UK Supreme Court rules on the duty of directors to exercise powers for a proper purpose

The UK Supreme Court has handed down its much-anticipated judgment in Eclairs Group Ltd v JKX Oil & Gas plc. The case now represents the leading English law judgment on the statutory duty on directors (set out in section 171(b) of the Companies Act 2006) that they must exercise their powers (whether conferred under the company’s constitution or under statute) only for the purposes for which they are conferred (the so-called “proper purpose” rule).

In short, the proper purpose rule “is concerned with the abuse of power, by doing acts which are within its scope but done for an improper purpose”. The test is therefore “necessarily subjective”, because “the state of mind of those who acted, and the motive on which they acted, are all important.”

Whilst, on the facts of the JKX case, it was clear that the duty had been breached, the Supreme Court has left open the precise scope of the duty in less clear cut cases.

As set out below, we anticipate this case having implications for the people with significant control (PSC) register regime which will apply to all UK companies (other than listed ones) from April 2016.

Background: a “corporate raid” on a UK listed company

The background to the case was a “corporate raid” on JKX Oil and Gas plc (JKX), a company listed on the London Stock Exchange. The Supreme Court described the situation as “an attempt to exploit a minority shareholding in [the] company to obtain effective management or voting control without paying what other shareholders would regard as a proper price.”

This minority shareholding represented 39% of JKX’s shares, and was held by two companies controlled by prominent Ukrainian businessmen: Eclairs Group Limited and Glengary Overseas Limited both incorporated in the British Virgin Islands and which the board of JKX suspected were corporate raiders, reinforced by reports in Ukrainian newspapers that the battle was over control of JKX’s principal Ukrainian subsidiary.

As the Supreme Court observed, “one of the tools available to a public company seeking to resist the covert acquisition of control by raiders” is that it can send a “section 793 notice” to any person whom it knows or has reasonable cause to believe is interested in the company’s shares, seeking information about that person’s interests. The Companies Act 2006 allows the company to ask the court to impose restrictions on a person who fails to give the information required by the section 793 notice within a specified time period.

Similarly, the articles of association of most publicly listed companies also set out restrictions that the company can itself impose on a person failing to give that information. Those restrictions will typically involve disenfranchising the relevant shares from being voted at general meetings of the company. It is the exercise of that power conferred by JKX’s articles which was it issue in the case.

The 793 notices

JKX served a series of section 793 notices on Eclairs and Glengary ahead of its 2013 AGM. Those notices sought information as to the beneficial owners of the Eclairs and Glengary shares and the relationships and arrangements, if any, between those owners.

JKX’s directors – having formed the view that the responses to those notices failed to disclose the information requested – purported to use their powers under JKX’s articles to restrict Eclairs and Glengary from voting at the 2013 AGM. Eclairs and Glengary were opposing resolutions being put to the AGM by the JKX board.

Eclairs and Glengary obtained an interim order ahead of the AGM, allowing them to attend and vote at the AGM. There was then a full trial of the issues in the High Court.

The High Court’s decision

At first instance, Mann J found that the disenfranchisement of Eclairs and Glengary was invalid.

The judge’s reasoning was that the JKX board had, in deciding to impose the voting restrictions, had been motivated by an improper purpose. That purpose was to improve the prospects of the board’s resolutions at the AGM being carried, rather than to compel the production of the information requested in the section 793 notices. The imposition of the restrictions was invalidated because it was tainted by that improper purpose.

The Court of Appeal’s approach

The Court of Appeal overturned Mann J’s judgment by a majority decision. Click here for our comment on the Court of Appeal’s decision.

Whereas Mann J had taken a purposive view of Part 22 of the Companies Act 2006 – that any restrictions imposed in response to a failure to provide information had to be for the purpose of eliciting that information – the majority in the Court of Appeal took a purely mechanistic view of Part 22 and of the disenfranchisement provisions in JKX’s articles.

That is, if the board had reasonable cause to believe that the required information had not been provided, then the board could impose those restrictions allowed by the company’s articles. The purpose of that imposition is not relevant. There is no “proper purpose” test. The majority judgment observed:

“The 2006 Act does not specify that the sanction of restrictions on voting can only be imposed for any particular purpose.

…For in reality it is precisely the circumstances of this sort of case where the section (or an article such as Art 42 [of the JKX articles]) is most likely to be invoked. A board of directors will not normally send out a disclosure notice unless it has cause to think that the recipients are up to something subversive but secret. And the most probable timing for such a notice will be when some controversial resolutions are pending or likely to be so shortly. In that most likely of scenarios it is also very likely that the board would not only like the recipients to be disenfranchised but have that as its predominant motive. The result is that if the predominant motive test applies the provisions would be unlikely to have any or much application: they would be emasculated.

We think that any other construction of the section (or in this case JKX’s Articles) would only be an encouragement to deceitful conduct and not something which English company law should countenance.”

The Supreme Court’s view – the disenfranchisement of Eclairs and Glengary was invalid

Establishing the proper purpose of the disenfranchisement power in JKX’s articles

JKX argued that, because no purpose of the power to disenfranchise shareholders was set out in JKX’s articles, the directors should not be constrained in its exercise, unless an implication of a limiting term was necessary for the power’s efficacy. The Supreme Court rejected this argument.

As the Supreme Court observed, often the purpose for which a power is conferred is not set out in the instrument which confers the power. Where this is the case, its purpose can be deduced from the mischief of the provision, its express terms and their effect, and the court’s understanding of the business context.

In the context of s793 notice, the power to restrict the rights attaching to shares was ancillary to the statutory power to call for information under s793. This disenfranchisement power had, in the view of the Supreme Court, three closely related purposes:

(i)    to induce a shareholder to comply with a disclosure notice;
(ii)   to protect the company and its shareholders against having to make decisions about their respective interests in ignorance of relevant information; and
(iii)  as a punitive sanction for a failure to comply with a disclosure notice.

Seeking to influence the outcome of shareholders’ resolutions or the company’s general meetings is no part of those proper purposes – “[h]owever difficult it may be to draw in practice, there is in principle a clear line between protecting the company and its shareholders against the consequences of non-provision of the information, and seeking to manipulate the fate of particular shareholders’ resolutions or to alter the balance of forces at the company’s general meetings. The latter are no part of the purpose of [the disenfranchisement powers set out in JKX’s articles]. They are matters for the shareholders, not for the board.”

Accordingly, the Supreme Court restored the first instance decision, which has been decided on the basis of an assessment of the subjective intentions of the Board. It noted that “[w]hat the judge’s findings amount to is that although at the critical board meeting the majority [four out of six directors] genuinely wanted to receive the information which they had requisitioned, once they were satisfied that it had not been provided and turned to consider the issue of restriction notices, they were interested only in the effect that this would have on the outcome of the forthcoming general meeting.” The power had therefore been exercised for an improper purpose and was therefore invalid.

Outstanding questions: is there a principal purpose test and should causation affect the grant of relief?

Because there was a clear finding of fact at the initial trial that the subjective intention of the majority of the JKX board in seeking to disenfranchise Eclair and Glengary was only to influence the outcome of the upcoming AGM, the Supreme Court unanimously agreed that the disenfranchisement was invalid.

However, a majority of the Supreme Court declined to express a view on the application of the proper purpose test in less clear cut cases. What has therefore been left undecided for the time being is what the outcome would be in the situation where the directors exercised the powers for mixed purposes, some good and some bad. Lord Sumption, delivering the principal judgment with which Lord Hodge agreed, believed that the statutory duty is broken where the directors are influenced by any improper purpose, but that relief should only be given where the board would have acted differently had they not had the improper purpose in mind – a “but for” test. The other judges declined to express a view on whether the statutory duty incorporates a principal, or primary purpose test, and whether or not a “but for” test in granting relief should equally apply – which all parties agreed would be a new development in company law.

Implications for the PSC register

It may not be long before the unresolved questions as to the scope of the proper purpose test come before the courts because of the parallels between this case and PSC register regime. Under that regime, companies will be obliged to send out notices to discover information about their beneficial owners and will have the statutory power to serve a restrictions notice on any person who fails to provide the required information.

Any board which seeks to issue a restrictions notices under the PSC register regime will need to consider whether they are making that decision for a proper purpose, as set out in this judgment.

Click here for further information about the PSC register regime.

Osborne Clarke comment

The Supreme Court’s judgment in JKX is of major significance to companies and their directors. For the time being boards will need to approach any proposed disenfranchisement with extra caution and will need to carefully consider, and appropriately document, their reasons for any exercise of a power to disenfranchise, as to do so “is a serious interference with financial and constitutional rights which exist for the benefit of the shareholder and not the company.” If the decision is ever challenged, directors must prepare themselves for a rigorous, subjective assessment of their intentions.