Takeover bid - frustrating action by board restricting hostile shareholder voting rights following incomplete response to restriction notice – analysis of directors’ duty to exercise powers for their “proper purpose”
In the first instance decision of Eclairs Group Ltd and another company v JKX Oil and Gas plc (“JKX”) and others  EWHC 2631 (Ch) the judge was clear that:
- provisions in a company’s articles broadly equivalent to section 793 of the Companies Act 2006 could not be used to manipulate voting in a takeover battle; and
- directors must exercise their powers for their proper purpose. The fact that the directors’ decision may have been in the best interests of the company as a whole did not mean that they could exercise their powers for an improper purpose.
The Court of Appeal subsequently overturned the decision in part and held that the directors power to issue the notices and impose restrictions, where the requested information was not provided, did not need to have been exercised for a proper purpose (Eclairs Group Ltd and another v JKX Oil and Gas plc and others -  All ER (D) 117). The Supreme Court handed down its judgment this week (Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc  UKSC 71) following a hearing earlier this year, allowing the appeal and restoring the decision at first instance. Whilst it is now clear that the decision to issue section 793 or equivalent notices must be made for a proper purpose, it is not clear whether there is a new test when applying the proper purpose rule.
The leading Court of Appeal judgment concurred with the first instance decision that the directors had not exercised their powers for a proper purpose. The judge, considering a number of precedents, considered that the directors’ belief that their action was in the best interests of the company did not override the directors’ duty to exercise powers for a proper purpose. This was particularly so where the exercise of a fiduciary power by the director (i.e. the issuance of the restriction notices) would impinge upon the constitutional balance of power between groups of shareholders. This fairly compelling argument was roundly disagreed with by the other two appeal judges who took a more practical approach. Their thinking was that the failure by the directors to exercise this particular power for a proper purpose was irrelevant where, as in this case, the other party had an opportunity to comply with the directors’ request. The judges went on to say that “the misuse of power doctrine has no significant place in the operation of...Part 22 of the 2006 Act”. The Supreme Court roundly disagreed with the Court of Appeal’s suggestion that the proper purpose rule had no application in this context considering that “a battle for control of the company is probably the one in which the proper purpose rule has the most valuable part to play”.
The Supreme Court’s judgment (paras 14-24) includes analysis of the proper purpose rule (now stated in section 171(b) of the Companies Act 2006). Lord Sumption, in the leading judgment, notes that courts have in the past sought to uphold the integrity of directors’ decision making and to limit intervention into the conduct of a company’s affairs. A director’s decision will be set aside only if “the primary or dominant purpose for which it was made was improper”. The question inevitably arises as to what is the “primary” or “dominant” purpose when there are multiple concurrent purposes. Lord Sumption suggests that the fundamental point is one of principle i.e. the statutory duty of the directors is to exercise their powers "only" or the purposes for which they are conferred. That duty is broken if they allow themselves to be influenced by "any" improper purpose. The question is therefore one of causation i.e “which considerations led the directors to act as they did. Whilst noting the relevance of causation to the application of the test it was noted that it was not the company’s case that despite one of the purposes being improper they would have come to the same decision without it and therefore the court did not express any firm or concluded view on the application of the test.
Impact - The judgments are a “must read” for anyone considering issuing restriction notices but they also have wider implications for directors when exercising their management powers. The decision’s relevance is not confined to public companies as, in addition to the general discussion of the proper purpose test when considering directors’ decision making, the forthcoming PSC regime which will apply to private companies, enables companies to issue restriction notices in the absence of sufficient information being provided by shareholders in relation to their beneficial interests.
Background - The board of JKX, a company listed on the London Stock Exchange, had proposed a number of resolutions at the company’s forthcoming AGM to re-elect directors, approve the remuneration report and authorise the allotment and market purchase of shares. The beneficial owners of approximately 40% of JKX (who had requisitioned a general meeting under section 303 of the Companies Act 2006 to remove certain of the existing directors) were considered likely to oppose the requisite shareholder resolutions. The board, seeking to establish interests in shares in JKX, issued section 793 notices. The company’s articles provided that if the board had “reasonable cause to believe” that section 793 responses were false, or materially incorrect, it could impose restrictions on the shares. Following responses to those notices (which the board considered to be materially incorrect) the company issued restriction notices in respect of those shares held by the hostile 40% shareholders thereby effectively avoiding opposition to the resolutions.
Prospectus Directive changes – a “simpler faster and cheaper prospectus regime”
The European Commission has published a proposal to improve the EU’s prospectus regime. Described by Commissioner Jonathan Hill as intended to create a “simpler faster and cheaper prospectus regime” the proposals implement changes in the following main areas:
- increasing the threshold below which a prospectus is not required (the existing exemptions will otherwise continue to apply). The Commission proposes raising the amount of capital that can be raised on EU markets without a prospectus from €100,000 to €500,000. In addition it is proposed that member states will be able to set a higher threshold where the issue only relates to their domestic market, previously capped at €5m this will increase to €10m;
- the threshold determining which companies fall within the small and medium sized company regime will increase to €200m from €100m. In addition, a new optional “question and answer” format will be introduced, intended to help SMEs draw up their own prospectus;
- creation of a frequent issuer regime through the introduction of an annual universal registration document. The intention is that this will promote the drawing up of prospectuses as tripartite documents (registration document, securities note and summary) and enable faster approval of the securities note and summary by the competent authority;
- existing issuers will be able to issue additional securities on the same market, without publishing a prospectus, provided that those securities represent less than 20% of the existing securities listed in that class (previously the test was limited to 10% and only applied to shares); and
- prospectuses will be shorter, focused and available across the EU from one central place.
The Commission has published a detailed impact assessment which contains a useful guide to both the history of the EU’s prospectus regime and the proposals for its development.
Impact – the proposal reflects the “Action Plan on Building a Capital Markets Union” published in September which prioritises lowering barriers to access capital markets across the EU. The intention is to reduce the administrative burden on issuers, make the prospectus a more useful tool for investors and achieve more convergence between the EU’s prospectus and disclosure rules. The Commission proposes replacing the current EU prospectus directive with a regulation which will also offer a more harmonised approach across the EU. The draft regulation will now be subject to the European Parliament and Council’s co-decision procedure.
- The first use of a deferred prosecution agreement (a “DPA”) in this country has been approved this week. Judgment was given on 30 November, validating a concluded agreement between the Serious Fraud Office (“SFO”) and Standard Bank Plc (“SB”). Following an investigation, the SFO had formed the view that there was a reasonable suspicion that SB had failed to prevent bribery contrary to section 7 of the Bribery Act 2010. A “relevant commercial organisation” (“C”) is guilty of an offence under section 7 if a person “associated” with C bribes another person, intending to obtain or retain business or a business advantage for C. C has a defence if it can show that it had in place “adequate procedures"
From February 2014, companies have been able to enter into DPAs with prosecutors in relation to fraud, bribery and money laundering offences. The benefit of a DPA is mitigated by the requirement that penalties broadly reflect fines, it must be court approved in an open hearing and only applies to the corporate entity. Any individual with liability, such as a director, is outside the scope of a DPA
Click here for more detail of the decision.
- The EU Commission has published draft technical standards in relation to the EU’s current prospectus directive. The draft is intended to be consistent with the current review of the EU’s prospectus regime. It details requirements regarding the approval, publication and advertisement of prospectuses. The Commission must decide within three months whether to endorse the draft standards.
- The Quoted Companies Alliance has published its third annual corporate governance behaviour review comparing corporate governance disclosures made by a randomly selected group of small and mid-size quoted companies taken from the Main List, AIM and ISDX. The review demonstrates that the “reporting landscape continues to evolve” and includes “The top five governance reporting tips”.
- The Financial Conduct Authority has published a reminder that from 1 January 2016, companies with a base prospectus (produced in connection with nonequity transferable securities issued under an offering programme) will no longer need to send final terms to host competent authorities as well as their home competent authority. Instead the home competent authority will be responsible for forwarding them on.
- The Financial Reporting Council (“FRC”) has announced that it will conduct a thematic review of companies’ tax reporting to encourage more transparent recording of the relationship between tax charges and accounting profit. The FRC will write to a number of FTSE 350 companies prior to their financial year end, informing them that the Corporate Reporting Review Team will review the tax disclosures in their next published reports. The FRC plans to take a particular interest in: the transparency of tax reconciliation disclosures and how well the sustainability of the effective tax rate is conveyed; and uncertainties relating to tax liabilities (and assets) where the value at risk in the short term is not identified.