In Eclairs Group Limited v JKX Oil & Gas plc (2015), the Supreme Court considered the application of the proper purpose rule in relation to the exercise of directors' constitutional powers.  The Court held that the proper purpose rule applied to the exercise of a constitutional power to issue a restriction notice to shareholders following a perceived failure to comply with a disclosure notice, and that the power had been exercised for an improper purpose.

Background


JKX Oil & Gas plc ("JKX") is an English company listed on the LSE. The Claimants in the case, Glengary Overseas Limited ("Glengary") and Eclairs Group Limited ("Eclairs") together had a 39% shareholding in JKX.  The directors of JKX perceived that JKX had become the target of a corporate raid by Eclairs and Glengary. 

Section 793 of the Companies Act 2006 ("CA") enables a public company to issue a disclosure notice to any person whom it knows or reasonably believes to be interested in its shares, which can require such person to disclose information about its interest in the shares and any agreements relating to the exercise of the rights attached to those shares.  Under Article 42 of the JKX articles of association ("Article 42"), the directors could issue a restriction notice suspending the right to vote at a general meeting if they believed that information provided in response to a section 793 disclosure notice was false or materially incorrect.

On 7 March 2013 Eclairs wrote to JKX requesting it to convene an extraordinary general meeting to consider ordinary resolutions to remove two directors.  In response to Eclairs' request, JKX issued several disclosure notices between 20 and 26 March 2013 and on 13 May 2013.  The responses admitted the existence of interests in JKX shares, but denied that the addressees were party to any agreement or arrangement among themselves.  The JKX directors believed that the responses did not correctly disclose that there were agreements or arrangements between the addressees, and exercised their power under Article 42 to issue restriction notices on the shares in which Eclairs and Glengary were interested.  These restrictions prevented Eclairs and Glengary from voting at the upcoming JKX annual general.  On 4 June 2013 the Claimants issued proceedings challenging the restriction notices.

Under section 171(b) CA, the director of a company must only exercise powers for the purposes for which they are conferred.  This is a codification of the equitable 'proper purpose' principle under which directors must only exercise their powers for the proper purpose.  In the High Court, Mann J found in favour of the Claimants, holding that the JKX directors had issued the restriction notices to influence or determine the fate of resolutions before the upcoming AGM, rather than to remedy the provision of inaccurate information in response to a disclosure request.   The directors of JKX therefore acted for an improper purpose, breaching section 171(b) CA.  JKX successfully overturned this decision on appeal, the Court of Appeal holding that the proper purpose doctrine had no significant place in the operation of Article 42.  Glengary and Eclairs then appealed.

Decision

The Supreme Court unanimously upheld the appeals by Glengary and Eclairs.  The Court held that the 'proper purpose' rule was of general application: it is a principle by which equity controls the exercise of a director's power in line with the manner determined by the relevant instrument and is one of the main means by which equity enforces the proper conduct of directors.  The JKX directors therefore had to exercise their constitutional power to issue restriction notices according to the 'proper purpose' of Article 42.  The Supreme Court held that Article 42 had three closely related purposes:

  1. to induce the shareholder to comply with a disclosure notice;
  2. to protect the company and its shareholders against having to make decisions about their respective interests without relevant information; and
  3. to punish an addressee of a disclosure notice for the failure or the refusal to provide the information requested.

The three purposes were directly linked to the non-provision of information requisitioned by a disclosure notice.  However, none of them extended to influence the outcome of resolutions at an AGM.  As JKX accepted that they had issued the restriction orders in good faith for the purpose of defeating Eclairs' and Glengary's supposed corporate raid by preventing them from voting in the AGM (contending that this was a proper exercise of their power), the Supreme Court allowed the appeal and set aside the restriction orders.

Lord Sumption (with whom Lord Hodge agreed) also proposed the inclusion of a 'but for' test in assessing whether a power had been exercised for its proper purpose in situations where a company's directors were motivated by more than one purpose, some of which were proper.  Lord Sumption suggested the court should focus on whether the relevant decision would still have been made if the directors had not been influenced by the improper purpose.  Lord Sumption considered that if the answer was that the decision would not have been made without the influence of the improper purpose, it would be irrational to allow it to stand simply because other, proper purposes had been considered in coming to the decision.  This would represent a departure for the law in relation to the proper purpose rule, which previously only looked at the "primary purpose" of the exercise of power.  However, this analysis was not unanimously adopted and Lords Neuberger and Mance declined to express any conclusive opinion without hearing submissions on the point.  The concept of a new 'but for' test is therefore currently not binding on the lower courts; however it may be persuasive, and could be accepted as binding law following relevant arguments on the point. 

Comment

The case confirms that directors must exercise a constitutional power to impose restrictions in accordance with the proper purpose for the exercise of that power.  If also suggests a possible new 'but for' test to assist with the assessment of a situation where directors have multiple possible purposes.  However, this new test currently remains non-binding and awaits further exploration by the courts.