Bulletins | February 2, 2016

Directors’ duties and ‘proper purpose’

A recent Supreme Court case[1] has explored the exercise of directors’ duties as codified under the Companies Act 2006 (the Act) and in particular the application of the so-called proper purpose test, i.e. that directors can ‘only exercise powers for the purposes for which they are conferred’.

The facts of the case revolved around two shareholders (Eclairs Group Ltd (Eclairs) and Glengary Overseas Ltd (Glengary), together owning about 40% of the company’s share capital) of JKX Oil & Gas Plc (JKX), an English company listed on the LSE, who tried to flex their shareholder muscle by blocking certain resolutions in respect of raising capital, calling for changes to the board, and making it publically known that they intended to block certain key decisions. The board of JKX responded by seeking information about the number of shares held and any agreement or arrangement between Eclairs and Glengary by issuing a statutory disclosure notice under Part 22 of the Act. The shareholders’ replies to these notices denied any such arrangement and the board, considering these responses inadequate, exercised a power under JKX’s articles of association to issue a restriction notice over the shares of Eclairs and Glengary to suspend their right to vote at general meetings and restrict their right to transfer the shares.

At first instance, Eclairs and Glengary successfully argued that the JKX directors had acted improperly in using the restriction notice to influence the outcome of AGM resolutions but this finding was reversed by the Court of Appeal.

Upon reaching the Supreme Court, the decision was once more reversed, with Lord Sumption noting that there may have been a proper purpose for issuing the restriction notices, had the motivation been to simply ‘ensure the passage of the resolutions at the AGM’. However, in stating that the purpose was to defeat the attempts of Eclairs and Glengary to control the company’s affairs, the purpose was instead judged to be one of subjective interest. Such subjective interest could not necessarily be said to be in the best interests of the company, and as such was improper.

As for the conduct of Eclairs and Glengary, the Supreme Court decision added that the Court of Appeal were incorrect to argue that applying the proper purpose rule would be tantamount to encouraging “subversive but secret” conduct by shareholders and that “whilst directors owe a duty of loyalty to the company, shareholders do not owe loyalty to the company or its board”. As such an objection in relation to subversion was invalid.

It should be noted that the power granted to the JKX directors by the articles of association to issue restrictions was more extensive than equivalent powers under the Act, but nonetheless their conduct was found to be wanting.

The case demonstrates that in exercising their powers, directors must consistently act in the best interests of the company, and will lead to interesting questions where there appear to be multiple reasons for taking a given board action, some proper and some less so. From a practical governance perspective, the case also emphasises the importance of a clear record of decision-making processes by directors in the event that such decisions are examined after the fact.

For further information please contact Rachael Taylor at rtaylor@wedlakebell.com

[1] The Supreme Court decision in Eclairs Group Ltd v JKX Oil & Gas plc [2015] UKSC 71 is available at http://www.bailii.org/uk/cases/UKSC/2015/71.html.