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Case law: Directors’ exercise of powers under Companies Act and articles not valid because not for ‘proper purpose’

Directors of a public limited company exercising their power to require a shareholder to give information about any third party interests in their shares cannot do so for a purpose which is not a ‘proper purpose’, the Supreme Court has ruled.

Legal Alert

This update was published in Legal Alert - January 2016

Legal Alert is a monthly checklist from Atom Content Marketing highlighting new and pending laws, regulations, codes of practice and rulings that could have an impact on your business.

Directors of a plc did not want a particular corporate shareholder to be able to vote at a shareholders’ meeting, suspecting it was owned by individuals trying to gain control of the plc. They feared those individuals would use the meeting to stop the company from passing shareholder resolutions to raise more capital. This would drive the price of the plc’s shares down and make them cheaper to buy.

The directors used their statutory powers under the Companies Act to ask the corporate shareholder whether any third parties held interests in its shares, and the nature of those interests. The effect of the Act and the plc’s articles of association was that if the shareholder did not give accurate replies, its shares could be stripped of their votes.

The directors decided the corporate shareholder’s reply was materially inaccurate and stopped it from voting on the resolutions to raise more capital at the shareholders’ meeting, just as the Act and the articles said they could in such circumstances.

The corporate shareholder claimed that the directors’ actions breached their fiduciary duty to ‘only exercise [their] powers for the purposes for which they are conferred’. This is often referred to as the ‘proper purposes’ rule. The shareholder said the proper purpose of the rule allowing directors to disenfranchise shares if the shareholder failed to provide accurate replies to a request for information under the Act is to incentivise shareholders to provide the information requested. However, the purpose of the directors in disenfranchising shares in this case had been to try to stop the acquisition of the plc, which was an improper purpose.

The directors argued that they did what they did to satisfy another fiduciary duty - to promote the success of the company by acting in its best interests.

The High Court found in favour of the corporate shareholder and ruled:

  • Even though the directors honestly believed that what they were doing was in the company’s best interests, their acts had been an improper use of their powers and therefore a breach of their duty to exercise their powers for the purposes for which they were conferred
  • In this case, the directors’ duty to act for proper purposes overrode their duty to promote the success of the company by acting in what they honestly believed to be its best interests

It ordered that the corporate shareholder’s votes should be counted when deciding whether the resolutions to raise more capital had been passed or not.

The Court of Appeal overturned that decision, and ruled:

  • The corporate shareholder could have chosen to avoid the sanction by providing full and correct answers, but failed to do so. It was a ‘victim of [its] own choice, not a victim of any improper use of a power of the board of directors'
  • The relevant provision in the Companies Act (on which the plc’s articles were based) does not say the sanction can only be applied for a particular purpose, and the Court found it ‘difficult to believe that Parliament intended a detailed inquiry into the minds of the directors of a company to be undertaken before the sanction can be imposed'

However, the Supreme Court has reinstated the High Court’s ruling. It said that a board must use its powers only for legitimate purposes, and the directors’ main purpose in this case was to influence the result of the relevant votes at a general meeting of the shareholders. This was not a legitimate purpose and was therefore improper. It did not matter that the directors honestly believed that what they were doing would promote the success of the company.

Operative date

  • Now

Recommendations

  • Directors considering whether to exercise statutory powers and/or powers under their company’s articles of association, should take legal advice before taking action, to ensure they do not breach their fiduciary duty to act only for proper purposes

Case law: Eclairs Group Ltd v JKX Oil & Gas Plc [2015] UKSC 71

Disclaimer: This article from Atom Content Marketing is for general guidance only, for businesses in the United Kingdom governed by the laws of England. Atom Content Marketing, expert contributors and ICAEW (as distributor) disclaim all liability for any errors or omissions.

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