High Court sets aside share transfer made by director in breach of fiduciary duty

In a recent decision, the High Court held that a share transfer provision in a settlement agreement was void because it had been agreed by a director acting in breach of fiduciary duty, to the knowledge of the counterparty, and therefore it was not a genuine good faith compromise of a dispute. The parties knew that the transfer would effectively strip the company of its business and could not be in the company's best interests: 12345 Retail Group Ltd v Bubble City Ltd and others [2025] EWHC 1083 (Ch).

The court also considered a number of other issues that arose in consequence of this decision including questions of dishonest assistance, knowing receipt, proprietary claims, tracing and how a claim for equitable compensation should be calculated.

The decision serves as a reminder that, while section 40(1) of the Companies Act 2006 may protect third parties where they are dealing with the company in "good faith", even if the directors have acted without authority or in breach of duty, it does not provide a shield from liability where the third party has acted improperly or in bad faith.

It also illustrates the court's willingness to apply a severance clause to remove specific contractual provisions that are invalid because they result from a director's breach of fiduciary duties and are not in the best interests of the company, while leaving other valid provisions in place.  

Background

The claim concerned a dispute over the control and operation of a chain of bubble tea outlets.

The brand was founded in 2013 by Mr Sachdeva (the third defendant) through Bubble City Ltd ("Bubble City"). In 2019, Mr Sachdeva was introduced by a business contact, Mr Meng (the second defendant), to Mr Xie, who was interested in investing in the business. A new company, Enno Capital Ltd ("Enno") was incorporated for this purpose, with Mr Xie and Mr Meng as directors. A subsidiary, Bubble Citea Ltd ("OpCo"), was formed. Mr Sachdeva sold Bubble City to Enno under an agreement which included an option for Mr Sachdeva to "recall" the transaction after one year. Following the transaction, OpCo operated the bubble tea outlets and Bubble City, now also a subsidiary of Enno, held the brand.

By early 2020, relations between the parties had broken down. Mr Meng purported to remove Mr Xie as a director of Enno and dilute his shareholding, actions which were later ruled unlawful in separate unfair prejudice proceedings. Shortly thereafter, Mr Sachdeva exercised his recall option to take back his shareholding in Bubble City. This led to a Settlement Agreement between Mr Meng (on behalf of Enno) and Mr Sachdeva, which effected two share transfers:

1. the transfer of Bubble City's sole share from Enno back to Mr Sachdeva (the "first share transfer"); and
2. the transfer of OpCo's sole share (the "Subscriber Share") from Enno to Bubble City (the "second share transfer").

Mr Xie was not aware of the Settlement Agreement. Its effect was to transfer the entire bubble tea business from Enno into the ownership and control of Mr Sachdeva.

Subsequently, OpCo issued 99 new shares, which were allotted to Bubble City, meaning that Bubble City now held 100 shares in OpCo including the Subscriber Share.

Enno was put into creditors' voluntary liquidation by Mr Meng, following which the claimant in these proceedings, 12345 Retail Group Ltd (a special purpose vehicle owned and controlled by Mr Xie), acquired Enno's claims. The claimant alleged that the Settlement Agreement was void and/or unenforceable because it was entered into by Mr Meng either:

1. without the authority of Enno, and Mr Sachdeva was aware of this. Mr Xie (following the judgment in the unfair prejudice proceedings) was still a director at the relevant time and had not approved the Settlement Agreement; or
2. in breach of his fiduciary duty to Enno, including at that point the so-called "creditor duty" (ie the duty to have regard to the interests of creditors that arises in an insolvency scenario), as the terms of the agreement were clearly not in the best interests of Enno or its creditors but rather were intended to extract the business from Enno and leave it insolvent, and again Mr Sachdeva was aware of this.

The defendants argued that the Settlement Agreement was a genuine compromise of a real dispute concerning Mr Sachdeva's recall option and control of the bubble tea brand.

This primary issue gave rise to a number of other issues between the parties, of which the following are considered in more detail below:

• whether the claimant had a proprietary claim to the Subscriber Share, whether Mr Sachdeva had dishonestly assisted in any breach of duty by Mr Meng and/or whether Bubble City's receipt of that share amounted to knowing receipt;
• whether the claimant had a proprietary claim to the 99 further shares that had been issued by OpCo, either as traceable proceeds or via a constructive trust; and
• if the claimant did have such a proprietary claim, whether it also had a claim for equitable compensation and if so how that claim should be calculated.

Decision

The High Court (Nicola Rushton KC) held that, in agreeing to the second share transfer, Mr Meng had acted in clear and fundamental breach of his fiduciary duty, and the Settlement Agreement was void to that extent. The court also found in the claimant's favour on its proprietary claims to the Subscriber Share and to the 99 new shares in OpCo, as well as claims for dishonest assistance, knowing receipt and equitable compensation.

First and second share transfers

In agreeing to the second share transfer, Mr Meng had essentially exported the entire value of the business out of Enno and to Bubble City, knowing that this was not in Enno's interests. He had prioritised his personal interests, and those of Mr Sachdeva, with the intention of continuing the business outside of Enno. Mr Meng was aware that making the transfer would leave Enno burdened with debt and effectively insolvent, thereby also engaging his duty to consider the interests of Enno's creditors as well. Mr Sachdeva was aware that Mr Meng was acting in breach of duty, that this was not a good faith compromise of a dispute, and that the second share transfer preferred the interests of Mr Meng and himself over those of Enno. Applying principles stated in GHLM Trading Ltd v Maroo and others [2012] EWHC 61(Ch), the clause in the Settlement Agreement providing for the second share transfer was therefore void.  

The first share transfer on the other hand was effective. It had been carried out by Mr Meng with actual or apparent authority and was not undertaken in bad faith. To the extent that Mr Meng had apparent authority, given to him by Mr Xie, to deal with Mr Sachdeva as regards his recall option and compensation claim, Mr Sachdeva could rely on the "good faith" threshold under section 40(1) of the Companies Act 2006. Section 40(1) provides protection to a third party dealing with a company by ensuring that the powers of the directors to bind the company are deemed free of any limitation under the company's constitution. This means that a third party can rely on the actions of the directors to bind the company, as long as the third party was acting in good faith.

In reaching this conclusion, the court rejected the claimant's first argument, which would have rendered the entirety of the Settlement Agreement void, but accepted the claimant's second argument, rendering void only the clause dealing with the second share transfer. Applying the severability clause in the Settlement Agreement, the court held that the clause relating to the second share transfer should be excised from the rest of the agreement.

Proprietary claim, knowing receipt and dishonest assistance

The court noted that it was well-established that, where a director of a company transfers company property in breach of fiduciary duty, the control which the directors as fiduciaries have over company property may be treated as analogous to the title that trustees have to trust property. As such, a misapplication of that property leaves the equitable beneficial ownership of the property with the company for the purposes of equitable proprietary claims to the property or its traceable proceeds (as well as personal claims in knowing receipt against a person who has received the property with notice of the misapplication, if they have subsequently transferred the property so that a proprietary claim is not available). In the present case, therefore, when the Subscriber Share was transferred from Enno to Bubble City in breach of fiduciary duty, the equitable interest remained with Enno, subject only to the question of whether Bubble City had knowledge of Mr Meng's breach (or whether it was a bona fide purchaser for value without notice of Enno's interest, in which case that interest would be overridden).

As to Bubble City's knowledge, the court held that the knowledge of Mr Sachdeva, who was a director of Bubble City and its sole shareholder at the relevant times and operated it as his company, should be attributed to Bubble City. Accordingly, if Mr Sachdeva was sufficiently dishonest to ground a claim against him for dishonestly assisting in the breach of duty, this would also satisfy the test for knowing receipt on the part of Bubble City. The test for dishonesty was firstly for the court to ascertain (subjectively) the actual state of the individual's knowledge or belief, and then to consider whether their conduct was honest or dishonest by applying objective standards of ordinary decent people. In entering into the Settlement Agreement, Mr Sachdeva was aware, amongst other things, that the true purpose of the transfer of the Subscriber Share was to transfer the business out of Enno and to prevent Mr Xie from taking further part in the business and obtaining repayment of his loan to the business. In doing so, he had acted dishonestly when judged by the standards of honest commercial behaviour, in order to improperly benefit himself and Mr Meng at the expense of Mr Xie and Enno.

In agreeing, executing and implementing the clause of the Settlement Agreement that gave rise to the transfer of the Subscriber Share, Mr Sachdeva had dishonestly assisted in Mr Meng's breach of duty. The claimant therefore had a valid claim of dishonest assistance against Mr Sachdeva. In receiving the Subscriber Share, Bubble City did so with knowledge of Mr Meng's breach of fiduciary duty such that it would be unconscionable to retain the Subscriber Share. The claimant, as assignee, therefore also had a personal claim in knowing receipt against Bubble City for the return of the share. As that share was still in the possession of Bubble City, it followed that the claimant also had a proprietary claim for its return.

Proprietary claim to further shares issued in OpCo

As noted above, a further 99 shares had been issued in OpCo and were held by Bubble City. This effectively reduced the value of the single Subscriber Share. The question therefore arose as to whether the claimant also had a proprietary claim to these shares, either on the basis that they were traceable proceeds or via a constructive trust.

In considering this issue, the court looked to the Cayman Islands authority of Autumn Holdings Asset Inc v Renova Resources Private Equity Ltd and others [2017] (2) (CILR) 136, a decision which was only of guidance but nevertheless carried weight. In that case, which also involved a share issue and subsequent dilution of interest, the court accepted that tracing was concerned not with locating the asset formerly owned by the claimant but identifying whether there was an asset in the hands of the defendant in which the value of the original asset was now located. The court concluded that, following the share issue, substantially the whole value of the claimant's interest was represented by the new shares and could be traced accordingly.

The court in the present case held that the same analysis applied here. The effect of the share issue was that 99% of the value in the Subscriber Share had been transferred to the new shares issued to Bubble City. In principle, the claimant could therefore trace into those new shares, subject only to the question of whether Bubble City was a bona fide purchaser for value of the shares without notice. On the basis of the previous findings as to Mr Sachdeva's dishonesty and Bubble City's attributed knowledge of the intention behind the transfer, this was not the case. As a result, the claimant had a proprietary claim to all of the issued shares in OpCo.

The alternative proprietary claim to the 99 shares, brought on the basis that Bubble City held them as a constructive trustee, was considered by the court for completeness but did not succeed and is not considered in this post.  

Claim for equitable compensation

As a starting point, the court accepted that the claimant might have both a proprietary claim and a claim for equitable compensation. This principle was already recognised in the context of the wrongful diminishment of a trust fund by a trustee. An equivalent claim for equitable compensation could be made where a proprietary claim was brought for the return of assets transferred away through a director acting in breach of fiduciary duty towards their company and where the value of the assets had been diminished in consequence.

The claimant elected equitable compensation rather than account of profits on the basis that the defendants had intentionally structured the business so profits were accounted for outside of OpCo. Indeed, the defendants claimed that OpCo had no value and the shares were worthless.

The court noted that, where directors had acted in breach of duty owed to their companies by diverting business or opportunities to themselves, it was usually the case that the company itself would not have been able to take advantage of such opportunities. For this reason, an account of profits was usually sought, because the directors had done better than the company would have done. Although this might seem unfair from the directors' perspective, this was confirmed to be the correct principle in Rukhadze v Recovery partners GP Ltd [2025] UKSC 10, which held that qualifying the duty to account for profits by introducing a "but for" test would strike at the essence of that duty and significantly hamper its deterrent effect. When accounting for profits, "but for" causation and counterfactuals were therefore irrelevant.

In a case where equitable compensation was sought, however, it was necessary to take a very different approach. The claim should be assessed on a "but for" basis, applying a common-sense approach and considering what the counterfactual scenario would have been, ie what Enno's position would have been if there had been no breach of duty by Mr Meng and the Subscriber Share had continued to be owned by Enno.

In this case, the financial consequences were not easy to determine, not least because there would likely have been legal disputes between the parties even if neither the unfair prejudice nor Mr Meng's breach of fiduciary duty had occurred. The court ultimately concluded that the appropriate counterfactual was to take the combined value of the current total bubble tea business (comprising outlets owned by OpCo and outlets owned by a separate company set up by certain of the defendants) and split the value between Enno, on the one hand, and Bubble City, on the other. Applying evidence on valuation, this led to an assessment of equitable compensation of £1.8 million. The defendants' argument that this loss was barred by the rule against reflective loss was considered by the court but rejected and is not considered further in this post.