UK: The Proper Purpose Rule And Battles For Control: The UK Supreme Court Decision In Eclairs Group Ltd v JKX Oil & Gas plc And Glengary Overseas Ltd v JKX Oil & Gas plc

Last Updated: 14 December 2015
Article by Mark Stefanini, Miles Robinson, Jeremy Holden and Greg Stonefield

Overview

The Supreme Court's recent decision in the conjoined cases of Eclairs Group Ltd v JKX Oil & Gas plc and Glengary Overseas Ltd v JKX Oil & Gas plc demonstrates that directors must act with caution when they are exercising their constitutional powers: in these cases placing restrictions on shareholders for failing to comply with disclosure notices served pursuant to s793 Companies Act 2006. Directors who wish to exercise a constitutional power to impose a restriction must ensure that their reason for taking action is in line with the purposes for which the power was conferred. If the directors have another significant motivation for the exercise of the power, they run the risk that any restriction will be overturned by the courts, even where it is clear that grounds for the exercise of the power did exist.

Background

JKX Oil & Gas plc is a public company listed on the London Stock Exchange. The claimants in the two cases were companies controlled by the Ukranian businessmen Igor Kolomoisky and Gennadiy Bogolyubov (Eclairs Group Ltd, "Eclairs") and the Russian businessman Alexander Zhukov (Glengary Overseas Ltd, "Glengary"). Together, the two claimants had a 39% shareholding in JKX Oil & Gas plc ("JKX").

In March 2013, the directors of JKX began to suspect that the owners of Eclairs and Glengary were conspiring to exploit their minority shareholding to obtain effective management or voting control without paying the other shareholders a fair premium: conduct known as a 'corporate raid'. Consequently, the directors of JKX issued two rounds of s793 notices requesting information about each recipient's interest in JKX's shares.

Although the directors received responses to these notices, they determined that the answers given in these were incorrect or incomplete and exercised the power given to them in the company's articles of association to impose restrictions on shareholders Eclairs and Glengary, preventing them from voting at the upcoming JKX AGM.

Part 22 and Article 42

Part 22 Companies Act 2006 sets out provisions entitling a company to issue a notice requiring information about interests in its shares. Under s793, a public company may issue such a notice to any person whom the company knows, or has reasonable cause to believe, to be interested in its shares. The information requested can include information about agreements relating to the exercise of the rights attached to the shares. s795 makes non-compliance with a s793 notice a criminal offence and s794 allows a company to apply to the court for an order that the shares in question be subject to restrictions. s797 identifies the restrictions capable of being imposed by the court, which include the restriction that no voting rights may be exercisable in relation to the shares in question.

Public companies often supplement this regime in their articles, granting the board specific powers to impose restrictions similar to those available under s794/797 where a s793 notice has not been complied with, without requiring an application to the court. This was dealt with in Article 42 of JKX's Articles, which also provided that the board could impose the relevant sanctions if they knew or had reasonable cause to believe that the information provided in response to a notice was false or materially incorrect.

Decision

In the High Court, the claimants were successful in having the restrictions imposed using Article 42 set aside on the basis that the directors of JKX had acted for an improper purpose. The Court found that the primary motivation of the majority of JKX's directors in imposing the sanction had been to prevent the defaulting shareholders from voting at the AGM, not to obtain information about the shareholdings. This was a breach of the 'proper purpose' rule, now enshrined in s171(b) of the Companies Act 2006, that a director of a company must "only exercise powers for the purposes for which they are conferred."

JKX successfully overturned this decision on appeal. The majority in the Court of Appeal took the view that the application of the proper purpose rule was inappropriate in the context of a battle for control of the company in circumstances where the defaulting shareholders only had to comply with their duties to provide information more fully in order to procure the lifting of the restrictions.

On appeal to the Supreme Court, however, the decision of the High Court was restored. The Supreme Court was unanimous in finding that directors who exercise powers contained in the company's articles to impose restrictions on shareholders for non-compliance with s793 notices must do so for the 'proper purpose'. The proper purpose is the reason for which that power was conferred on the directors. The Supreme Court recognised three proper purposes for exercising the powers set out in Article 42 of JKX's Articles, all relating directly to the non-provision of information: (1) to induce the shareholders to provide the information; (2) to protect the company and its shareholders against making uninformed decisions before the information was provided; and (3) as a punishment for failing to provide the information requested. Therefore, in light of the finding in the High Court that the majority of JKX's directors had acted with the purpose of preventing Eclairs and Glengary from voting at the AGM (which was not disputed by JKX), the restrictions were set aside.

Lord Sumption (with whom Lord Hodge agreed) proposed a 'but for' test to be applied in deciding whether or not a power had been exercised for a proper purpose where there was clearly more than one purpose behind the directors' exercise of a power, and not all those purposes were proper: Would the decision have been made if the directors had not been moved by the improper purpose? Lord Sumption considered that if there was a proper reason for exercising the power and it would have been exercised for that reason even in the absence of any improper reasons, then it would be difficult to argue that the decision should be set aside. However, this analysis was not adopted by the majority and Lords Mance and Neuberger expressed concerns about such a test. This 'but for' test is, therefore, not binding on the lower courts but may be influential in future cases until the position is clarified.

In contrast to the approach taken in the court below, the Supreme Court considered that the proper purpose principle was particularly important in the context of a battle for control of a company, so as to preserve the constitutional boundaries between the powers of the board and those matters reserved for shareholders.

Key Learning Points

  • Directors exercising power given in the articles of association to impose restrictions on shareholders must ensure that they are seen to act in accordance with the proper purpose for which the power was conferred. Making a contemporaneous record of the purpose for which the restrictions have been imposed may help by providing evidence that can easily be deployed in defending any subsequent challenge.
  • The proper purpose rule is concerned with an abuse of power: the doing of acts which are within the scope of a power but done for an improper reason. As the rule relates to the reason for which an act is done, the test is necessarily a subjective one.
  • Articles of association don't usually express the purpose for which any power is given, so one must look at the mischief which the power is designed to deal with. The mischief itself should be deduced from the provision's "express terms, from an analysis of their effect and from the court's understanding of the business context."

Greg Stonefield, partner in the Corporate & Securities Group, commented: "What the Supreme Court has made clear is that directors may exercise a power to impose restrictions on shares if that is part of an effort to find out who is "pulling the strings" in order to ensure that the company and other shareholders are not making decisions in ignorance of the facts. What directors may not do is use the power with the intention of trying to influence decisions made at shareholder meetings, or to deny the shareholders their rights, as this would amount to an exercise of power for an improper purpose. This will become relevant to private companies as well as public companies when the "people with significant control" regime comes into force early next year."

Originally published 11 December 2015

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