The parties in this case had signed a shareholders agreement governing, amongst other things, shareholder funding of the company in which they held shares. One party argued that the provisions concerning how the company obtained funding from shareholders were void. The drafting of those provisions allowed the board a discretion to request shareholder funding, within certain parameters. The specific wording in question was “…the Board may request for Shareholder Loans …” (the court’s emphasis). This discretion was tied in later paragraphs to circumstances where the company required funding.
The court needed to determine whether the discretion of the board to carry out what appears to be a promise amounted to what is known as an “illusory obligation”; in this case the promise was to request shareholder funding.
An illusory obligation is a contract or a term of a contract that allows a party a true discretion or option whether to carry out what appears to be a promise. Such provisions are void. This determination turns on whether or not the party with the discretion has an “unqualified option whether to perform the promise or not”. Even where there is only a “vestige of an objectively ascertainable obligation” the discretion will not result in the contract or terms being void.
The court ruled that there was no illusory obligation on the basis that the discretion concerned must be exercised in the context of:
- the need to secure funding; and
- the parameters of the directors’ obligations to act in good faith and in the best interests of the company.