantages that result from this association;(d) the impact on employees, customers, suppliers and other shareholders would be disastrous and would be likely to cause a significant deterioration in the RGL Group's performance and consequently its value; and(e) the litigation would provide a significant distraction to any remaining senior management."
Section 263(3)(e) (whether the company has decided not to pursue the claim)
Section 263(3)(f) (whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company)
"If the Companies were to bring a claim against the Defendant Directors they would be bringing a claim against the majority shareholders, namely Theo Paphitis and Ian Childs, who together own around 85 per cent. of the shares in RGL. Even assuming, for present purposes, that the sums which the Companies could recover are as large as those asserted by Tony Kleanthous, the Companies have no immediate requirement for such very large sums. This means that, after paying legal costs, the majority of any sums recovered by the Companies from the Defendant Directors would be likely to be returned to shareholders. Therefore 85 per cent. of any sums recovered, after the payment of costs, would be returned to two of the Defendant Directors. We do not consider this a rational way of proceeding when we are advised that Tony Kleanthous could bring proceedings by way of an unfair prejudice petition to obtain a remedy from the Defendant Directors for wrongs which he contends he has suffered at their hands without involving the Companies other than as nominal defendants."
Section 263(4) (views of members with no personal interest in the matter)
"… I do not think that it would be in the best commercial interests of RGL (or of me as a minority shareholder) for Mr Kleanthous to be given permission to bring the claims which he seeks to bring on behalf of RGL. RGL bringing proceedings against the majority of its own board will be damaging to the Ryman brand as well as disruptive and very costly …. If Mr Kleanthous wishes to pursue his allegations, he has the ability to do so as a minority shareholder in his own right, and can seek a buy-out order for his shares, which is plainly what he really wants."