“I honestly thought it was best”: Supreme Court confirms that directors must act in good faith when taking steps to promote the success of the company.

All company directors are required under section 172 of the Companies Act to act in the way they consider, in good faith, would be most likely to promote the success of the company.

Most directors will at some point find themselves in a genuine disagreement with their board; it is a healthy aspect of leading a robust business.

However, in the case of Saxon Woods Investments Limited v Francesco Costa [2026] UKSC 21, the Supreme Court has made it clear that how a director handles that disagreement matters just as much as what they believe. Getting it wrong can amount to a breach of duty, regardless of the sincerity of the director’s intentions.

The case in a nutshell

Spring Media Investments, a creative services group in the fashion beauty and luxury sectors, had a shareholders’ agreement committing the parties to work in good faith towards the sale of the business by the end of 2019.

Its chairman at the time, Mr Costa, thought a later sale would achieve a better price. Mr Costa did not obtain board approval for this but instead secretly ran his own strategy to delay the sale. The Court found that Mr Costa kept fellow directors and shareholders at arm’s length from the sale process, he deflected their enquiries, allowed the board to believe the company was on track to meet its obligations, and used delaying tactics to hold up sale timings.

These delay tactics worked; but then the pandemic arrived, destroying the prospect of a good sale.

The trial judge accepted that Mr Costa genuinely believed he was acting in the company’s best interest in his approach. On the traditional, subjective reading of the duty in section 172 of the Companies Act 2006, the judge found no breach. The Court of Appeal disagreed, and the Supreme Court has now unanimously upheld that outcome.

What the Supreme Court decided

Section 172 requires a director to act in the way they consider, in good faith, would be most likely to promote the success of the company. Mr Costa’s argument was, in essence, that this is a test of a director’s state of mind; if the belief is honest, the duty is satisfied.

The Supreme Court rejected that argument. Good faith under section 172 governs a director’s actual conduct, not just their thinking. A director must not only hold an honest belief about what is best for the company, they must also pursue it loyally and openly.

Concealing a strategy from the board, misleading fellow directors, and/or covertly frustrating a course that the board has settled on is not acting in good faith, whatever the director privately believes.

Interestingly, the Supreme Court reached the same outcome as the Court of Appeal by a different route. The Court of Appeal had framed the issue around dishonesty, meanwhile, the Supreme Court’s reasoning was based on good faith and the fiduciary duty of loyalty from which section 172 derives.

That framing arguably makes the principle broader; conduct can fall short of good faith without needing to be characterised as dishonest.

Why this matters

The judgment does not create a new express duty to be collegiate. However, it gives real teeth to something good governance codes have long assumed. The management of a company is entrusted to the board as a whole, and loyalty to the company means respecting the collective process. While dissent is legitimate, secrecy is not.

For directors, the practical rule of thumb is simple: disagree in the boardroom, not around it. It is completely fair to raise a dissenting view and argue its merits. However, if the board decides otherwise, the director is duty bound to implement the collective decision. Director should not therefore nod along in meetings while secretly steering the company in a different direction. To do some would subvert the collective process of decision making by the board.

What should boards and shareholders do?

If you suspect a director is covertly pursuing their own agenda, there are a few steps that may be worth considering. For example, it is important to preserve the record; board minutes, emails, advisor instructions and information requests were central in this case. Document what happened, what was disclosed and what was not.

It is also worthwhile testing the information flow on any major transaction. The board collectively should instruct and receive reports from advisers such as banks and lawyers. Part of the case against Mr Costa was that the instructions to advisors quietly diverged from what the board believed to be occurring.

If there is a problem, the response should be carefully calibrated; how and when concerns are raised can affect both the evidence and critical relationships, particularly in owner-managed and PE-backed businesses, where a director may also be a significant shareholder.

The bottom line

Saxon Woods has confirmed that a director who says “I honestly thought I was doing the right thing” will nevertheless be in breach of duty if their behaviours involve concealment and misleading the board or undermining an agreed strategy.  Good faith is about what directors do, not just what they think.

Picture credit: Rawpixel

English law upholds the principle of contractual autonomy, granting parties the freedom to negotiate and establish terms tailored to their specific needs and objectives. Contractual certainty is business critical in order to clearly delineate duties and obligations and to provide recourse for an innocent party in the event of a breach.

For contracting parties, it is important to note that contractual autonomy is not absolute and operates within legal frameworks aimed at ensuring fairness and equity in contractual relationships. This article explores the limitations designed to prevent abuse and safeguard parties from unfair or oppressive clauses.

Understanding Penalty Clauses

A contractual term that specifies predetermined consequences for a breach of contract is known as a “liquidated damages” clause. The purpose of this type of clause is not to punish the breaching party but rather to estimate, in a reasonable and realistic manner, the likely losses that would result from the breach. Importantly, the pre-estimate must be made at the time the contract was made (Clydebank Engineering v. Castaneda). This should not be confused with a penalty clause, which imposes excessive financial penalties to deter breaches and can be unenforceable if challenged in court.

The complexity of distinguishing between these two types of clauses often leads to legal challenges, with courts examining the true nature of the clause and the context of its inclusion in the contract. Factors that can be considered include the rationale behind the clause, the bargaining power of the parties, and whether the sum stipulated is excessively high or unconscionable.

Understanding whether or not a clause may amount to a penalty clause could have costly consequences. If a clause is deemed to amount to a penalty clause, it could be struck out as unenforceable.

Evolution of the Test for Penalty Clauses

The legal framework surrounding penalty clauses in UK law has significantly evolved, especially following key judicial decisions that have reshaped their assessment and enforceability.

Historical Perspective:

Historically, the assessment of penalty clauses revolved around the concept of exorbitance in relation to common law damages. In Dunlop Pneumatic Tyre Co Ltd v. New Garage & Motor Co Ltd [1915], the court held that a clause would be considered a penalty if it was not a genuine pre-estimate of costs or sought to impose a detriment on a party out of proportion to the innocent party’s legitimate interest in enforcing the contract.

Shifts in the legal test:

In recent years, the UK courts have moved away from the strict prohibition of penalty clauses. The Supreme Court judgment in Cavendish Square Holding BV v. Talal El Makdessi and ParkingEye Limited v. Beavis [2015] noted that the Dunlop test had taken on the status of a “quasi-statutory code”, which was never the intention.

Lords Neuberger, Sumption and Carnwath took a more nuanced stance, emphasising that the rule on penalty clauses does not permit the courts in every instance to review the fairness of a contractual term when parties can be said to have equal bargaining power. Instead, the focus will be on whether the term in question is a primary or a secondary obligation.

Key principles when assessing penalty clauses:

• Primary vs. secondary obligations: A primary obligation refers to an obligation that arises independently of a breach of contract, while a secondary obligation is triggered by a breach. The Supreme Court emphasised that the penalty rule applies only to secondary obligations. This distinction is crucial in determining the enforceability of penalty clauses, as primary obligations are not subject to the penalty rule.
• Legitimate interest and proportionality: The court highlighted the importance of assessing the legitimate interest in enforcement of the clause in question. The penalty rule will not be engaged if the clause serves a legitimate commercial purpose and is proportionate to the interest being protected. This requires courts to consider the context and commercial rationale behind the clause when determining its enforceability.
• Unconscionability or exorbitance: Even if a clause constitutes a secondary obligation, it may still be enforceable if it is not unconscionable or exorbitant in relation to the legitimate interest which is served by the clause. The courts will assess whether the clause imposes a penalty that is disproportionate to the loss suffered or the legitimate interest being protected. This requires a contextual analysis that considers the specific circumstances of the case.

The following can act as a checklist when considering whether or not a clause is likely to fall foul of the law of penalties:

In the well-established ruling of Parking Eye, an £85 parking fine for a 56 minute overstay was held not to be a penalty clause because the fine was considered not to be out of proportion to the legitimate interest which was served in managing the maximum parking stay for the retail outlets, their customers and the wider public.

Implications for Businesses: Drafting Strategies

The recent refinements in the test for penalty clauses have significant implications for businesses engaged in contractual negotiations and drafting. Understanding these implications is essential for businesses to ensure compliance with legal requirements while safeguarding their interests.

Key considerations include:

• Clarity and Precision: Where possible, contracts should clearly delineate between primary and secondary obligations to avoid ambiguity and potential disputes over enforceability.
• Commercial Justification: Breach clauses should be supported by legitimate commercial justifications that demonstrate their necessity and proportionality to the legitimate interests being protected.
• Avoiding Unconscionability: Businesses should refrain from including breach clauses that are unconscionable or exorbitant in relation to the loss suffered or the legitimate interest being protected.
• Consideration of Context: Drafters must consider the specific circumstances and commercial context of the contract when drafting breach clauses to ensure they align with the parties’ intentions and expectations.

What’s next…

Our next blog post in this series will examine exclusion clauses and unfair terms, another category of contractual terms which could be scrutinised by the courts.

If you would like to discuss this blog, please contact Sarah Bazaraa on 07920 237599 or by email to sarah.bazaraa@pannonecorporate.com