UK: Directors' Duties And The Proper Purpose Rule

Last Updated: 20 December 2015
Article by Colin Riegels and Rachel Graham

In Eclairs Group Ltd v JKX Oil & Gas plc [2015] UKSC 71 the UK Supreme Court reviewed the law relating to directors' duties, and in particular in connection with the so-called "proper purpose" rule in relation to exercise by the directors of their powers. Unfortunately as a result of a decision which is expressed to be unanimous but looks somewhat split, it is not entirely clear whether the law in this area has changed or not.

The case concerned a company called JKX Oil & Gas plc. Two of its shareholders who held 39 per cent of the issued shares between them appeared to be acting in concert with a view to conducting a corporate raid. The company had a provision in its articles of association allowing the directors to request information by notice in relation to persons interested in its shares, and whether they were acting in concert pursuant to any agreement. The directors also had power to suspend rights attached to shares in the event of non-compliance by a shareholder in relation to a notice. Notices were duly served, but the two shareholders denied that there was any agreement between them. The directors formed the view that these replies were untrue, and suspended the rights attached to the shares under the articles. The two shareholders challenged those actions as being done for an "improper purpose", specifically, to stop the two shareholders voting for a change in management at the AGM.

The main judgment was given by Lord Sumption. In his review of the law, Lord Sumption noted that directors were fiduciaries, and as such the exercise of their powers was always subject to the proper purpose rule. Lord Sumption noted the long history of cases where the directors had acted with improper purposes to try and prevent the takeover of companies, usually ending with judicial censure. The court needed to ascertain what the proper purpose of the relevant power was, and in this case the power to suspend rights attached to the shares could only be exercised for a single purpose – to ensure that shareholders responded honestly to such notices requesting information. In this case the board had formed the view that the two shareholders were embarking upon a plan to depress the share price of the company in order to buy up further shares at a discounted price. Whether that view was right or wrong (as to which the trial judge expressed no view – although he was satisfied that the view was honestly held), it was nonetheless not a proper purpose for the exercise of the power.

Thus far the judgment was relatively uncontroversial. However, Lord Sumption went on to consider the position where the members of the board had multiple purposes – some of which were proper and some were not. Should the court act to set aside such an exercise? Here the court was divided. Lord Sumption and Lodge Hodge felt that the question should be one of causation. Lord Sumption wished to follow the Australian High Court decision of Whitehouse v Carlton House Pty (1987) 162 CLR 285 where Dixon J had held that the exercise of a power "will be invalidated if the impermissible purpose was causative in the sense that, but for its presence, 'the power would not have been exercised'." This appeared to be a departure from the previously understood position under English common law which looked to the "primary purpose" of the exercise of a power as outlined in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 by Lord Wilberforce (although in the course of his judgment Lord Sumption attempted to put a new spin on Lord Wilberforce's speech).

However, when the parties received Lord Sumption's judgment in draft before it was formally handed down, they each objected for separate reasons. The appellant shareholders complained that they had not believed causation to be in issue based on the grounds of appeal, and had therefore advanced no arguments on that point. Conversely the respondent company argued that this was a "new development in the law" and so there should be a further hearing on causation. Faced with those objections the majority balked, and resiled from Lord Sumption's judgment with respect to the issue of causation (whilst still agreeing that the appeal should be upheld).

Accordingly, the law is left in a slightly tenuous state. Lords Sumption and Hodge have made clear their view that the common law rules on the proper purpose test should be modified with respect to causation. Lords Neuberger, Mance and Clarke are in the invidious position of having agreed with that position in a draft judgment, and then subsequently indicating that they could not support it without hearing specific argument on the point. It seems likely that this is one of those rarest of cases – where the views expressed by the minority should probably be treated as authoritative and likely to be adopted by the judiciary more widely at the first opportunity.

Separately, in his reversal of the Court of Appeal's decision Lord Sumption also made some useful comments in relation to the position of the shareholders. The Court of Appeal had upheld the directors actions, stating that to do otherwise "would only be an encouragement to deceitful conduct". Lord Sumption felt that was wrong in principle. Whilst directors undoubtedly owe a duty of loyalty to the company, the "shareholders owe no loyalty either to the company or its board. Within broad limits...they are entitled to exercise their rights in their own interest as they see it and to challenge the existing management for good reasons or bad."

Although the judgment was given on the basis of the statutory duty under the English Companies Act 2006, the court confirmed that this duty was the same as had existed at common law, and therefore the guidance for the Supreme Court – warts and all – will likely be followed in the various common law jurisdictions like Bermuda, the BVI, Cayman and Cyprus.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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