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One of the strangest decisions in the company law sphere over the last couple of years was that of the Court of Appeal in Eclairs Group Ltd v JKX Oil & Gas plc, which held, by a two to one majority, that a director’s duty to exercise his powers for the purposes for which they were conferred did not apply to the exercise of a particular power under a company’s articles to disenfranchise shareholders in certain circumstances. This analysis flew in the face of the traditional understanding that the duty, which is one of the key fiduciary duties to which directors are subject, is of general application, and at the end of last year the decision was overturned by the Supreme Court.
To a purist, the confirmation of the traditional understanding that the duty applies to all powers which a director may exercise is to be welcomed. Directors and their legal advisers, however, may be less pleased, for the nature of the duty is such that in practice it can be extremely difficult to ensure compliance with it.
This article examines the JKX saga before outlining steps which a director can take to reduce the risk that he will be found to have exercised his powers for an improper purpose.
Eclairs Group Ltd v JKX Oil & Gas plc – the facts
The relevant facts of the case were, in outline, as follows:
At issue, then, was the duty of a director under section 171(b) of the Companies Act 2006 to exercise powers only for the purposes for which they were conferred.
Eclairs Group Ltd v JKX Oil & Gas plc – a tale of three courts
In the High Court ( EWHC 2631 (Ch)), Mann J did not address the possibility that the duty to act for a proper purpose might not be applicable to the particular power in question. He simply adopted the traditional approach of identifying the purpose for which the power was given to the directors and considering whether it was exercised for that purpose. On the facts, he concluded that the power was given to the directors in order to assist them in obtaining information from shareholders in connection with a section 793 notice, but that in fact the majority of them had used it because they wished to disenfranchise the shareholders. He held, therefore, that the power had been used for an improper purpose.
In the Court of Appeal ( EWCA Civ 640), Sir Robin Jacob and Longmore LJ delivered a short joint judgment in which they took the view that “the misuse of power doctrine has no significant place in the operation” of the relevant provision of the company’s articles. They gave several reasons for this unorthodox view, one of which was that it would be unfair to protect a shareholder from the consequences of failing to provide information requested in a section 793 notice, since he could avoid those consequences by the simple expedient of providing the information. As they put it: “a party who chooses not to answer the questions properly is a victim of his own choice, not a victim of any improper use of a power of the board of directors”. The majority view was vigorously opposed by Briggs LJ, who was of the view that the duty under section 171(b) applied to the power in question. In the course of his judgment, he noted that the “underlying assumption, both of the common law and now of Parliament, is that all fiduciary powers are conferred on directors for a purpose or purposes”, and that fiduciary powers “have always been subject to the requirement that they be exercised for the purposes for which they are conferred”.
In the Supreme Court ( UKSC 71), the judges were unanimous in their view that the duty applied to the power under JKX’s articles. The main judgment was delivered by Lord Sumption, who noted that: “The rule that the fiduciary powers of directors may be exercised only for the purposes for which they were conferred is one of the main means by which equity enforces the proper conduct of directors.” He rejected the various reasons given by the majority in the Court of Appeal for their conclusion that the duty was not applicable to the power to issue restriction notices, and held that Mann J’s decision that the power had been used for an improper purpose should be restored.Article continues below...
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Implications of the Supreme Court’s decision
The effect of the Supreme Court’s decision is that directors must now assume that the duty under section 171(b) applies to all of their powers. As a matter of principle, this state of affairs is satisfactory: a director’s relationship with his company is fiduciary in nature, and a director who exercises his powers for an improper purpose can hardly be said to be acting loyally. In practice, however, it puts directors in the difficult position of having to try to identify the purpose for which every one of their powers has been conferred on them.
How, then, should a director go about this task?
The most interesting feature of the High Court’s decision in JKX was not the judge’s application of the law on section 171(b), which was, after all, in keeping with the traditional approach to the duty, but rather the painstaking approach which he had to adopt to the task of identifying, as a matter of fact, the purpose for which the directors had exercised the power to issue restriction notices. Not only were the directors’ witness statements largely silent on the point, but it appeared that the minutes of the board meeting at which the decision to exercise the power was taken referred only to the directors’ duty under section 172 to promote the company’s success.
When we reported on the decision in 2014 (see the article entitled ‘Board minutes – recording directors’ compliance with their duties’), therefore, we focused on the importance of recording compliance with section 171(b) in board minutes, at least where a power is being exercised in controversial circumstances, and that message still holds good. Assuming a director’s understanding of the purpose for which a particular power was conferred on him is correct, a reference to that purpose in the board minutes should go a long way towards protecting him in the event of a future allegation of breach. Equally importantly, a director who acquires the habit of ensuring that compliance with the duty is, in appropriate cases, recorded will be likely to take the trouble to think about the scope of the duty in the first place. He will reflect on the power which he is exercising, do his best to identify the purpose for which it was conferred on him (seeking legal advice where necessary) and exercise it for that purpose alone.
Ultimately, it is for the courts to decide for what purpose any particular power was conferred, and that fact renders section 171(b) one of the more problematic duties from a compliance perspective. There is, however, a good deal a careful director can do to minimise the chances that he will fall foul of it.