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Supreme Court reinvigorates the proper purposes rule

The Supreme Court has provided helpful clarification on the scope of section 171 of the Companies Act 2006 (CA 2006) in Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc [2015] UKSC 71.

Section 171, CA 2006 provides that:

“A director of a company must –

(a) act in accordance with the company’s constitution, and

(b) only exercise powers for the purposes for which they are conferred.”

The key points from the Supreme Court decision

(1) The rule that the fiduciary 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.

(2) Further, the proper purposes rule is fundamental to the constitutional distinction between the respective domains of the board and the shareholders. Without the rule, directors’ powers might be used for the purpose of influencing the outcome of a general meeting. This would not only be an exercise of power for a collateral purpose, but also an abuse of the constitutional distribution of powers between the different organs of the company, as it involves the use of the board’s powers to control or influence a decision that the company’s constitution assigns to the general body of shareholders.

(3) The proper purposes rule is not concerned with the situation where a power is exceeded because it is outside the scope of the authority by which it was conferred (for example, where an act is outside the scope of a company’s articles of association). It is instead concerned with an act that is within the scope of the authority by which it was conferred, but which is done for an improper purpose. It necessarily follows that the test is subjective: it is concerned with the state of mind of those who acted and their motive.

(4) The duty to exercise powers for a proper purpose is additional to, and not separate from, the requirement of a director to act in good faith to promote the success of the company (now section 172, CA 2006). A finding that the latter duty has been complied with will not preclude a finding that the former has not been.

(5) The question of a director’s purpose in exercising a particular power is not a question of the proper construction of the instrument by which the power was conferred. Accordingly, the test for the implication of a term into a contract has no application. The rule is instead a principle by which equity controls the exercise of a fiduciary’s powers in respects that are not, or not necessarily, determined by the instrument conferring them. The court’s function is to determine the purpose of the power by considering the mischief of the provision conferring it. That, in turn, involves an analysis of the express terms of the provision, an analysis of their effect, and the court’s understanding of the business context.

(6) Situations may commonly arise where a director has more than one purpose. In those circumstances, what test should be applied to determine whether the rule has been infringed? Per Lords Sumption and Hodge, the court should apply a “but for” test. In other words, if the improper purpose was dispositive, that is, but for the improper purpose, the decision would not have been made, then the rule has been infringed. If on the other hand, even if the director had had an improper purpose, it would have made no difference to the outcome of the decision (being based on purposes that were proper), then the rule has not been infringed and any decision made pursuant to it will stand.

(7) However, per the majority (Lords Clarke, Mance and Neuberger), it was not appropriate in JKX to decide (in the absence of further argument) that a “but for” test applied, as opposed to a “dominant purpose” test. In those circumstances, the dominant purpose test will continue to apply. However, no doubt arguments will continue to be raised (where it makes a difference) that a “but for” test should be adopted.

Comment

The Supreme Court unanimously allowed the appeal, overturning the Court of Appeal’s decision. In doing so, it breathed new life into the proper purposes rule. Litigators may have a revived weapon with which to attack directors’ decision-making. Corporate advisors will need to be aware of the risk of a board decision being challenged, even if it passes the test of being taken in good faith and in the company’s best interests.

The further question of whether a “but for” or “dominant purpose” test (or some other test) should apply will have to wait another day. In some cases, the distinction may not make any difference but, in others, the courts will no doubt need to reach decisions that can be justified on the application of both tests.

The facts

JKX was concerned with the imposition of restrictions on minority shareholders in JKX Oil & Gas plc, an English company listed on the London Stock Exchange. The restrictions suspended the rights of the shareholders from voting at general meetings and from transferring their shares. The restrictions were imposed pursuant to provisions of the company’s articles following the failure of the shareholders to comply with disclosure notices requiring them to provide information on the number of shares held by them, their beneficial ownership, and any agreements or arrangements between the various persons interested in them. The provisions of the articles corresponded to provisions as to disclosure notices and restrictions contained in section 794, CA 2006.

The shareholders challenged the imposition of the restrictions. They argued that the only proper purpose for which the power could be exercised was to extract the information sought in the disclosure notices. The power had instead been exercised to ensure that resolutions proposed for the forthcoming AGM would be passed. The resolutions were intended, they argued, to shore up the company from a perceived “corporate raid”, by which the shareholders sought to obtain effective control over the company.

High Court decision

Mann J found for the shareholders and set aside the restrictions and the board resolutions authorising them. The Judge concluded that the only purpose for which the power to impose restrictions was conferred was to provide a sanction or an incentive to remedy the default (that is, in not providing the information requested under the disclosure notices). The primary purpose of the board in issuing the restrictions had been to influence or determine the fate of the resolutions before the AGM. That was an improper purpose and the restrictions could not therefore stand.

Court of Appeal decision

The Court of Appeal allowed the appeal. The court held that the restrictions did not reflect a “unilateral” exercise of power by the board, in that the shareholder could avoid the restrictions by simply complying with the disclosure notice: “why should the law protect him when all he had to do was tell the truth?” Secondly, the court held that, once the board had concluded that the disclosure notices had not been complied with, there was no further limitation on their power to impose restrictions. Thirdly, they relied on the absence of any express limitation on the proper purpose of a restriction notice in Part 22, CA 2006 or the company’s articles.

Andreas Gledhill QC, Blackstone Chambers, acted for one of the two successful appellants, Glengary Overseas Limited.

Blackstone Chambers Peter Head

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