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Law for Business

Knowhow - guidance - precedents

08 MAR 2016

Directors’ duties – the duty to exercise powers for a proper purpose

Directors’ duties – the duty to exercise powers for a proper purpose

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:

  • JKX Oil & Gas plc was a listed company
  • Eclairs Group Ltd and Glengary Overseas Ltd beneficially owned large minority stakes in the company.
  • Eclairs Group Ltd was, in effect, owned by a Mr Kolomoisky and an associate of his. In the High Court, the judge described Mr Kolomoisky as having the reputation of being a “corporate raider” (that is, a shareholder who uses his minority stake - possibly in a disruptive way - with a view to acquiring control of the company at a discount).
  • Amidst concerns on the part of at least some of JKX’s directors that Eclairs might be trying to work with other shareholders to gain control of the company, the company issued section 793 notices (notices requiring information about interests in the company’s shares) to various parties, including Eclairs and Glengary. The notices asked the recipients to disclose information about any agreements they had entered into concerning the exercise of voting rights in the company.
  • The directors of JKX held a board meeting at which they concluded that they had cause to believe that the responses to the section 793 notices, which were to the effect that there were no agreements between Eclairs, Glengary or the individuals behind those companies, were incorrect. The articles of association of JKX gave the board the power to issue to a shareholder who had failed to comply with a section 793 notice to the board’s satisfaction a “restriction notice” preventing him from voting at general meetings, and the directors proceeded to exercise that power by issuing restriction notices to the holders of the shares which were beneficially owned by Eclairs and Glengary.
  • The board minutes recorded the fact that the directors felt that the issue of the restriction notices would promote the company’s success, but were, it seems, silent as to the purpose for which they were being issued.
  • Eclairs and Glengary challenged the restriction notices on the ground that the directors, in issuing them, had acted for an improper purpose, namely to affect voting control within the company and ensure that resolutions at an upcoming AGM were passed.

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 ([2013] 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 ([2014] 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 ([2015] 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.

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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 first step is to check whether the source of the power provides any instructions or guidance. For example, do the articles, when conferring a power, set out the purpose for which it is being conferred? If, as will often be the case, the source of the power does not provide express instructions as to its use, the director should consider what the provision in question is seeking to achieve, and in doing so he should reflect not only on the express terms of the provision, but also on the surrounding business context. Lord Sumption described the procedure to be followed in the following terms in his judgment in JKX: “Ascertaining the purpose of a power where the instrument is silent depends on an inference from the mischief of the provision conferring it, which is itself deduced from its express terms, from an analysis of their effect, and from the court’s understanding of the business context.”
  • If the source does not provide a satisfactory answer, the next step is to check whether any help can be gleaned from case law. The power to allot shares, for example, has been examined at great length by the courts over many decades, and it is clear that directors should normally exercise it only in order to raise money for the company, and certainly should not exercise it in order to alter the constitutional balance of the company. Thus, a board which is having difficulties with the majority shareholder will not be permitted to allot shares to another, supportive shareholder in order to reduce the former’s influence. Even if there has not been a case directly concerning the power in question, general guidance from the decisions on the duty – for example, that a power must not be exercised in the director’s self-interest – may be of assistance.
  • An important point to bear in mind is that some powers are conferred for no purpose other than that the directors should use them in what they believe are the company’s interests, and a director will comply with his duty under section 171(b) in respect of such powers if he exercises them for the company’s benefit. Briggs LJ’s dissenting judgement in the Court of Appeal in JKX suggests that “purely managerial powers, concerned with the planning and conduct of the company’s business” will normally fall within this category. Presumably, therefore, a director who exercises a power to purchase a particular asset for the company’s business, say, will normally comply with his duty under section 171(b) as long as he believes that the acquisition will benefit the company. This is not to say, however, that a director who acts in his company’s interests will always be in compliance with section 171(b). To return to the example in the bullet point above, a director who allots shares in order to alter the balance of power amongst the shareholders will be in breach of section 171(b) even if he was genuinely convinced that the allotment was in the company’s interests. The question in each case is whether the particular power under consideration was conferred for a specific purpose in addition to the default underlying purpose of serving the company’s interests.

Recording compliance

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.