Disclosing business secrets to share purchasers

Sweet, sour, salty and savoury. Balancing these basic flavours can result in delicious food. A combination of the flavours can be found in natural foods such as tomatoes (well, if you add some salt, as many people do with tomatoes) and Parmesan cheese, and in manufactured products such as Lea & Perrins’ Worcester Sauce.

Balancing the flavours of a High Court judgment can produce similar effects in the mind, if not in the taste buds. The recent case of Richmond Pharmacology Limited v Chester Overseas Limited and others [2014] EWHC 2692 (Ch) illustrates the point.

The case concerned confidential information relating to the business of the claimant, a Clinical Research Organisation (CRO) that specialises in conducting Phase I clinical trials. The defendants included the Levine brothers, who were investors and who controlled a minority shareholding in the claimant company. The Levine brothers were also non-executive directors of the claimant. The first defendant, an offshore company, was that minority shareholder. The main questions before the court were:

(a) were the defendants in breach of confidentiality obligations to the claimant, when they disclosed information about the claimant to potential purchasers of their shares; and

(b) if they were in breach, did the breach cause the claimant any loss?

The background to the case can be summarised as follows:

1. In 2002, the first defendant subscribed for a 44% shareholding in the claimant. The remaining 56% was owned by the three founders, who ran the company. The parties signed a shareholders agreement. The Levine brothers joined the Board of Directors.
2. In 2008, the Levines fell out with the founders over a business issue, not related to the present dispute.
3. In 2009, the Levines appointed a company, known as NWCF, to act as a broker/adviser to sell their shares.
4. Initially, they tried to sell their shares to the founders, ie by means of a management buyout (MBO). When that proved to be unsuccessful, they asked NWCF to contact unrelated third parties who might want to purchase their shares.
5. NWCF disclosed non-public information about the claimant (obtained from the Levines) to prospective purchasers under the terms of written confidentiality obligations.

The shareholders’ agreement included conventional confidentiality obligations on the first defendant to prohibit it from disclosing information about the claimant to others. The judge concluded that the Levine brothers owed similar obligations of confidentiality to the company.

The shareholders agreement also included conventional terms that allowed a shareholder to sell their shares to a third party, subject to certain pre-emption rights in favour of the other shareholders.

Brian Doctor QC of Fountain Court Chambers (note fountain in background)

In court, the defendants’ counsel Brian Doctor QC presented a persuasive commercial argument for why the defendants were not in breach of confidence. In order to sell one’s shares to a third party, it would be necessary to disclose information to them about the company. Therefore the confidentiality obligation should be interpreted as an obligation to disclose information only to trustworthy potential purchasers who had entered into appropriate confidentiality obligations. If there was no right to disclose this information, the right to sell the shares to third parties would be “entirely illusory”.

The judge did not accept this argument. The terms of the confidentiality obligations were clear and did not allow disclosure to a potential purchaser. He considered that any purchaser would want to hold discussions with the founders before investing, and therefore the shareholders would need to agree a sales process. If they couldn’t agree on a sales process, the deadlock provisions of the shareholders’ agreement could be invoked. Therefore it was not necessary to depart from the ordinary meaning of the words used in the confidentiality agreement, and to interpret it in the way that Mr Doctor proposed. The judge’s interpretation of the confidentiality obligations was consistent with commercial commonsense.

This sour conclusion (from the defendants’ perspective) was then balanced by the judge’s sweet view on the amount of loss that the claimant had suffered.

The judge considered that there were two ways in which loss might have been suffered:

(a) if the disclosed information cast doubt about the financial stability of the claimant, or the commitment of the founders to the business, or its ability to operate from its key hospital sites, this might have deterred potential customers from placing contracts with the claimant; and

(b) if the disclosed information concerned the claimant’s customers, pricing or terms of business, which might have been used by competitors to win business from the claimant.

The claimants did not produce convincing evidence of either of these alternatives, and therefore, in the judge’s view, the claimant had not suffered any loss. The Levines were conscious of the risk that marketing the shares might damage the claimant’s business and “took considerable care to avoid any such damage occurring”.

Finally, the written judgment records the judge’s provisional view, subject to hearing submissions from counsel, that the proper order to make was to award nominal damages of £1 against the first defendant, and to dismiss the claims against the Levines.

Some salt and spice are added to the judgment by the judge’s comments on the reliability of the witnesses’ evidence (he seems to have preferred the Levines over the founders).

Comments

Several points interest IP Draughts in this judgment:

1. The judge was not prepared to stretch the interpretation of the confidentiality obligation in the way that the defendants’ counsel proposed. Stick to the natural meaning of the words used. If it doesn’t say that you can disclose the information to prospective purchasers of your shares, you are not permitted to do this.
2. And yet, at a commercial level, Brian Doctor QC was right: if you can’t disclose information to a prospective purchaser, how can you sell your shares? IP Draughts is not entirely convinced by the commerciality of the argument that the shareholders are supposed to agree a sales process and, if they can’t, the deadlock provisions of the shareholders’ agreement can be invoked. This seems like after-the-event rationalisation.
3. It is sometimes tempting to treat the question of breach of contract as the primary issue, with the question of the amount of damages as something to be calculated at a later point. This judgment reminds us that the two issues run in parallel and, except for the question of legal costs (which are usually borne by the loser), neither is more important than the other.

IP Draughts has previously commented on this blog about the practice of business people when negotiating corporate transactions. Due diligence packs are typically prepared, which enable the purchaser to view and assess the company’s assets. Those assets may include contracts (eg a licence agreement or a clinical trial agreement between the target company and a hospital or CRO), and the contracts may include strict confidentiality obligations that prohibit their disclosure to third parties. There is not usually an exception for disclosure to potential purchasers of the business. In IP Draughts’ experience, parties sometimes include contracts of this kind in due diligence packs, despite the confidentiality restrictions set out in the contracts. In practical terms, this may be necessary for the corporate transaction to happen, and the disclosure may not cause the other contracting party any loss, particularly if the the selling party is careful about its process. Nevertheless, it has long seemed to IP Draughts that there is a strong element of “skating on thin ice” about such arrangements.

The other issue that this case raises in IP Draughts’ mind is also one that he has raised before on this blog. It is the practice of the courts, when allocating cases to judges, to ask deputy judges to hear cases that involve the interpretation of contracts. The judge in this case was a practising barrister, Stephen Jourdan QC, sitting as a Deputy High Court judge. In IP Draughts’ view he did a competent job, even though IP Draughts doesn’t entirely agree with his reasoning.

Other examples in recent years that IP Draughts recalls, where a significant case on contractual interpretation was decided by a deputy judge at first instance, include the case of Rhodia vHuntsman (Julian Flaux QC, later a High Court judge; meaning of reasonable endeavours) and Oxonica v Neuftec (Peter Prescott QC; upheld on appeal; interpretation of a definition of Licensed Product in a licence agreement).

Why do the courts sometimes give important questions of contractual interpretation to deputy judges and not to proper (ie full-time) judges? Is it because:

1. Most judges have little professional experience of drafting and negotiating commercial contracts, and therefore there is no real advantage in giving such a case to a full-time judge. This is unlikely to be an acknowledged reason (!)
2. Such cases are not considered particularly significant by the judge in charge of the list, as they are considered to raise few questions of public importance. Contracts are mostly private matters for the parties. Therefore they can be delegated to a deputy judge. In IP Draughts’ view, the present case has some public importance in the context of parties’ obligations in mergers and acquisitions, which are a significant part of the commercial life of the country.
3. Such cases are easy to manage and decide, and therefore suitable for deputy judges. Sometimes the deputy judge is being assessed for his or her suitability for promotion to a full-time role (as happened in the case of Julian Flaux and could well happen to Stephen Jourdan) and cases of this kind are good tests of judicial calibre.

In the interests of transparency, it would be good if a listing judge (past or present) would comment on this issue.