A recent Supreme Court case has highlighted the need for directors to carry out their duties and exercise their powers in accordance with the proper purpose rule.

The facts

The case concerned a perceived “corporate raid” on a company, JKX Oil & Gas Plc, by two of its shareholders, Eclairs and Glengary. The directors of JKX called an AGM and, in accordance with the Companies Act 2006 and its Articles of Association (Article 42), issued disclosure notices requesting information in relation to persons interested in its shares and whether there were any arrangements affecting the shares in the company. The Articles also empowered the Board to, inter alia, suspend voting rights attached to shares in the event of non-compliance with the disclosure notices or if the Board concluded that it had reasonable grounds to believe the replies to be inaccurate.

Prior to the AGM, Eclairs publicly opposed the Board’s proposals to issue additional capital and disapply pre-emption rights and sought to remove the Chief Executive and Commercial Director from office.

Eclairs and Glengary replied to the disclosure notices but the Board concluded their replies to be inaccurate and suspended their right to vote at the AGM. The two shareholders challenged the findings relying on the proper purpose rule at s 171(b) of the Companies Act 2006 which requires that a director must “only exercise powers for the purposes for which they are conferred”.

The shareholders won at first instance with the trial judge concluding that the Board had infringed the proper purpose rule by acting predominantly for the improper purpose of preventing the shareholders from voting at the AGM even though the Board had honestly believed it was acting in the company’s best interests.

The Court of Appeal overturned the trial judge’s decision holding that the proper purpose rule did not apply to article 42 because the shareholders only had to answer the questions more fully in order to avoid the restrictions of their voting rights and because the application of the rule was inappropriate in the course of a battle for control.

The judgment

The Supreme Court reinstated the trial judge’s decision holding that the proper purpose rule does apply to the exercise of powers under article 42 and that the Board had acted for an improper purpose.

Lord Sumption stated that the power under article 42 to restrict the rights attaching to shares is ancillary to the statutory power to call for information under s 793 of the Companies Act. Article 42 has three closely related purposes: (i) to induce a shareholder to comply with a disclosure notice; (ii) to protect the company and its shareholders against having to make decisions about their respective interests in ignorance of relevant information; and (iii) as a punitive sanction for a failure to comply with a disclosure notice. Seeking to influence the outcome of shareholders’ resolutions or the company’s general meetings is no part of those proper purposes.

Lord Sumption also held that the proper purpose rule applies to article 42. It is irrelevant whether Eclairs and Glengary could have averted the imposition of restrictions on their rights as shareholders by giving different answers to the questions. The proper purpose rule is the principal means by which equity enforces directors’ proper conduct and is fundamental to the constitutional distinction between board and shareholder. A battle for control of the company is probably the context where the proper purpose rule has the most valuable part to play.

Eclairs Group Ltd v JKX Oil & Gas Plc; Glengary Overseas Ltd v JKX Oil & Gas Plc [2015] UKSC 71