Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc

The continuing importance of the ‘proper purpose rule’ in English company law

Publication April 2016


Introduction

A recent decision of the Supreme Court has brought into focus the continuing importance of the ‘proper purpose rule’, which applies to directors of English companies under s171(b) of the Companies Act 2006. This long- standing equitable rule, codified by the 2006 Act, requires that a director must ‘only exercise powers for the purposes for which they were conferred’.

The decision also serves as authority on the appropriate use of the procedure set out in ss793–797 of the 2006 Act, which allows companies to issue a notice to their shareholders requesting information about the beneficial ownership of those shareholders.

The facts

JKX is an English company listed on the London Stock Exchange whose business involves the development of oil and gas reserves in Russia and the Ukraine. The Appellants in this case – Eclairs and Glengary – were shareholders in JKX.

Eclairs and Glengary had taken a number of steps in the period up to early 2013 which JKX perceived to be a ‘corporate raid’ on the company – in other words, an attempt to destabilise the company in order ultimately to obtain control of it without paying what other shareholders would regard as a fair price. As part of this alleged tactic, Eclairs and Glengary had sought the removal of a number of JKX’s directors and had opposed a number of steps which JKX had taken to raise funds.

In the period prior to JKX’s 2013 AGM, JKX served notices on Eclairs and Glengary pursuant to s793 of the Companies Act 2006, seeking information about their beneficial ownership and enquiring whether any agreements or arrangements were in place between the persons who had an interest in each company. JKX, like many companies, had a provision in its articles of association specifically permitting the company to impose restrictions on the voting rights attached to shares where there was reasonable cause to believe that the information provided in response to a s793 notice was false or materially incorrect.

Eclairs and Glengary responded to the disclosure notices but the directors of JKX took the view that the information provided was such that a restriction on voting rights was permitted under the company’s articles. The directors sought to impose such restrictions, with the effect of barring Eclairs and Glengary from voting at JKX’s 2013 AGM. The directors of JKX were also aware at that time that Eclairs and Glengary were likely to vote against a number of proposed resolutions at the AGM and that the two shareholders could, given their combined 39 per cent shareholding in JKX, have blocked any special resolution that was to be voted on at the AGM.

The proceedings

In response, Eclairs and Glengary commenced proceedings in the High Court seeking a declaration that the notices restricting voting rights had been unlawful under s171(b) of the Companies Act 2006, on the basis that the directors had breached their obligation to ‘only exercise powers for the purposes for which they were conferred’. Eclairs’ and Glengary’s contention was that:

  • the notices had been served with the improper purpose of preventing the shareholders from voting at the AGM and thereby maximising the possibility that the proposed resolutions would be passed at the AGM
  • the proper purpose of restricting voting rights would have been limited to obtaining the information sought from shareholders in a disclosure notice.

At first instance, Mann J agreed with Eclairs and Glengary and the restrictions on their voting rights were therefore set aside. This affirmed the importance of the proper purpose rule and suggested that the rule must be borne in mind when directors are exercising powers that are expressly conferred upon them, including in circumstances where the directors are acting in a way which they genuinely believe is in the best interests of the company.

The Court of Appeal

However, a majority in the Court of Appeal overturned Mann J’s judgment and determined that the proper purpose rule did not apply in the context of a struggle for control of a company.

The majority in the Court of Appeal gave primacy to the express provision set out in JKX’s articles of association, allowing a restriction on voting rights where there is reasonable cause to believe that information provided by a shareholder in response to a disclosure notice was false or materially incorrect. The majority also placed weight on the fact that the shareholders could have avoided the imposition of restrictions on their voting rights by voluntarily providing further information.

The Court of Appeal, therefore, took a much more restrictive view of the role of the proper purpose rule.

The Supreme Court

The Supreme Court reverted to the High Court’s position in determining that the proper purpose rule did apply to the imposition of restrictions on the voting rights of Eclairs and Glengary. The Supreme Court also found that those restrictions were imposed for an improper purpose.

In particular, the Supreme Court found that the relevant article of JKX’s articles of association had three related purposes:

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

These purposes do not extend to directors seeking to influence the outcome of the AGM, which it was accepted was a purpose underlying the board’s decision to impose restrictions on the shares of Eclairs and Glengary. The restrictions had therefore been imposed for an improper purpose and were invalid.

In reaching this conclusion, Lord Sumption highlighted the fundamental importance of the proper purpose rule in stating:

‘The rule that the duciary powers of directors may be exercised only for the purposes for which they were conferred is one of the main means by which equity enforces the proper conduct of directors. It is also fundamental to the constitutional distinction between the respective domains of the board and the shareholders.’

Lords Sumption and Hodge applied a ‘but-for’ causative test in determining whether the actions of a board will be invalid due to a breach of the proper purpose rule. That is to say, where there are a mixture of proper and improper purposes underlying the board’s decision, the decision will breach the rule if it would not have been taken but for the existence of the improper purpose(s). Lords Mance, Clarke and Neuberger reserved their position on what the proper causative test should be, given the absence of detailed submissions on this point during the hearings.

What does this mean for directors?

The Supreme Court’s decision makes clear that the proper purpose rule is pervasive and should be considered whenever a board is exercising the powers conferred upon it. The rule is not about directors acting in excess of their powers. Rather, it is an obligation imposed on directors to act for a proper purpose when exercising the powers which they have. It is not sufficient for the directors to act in a way which they genuinely consider to be in the interests of the company – the proper purpose rule is an additional consideration which must at all times be borne in mind.

Directors should therefore consider in detail what the purpose is behind any decision that they take and whether that purpose would be considered proper, given the intended nature of the relevant power conferred upon them. This will, in each case, be a subjective judgment which will be open to challenge.

In making these considerations, directors should therefore ensure that their compliance with the proper purpose rule is considered in detail, properly documented and supported by legal advice, where necessary.


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