COMPANIES: THE ‘PROPER PURPOSE RULE’
Study Unit COMPANIES: THE ‘PROPER PURPOSE RULE’
(A) DIRECTORS’ DUTIES IN GENERAL A company’s Articles delegate certain powers to its directors. However, this power is balanced by the strict duties that common law and statute impose upon them. The legal principles stating that a director owes these duties originated in the common law, but the Companies Act 2006 clarified and codified them, a process which was generally regarded by the legal profession as being long overdue. A director’s duties are generally owed to the company itself and not to its members, so it is therefore only the company rather than its members which is entitled to issue proceedings against a director for any breach of a particular duty. If this happens then the company may seek: (i) an injunction to prohibit a director from continuing to breach his or her duties; (ii) an award of damages; (iii) the setting aside and therefore voiding of an offending transaction; or, (iv) the termination of a director’s service contract or his or her disqualification from office.
(B) THE DUTY TO ABIDE BY THE PROPER PURPOSE RULE Under the Companies Act a director has a duty to exercise his or her powers only “for the purposes for which they were conferred”. This duty is known in English law as the ‘Proper Purpose Rule’. The Supreme Court case of Eclairs Group Limited and Glengary Overseas Ltd v JKX Oil & Gas Plc (2015) is a good illustration of how the Proper Purpose Rule works in practice. The facts of the case are that JKX, an English company listed on the London Stock Exchange, exercised its right to impose restrictions on the voting rights attached to shares held by the claimants Eclairs and Glengary. The background to this rather drastic action was that the two shareholders had recently made moves that the board of JKX saw as leading to a potential ‘corporate raid’ on the company. In short, the board thought that Eclairs and Glengary may have been trying to destabilise JKX in order to reduce the market value of its shares, only to gain control of the company by buying up those shares at the reduced price. Some of the evidence for the board of JKX reaching this conclusion was that Eclairs and Glengary had, in their view, unreasonably opposed steps that the company had taken to raise funds and had actively sought the removal of a number of its directors. Perhaps understandably, the company issued disclosure notices, as was its right under s.793 of the Companies Act 2006, to the two shareholders, requiring them to provide information about any ‘arrangements’ that were in place between them that the company was unaware of. When the responses came from Eclairs and Glengary the company decided that the disclosures had done little to allay its concerns and it was therefore within its rights to restrict their voting rights. Eclairs and Glengary commenced legal action on the basis that, in taking this action, the company’s directors should have abided by the Proper Purpose Rule.
The High Court Lawyers for the claimants argued that the disclosure notices had been served by the company with the improper purpose of preventing the two shareholders from voting at the AGM and in doing so had sought to give its directors a better chance of passing their proposed resolutions. The High Court found for the claimants and JKX appealed.
The Court of Appeal The Court of Appeal overturned the judgment of the High Court and held that the Proper Purpose Rule was not applicable in the context of a struggle for the overall control of a company. In doing so the court referred to the provision in JKX’s Articles of Association allowing a restriction on voting rights where there is reasonable cause to believe that information provided by a shareholder in response to a disclosure notice was false or materially incorrect.
The Supreme Court The Supreme Court reverted to the decision of the High Court. It held that the voting restrictions had been imposed for an improper purpose, in this case with the intention of influencing the outcome of an AGM. This case demonstrates that the Proper Purpose Rule is alive and well, may possibly be considered as inescapable, and that it is not always enough for directors to act in a way which they consider to be in the best interests of the company.
Replace the underlined word in the following sentences with one of the highlighted words or phrases opposite.
1. If a director breaches a duty a company may be able to seek an order reversing a questionable transaction. 2. The directors felt that severe action was necessary when they suspected a potential corporate raid. 3. Sometimes shareholders try to disrupt a company in order to buy up cheaper shares. 4. The responses that came from the shareholders did little to calm the concerns of the board. 5. The Court of Appeal held that in a battle for the complete control of a company, the directors can restrict shareholders’ voting rights if they have reasonable cause for doing so. 6. At the end of the appeals process, the Supreme Court may decide to return to the decision of a court below the Court of Appeal.
Answer yes or no to the following questions.
1. Is JKX a private limited company? 2. Were either of the claimants in this case a natural person? 3. Did the defendants in this case believe that the claimants intended to make a hostile move against the company in the form in which it existed at the time? 4. Did the company exercise a right that it had under legislation in order to try and find out more about the intentions of the two shareholders? 5. Did the lawyers for the claimants argue that the defendants had acted tactically in restricting their client’s voting rights? 6. Did the Court of Appeal accept that the Proper Purpose Rule should have been used in the way that it was by the directors in this case? 7. Did the Court of Appeal decide that the defendants needed proof beyond reasonable doubt that the information provided by the shareholders in response to the disclosure notice was false or materially incorrect? 8. Could the correct use of the Proper Purpose Rule sometimes prevent a director from acting in the best interests of the company?
The following extract is from s.793 of the Companies Act 2006, which allows a company to issue a disclosure notice to a shareholder. Complete the extract with a word from the box below.
(a) parties (c) arrangement (e) particulars (g) applies (i) referred (b) subsection (d) knowledge (f) identity (h) lies (j) present Notice by company requiring information about interests in its shares (3) The notice may require the person to whom it is addressed to give (1) ….. of his own present or past interest in the company’s shares (held by him at any time during the three-year period mentioned in (2) ….. (1)(b)). (4) The notice may require the person to whom it is addressed, where: (a) his interest is a (3) ….. interest and another interest in the shares subsists, or (b) another interest in the shares subsisted during that three-year period at a time when his interest subsisted, to give, so far as (4) ….. within his (5) ….., such particulars with respect to that other interest as may be required by the notice. (5) The particulars (6) ….. to in subsections (3) and (4) include: (a) the (7) ….. of persons interested in the shares in question, and (b) whether persons interested in the same shares are or were (8) ….. to: (i) an agreement to which s.824 (9) ….. (certain share acquisition agreements), or (ii) an (10) ….. relating to the exercise of any rights conferred by the holding of the shares.
Speaking & Writing for this topic
Two short tasks scored against TOEFL rubrics. The prompt is generated for this topic — use the vocabulary you have just studied.