High Court orders scent-sational board reshuffle over director's breach of the UK's Russia sanctions for exporting perfumes

Background

The Petitioner ("Mr Garofalo") and the First Respondent ("Mr Crisp") were shareholders and directors of a number of companies involved in the perfume industry (the "Respondent Companies"). On 4 January 2016, Messrs Garofalo and Crisp entered into a relationship agreement governing the management of the Respondent Companies, pursuant to which: (i) they were required to exercise reasonable endeavours to promote the success of the business; and (ii) Mr Crisp was to be allowed free rein to run the business without undue interference (the "Relationship Agreement").

Following the Russian Federation's invasion of Ukraine on 24 February 2022, Mr Garofalo alleges that he and Mr Crisp agreed that that the Respondent Companies would cease supplying their products to Russia (the "Russia Agreement"). However, in June 2023 a confidential report into the Respondent Companies' operations found that not all was smelling of roses:

1. One of the Respondent Companies, VC1, appeared to be continuing to fulfil orders placed from Russia through a US distributor (in contravention of the Relationship and Russia Agreements and Articles 46B and 55 of the Regulations); and
    
2. The revenue generated from VC1's ongoing trade with Russia had not been properly recorded in the Respondent Companies' consolidated management accounts – while Russia sales were previously included in a specific Russia category, this revenue was now concealed under "Rest of World".

In light of the serious allegations within the report, Mr Garofalo then instructed a private investigator to conduct surveillance on Mr Crisp, during which Mr Crisp told the investigator that the Respondent Companies' Russia market was doing "really well", and that he had ignored "government edicts" to continue to trade with Russia.

On the basis of these findings, Mr Garofalo brought an unfair prejudice petition against Mr Crisp under section 994 of the Companies Act 2006 and applied for an ex parte injunction to remove Mr Crisp as a director of the Respondent Companies. The injunction was granted by Ms Caroline Shea KC sitting as a judge of the Chancery Division on 9 October 2023 (the "Order"). The continuation hearing for the Order was held before Mr Justice Freedman (the "Judge") on 9 and 10 May 2024.

The Respondent Companies' alleged breach of the Regulations

Under Article 46B of the Regulations, it is prohibited to export luxury goods (including "perfumes, toilet waters and cosmetics" where the sales price exceeds £250 per 6.25 litres) to, or for use in, Russia. Under the Regulations, a UK person (i.e., a UK national or a body incorporated or constituted under the laws of any part of the UK²) must not directly or indirectly:

1. Supply or deliver luxury goods from a third country (a country that is not the UK, the Isle of Man or Russia³) to a place in Russia;
    
2. Make luxury goods available to a person connected with Russia⁴; or
    
3. Make luxury goods available for use in Russia.

In supplying "Boadicea the Victorious" perfumes (the sales price of which exceeds £250 per 6.25 litres) and other branded goods sold by the Respondent Companies to a Russian entity through a US distributor, Mr Crisp accepted that he had caused the Respondent Companies to breach Article 46B. It was also alleged that Mr Crisp's conduct amounted to a contravention of Article 55 of the Regulations, which prohibits a person from participating in activities which have as their object or effect the circumvention of the prohibitions on trade.

Mr Crisp argued that he had a defence under Article 46B(4) of the Regulations as the Respondent Companies' breach was a genuine and understandable error, and that he did not know and had no reasonable cause to suspect that:

1. The goods were destined (or ultimately destined) for Russia;
2. The person was connected with Russia; or
3. The goods were for use in Russia.

The threshold test

As a preliminary point, the Judge confirmed that the High Court has the power to remove directors by way of interim relief in support of an unfair prejudice petition pursuant to s.37 SCA 1981⁵. However, the Judge clarified that the threshold for the grant of this relief is higher than the than that set out in American Cyanamid ⁶ (i.e., whether there is a serious issue to be tried) because:

1. This was an exceptional order, which would change the status quo of the person who was in day-to-day charge of the companies, and have an immediate impact on the relationship of the parties in the Relationship Agreement. In particular, the Judge noted the "heavy starting point" that the Court will not generally intrude in the management structure of a company; and
    
2. The Order was in effect a mandatory injunction which therefore carried a greater risk of injustice ensuing from the risk that the court may make the "wrong" decision.

The Judge therefore held that the Order would be continued only if there was a "high degree of assurance" that Mr Garofalo will succeed at trial and if the balance of convenience lay in favour of continuing it.

The High Court's decision

On reviewing the evidence before him, the Judge considered that there was a strong prima facie case that Mr Crisp traded with Russia knowing that this was in breach of the Regulations. On the basis of those findings alone, the Judge held that there was a strong prima facie evidential basis for the allegations that Mr Crisp was in breach of the Relationship Agreement, his fiduciary duties, the Russia Agreement, and his statutory duties as a director and that it was unfair.

The Judge did not distinguish a strong prima facie case from that which meets the "high degree of assurance" threshold test. He therefore held that the evidence before him provided a high degree of assurance that: (i) the conduct of Mr Crisp was unfair; (ii) the conduct of Mr Crisp was in breach of the Relationship Agreement, his fiduciary duties, the Russia Agreement, and his statutory duties as a director; (iii) prejudice was caused to the Respondent Companies as a result; and, on that basis (iv) Mr Garofalo will succeed in establishing unfair prejudice.

Balance of convenience

The Judge held that the balance of convenience lay in favour of continuing the Order as:

1. Mr Crisp posed an "existential threat" to the Respondent Companies if reinstated to a management position. An award of damages would therefore not compensate Mr Garofalo; and
    
2. The greater risk of injustice was to Mr Garofalo in the event that the injunction was discharged.

The Judge also held that, although the usual desire of the Court is to maintain the status quo of a company in interim injunction cases, the successful appointment of new management in the seven months between the Order and the continuation hearing had created a "new status quo". The Judge therefore held that the Order was appropriate and that it should remain in force until trial or earlier order and will not be discharged.

Analysis

The decision of the Court is an exceptional one; the English courts are rarely willing to impose mandatory injunctions in unfair prejudice petitions, still less continue them. The continuance of the Order demonstrates the gravity which the Court attributes to sanctions breaches.