The Companies Act 2006 sets out duties that are owed to a company by its directors. This is to provide greater clarity on what is expected of directors in terms of their relationship with the company and its shareholders and creditors.
One of the principal duties is a director’s duty to act within powers. This duty is split into two parts:
- a director is required to act in accordance with company’s articles of association; and
- a director is to exercise powers only for purposes for which they are conferred (the ‘proper purpose’ rule).
This is of particular importance to directors acting on behalf of a company where there are individuals (especially independent shareholders or creditors) who will be affected by their actions and decisions and for acts outside the usual day to day business of the company.
Last month the UK Supreme Court reviewed the law in relation to the proper purpose rule. The shareholders challenged the exercise of powers by the company’s directors as being done for an improper purpose.
The case, summarised below, demonstrates that, whilst the intention of including duties under the Act was to provide clarity as to what is expected from directors, there will continue to be a role for the UK courts in interpreting how those duties should be complied with. It is therefore important that where directors make any decisions which could be seen a detrimental or controversial that care is taken to document the reasons for the decisions
Eclairs Group Ltd v JKX Oil & Gas plc  UKSC 71
The board of JKX Oil & Gas suspected that two minority shareholders were acting in concert to reduce the share price of the company in order to purchase further shares at a discount (a so-called "corporate raid").
The powers held by the board of directors subject to dispute in this case were:
Under the Companies Act - the power to issue a disclosure notice requesting information in relation to persons interested in its shares; and
Under the company’s articles - a power to suspend rights attached to shares where the disclosure notice had not been complied with.
The board issued a notice to the shareholders and subsequently deemed their response to be non-compliant. The board then issued restriction notices in relation to the shares held by the shareholders, suspending their right to vote and transfer shares.
The issues in dispute were whether:
- the proper purpose rule applied to this particular exercise of power; and
- the powers were exercised by the directors for a proper purpose.
On the first point as a case where there is a battle for control of the company, ensuring directors’ powers are being exercised properly is vital and therefore, the proper purpose rule should apply, allowing shareholders to enforce proper conduct by a director.
Considering the second issue, the court had to consider the situation where there could be more than one purpose for the exercise of power (some being proper, and some improper). In this case, they found there were three purposes which were proper:
- to ensure compliance with the request for information;
- to protect the company and its shareholders from having to take decisions in ignorance of relevant information; and
- as a punishment for failing to comply with the disclosure notice.
The shareholders argued that the directors were actually using this power to stop the shareholders from voting for a change in management at an AGM and that this was an improper purpose.
The court had to decide which of these purposes was the relevant purpose.
Ultimately the court unanimously agreed with the shareholders that the director’s actions were exercised for an improper purpose, however the judges’ reasoning was a lost opportunity to clarify a key aspect of director’s duties.
The leading judge, Lord Sumption, believed that the key issue was that of causation: The relevant purpose being the one without which, the decision of the directors would not have been made. He found that the relevant purpose was Influencing the outcome of a shareholder resolution and that this was an improper purpose. Lord Sumption’s reasoning is a departure from past cases where courts would consider the ‘primary purpose’ for the exercise of power.
Both parties in this case immediately objected to Lord Sumption’s judgment as they didn’t realise causation would be considered and so had not advanced any arguments on that point. As the issue of causation was a new development in the law, they believed there should be a further hearing on this particular issue if it was to be decisive in this case.
Having initially agreed with the view put forward by Lord Sumption in his leading judgment, three of the five judges, therefore abandoned the view on causation in their final judgments and found that the directors’ actions were improper as their primary purpose was one which was improper.
The law in respect of this particular duty is left in an unusual position where, whilst the decision of the Supreme Court was unanimous, there remains uncertainty as to how cases like this will be decided in the future. Will the minority view of two judges in respect of causation be adopted even though this was not supported by the majority view of the other three?
For more information, please contact Greg Vincent (Senior Associate Solicitor) or Alexander Bishop (Solicitor) in the Corporate and Commercial team at our Wimbledon office on 0208 971 1033. Address: Morrisons Solicitors LLP, 5th Floor Sterling House, 6 – 10 St George’s Road, Wimbledon SW19 4DP. Further details relating to our Corporate and Commercial team can be found here.