Corporate raids and proper purposes
A recent decision of the Supreme Court is a useful reminder of the purposes for which directors must exercise their powers.
A recent decision of the Supreme Court is a useful reminder of the purposes for which directors must exercise their powers, whether these are created by the company’s constitution or by corporate legislation.
Although the company in question was a public company, there are implications for directors of all companies. We start by putting the decision in context.
The statutory right to investigate shareholdings and the "proper purpose"
Public companies have a statutory right to investigate the identity of their shareholders under s.793 of the Companies Act 2006 (the "Act"). The right enables a company to send a notice asking for details of a person’s interest in its shares and details of any other interest of which that person is aware (a "s.793 notice").
If a recipient of a s.793 notice fails to comply with it, the company may apply to the court for an order that the shares in question be made subject to restrictions. These restrictions are prescribed by the Act but a company may, as in the JKX cases below, set out the restrictions in their articles of association, to preclude the need to apply to court. It is then for the directors to exercise their power to impose such restrictions. In doing so, as with any exercise of their powers as directors, they are bound to comply with s.171(b) of the Act which provides that they must "only exercise powers for the purposes for which they are conferred".
Eclairs Group Ltd v JKX Oil & Gas plc and Glengary Overseas Ltd v JKX Oil & Gas plc
JKX Oil & Gas plc ("JKX") is a public company listed on the London Stock Exchange, and the parent company of a group whose business is the development and exploitation of oil and gas reserves, primarily in Russia and the Ukraine. Its articles of association empowered the board of directors to impose restrictions on shares without applying to court if it knew or had reasonable cause to believe that the information provided in response to a s.793 notice was false or materially incorrect.
The directors of JKX suspected that Eclairs Group Ltd ("Eclairs") and Glengary Overseas Ltd ("Glengary"), companies owning 27.55% and 11.45% of JKX and controlled by respectively two Ukrainian businessmen and a Russian businessman, with reputations as corporate raiders, were conspiring to use their minority shareholding to obtain voting control without paying what other shareholders would regard as a proper price – commonly referred to as a corporate raid.
The directors issued s.793 notices and, determining that the information given in response was inaccurate or incomplete, exercised the power in the articles of association to impose voting restrictions on the shares held by Eclairs and Glengary. This would prevent them from attending or voting at shareholder meetings. JKC had an upcoming AGM at which resolutions could be blocked by Eclairs and Glengary if they attended and voted against.
Eclairs and Glengary brought a claim against JKX, alleging that the directors had used their powers under s.793 for an improper purpose. The High Court agreed with the claimants, finding that the s.793 notices had not been issued solely to find out information about shareholdings but at least partly with the aim of preventing the two shareholders from attending and voting at meetings.
JKX appealed successfully to the Court of Appeal, which held that the purpose of the restrictions was immaterial as it was within the shareholders’ control to lift the restrictions by providing the information requested in the s.793 notices.
Eclairs and Glengary appealed to the Supreme Court, which reversed the Court of Appeal decision. It found unanimously that directors must always exercise their powers for a ‘proper purpose’, being the reason for which the powers were given.
The Supreme Court gave three valid reasons for exercising the directors’ power in the articles to impose restrictions on shareholders following an incomplete or inaccurate response to a s.793 application. These were:
- To induce the defaulting shareholders to provide the information;
- To protect the company and its shareholders from making decisions before the information was provided; and
- As a punishment for failing to provide the information requested.
None of these reasons extended to influencing the outcome of a resolution at a general meeting. Although this may be a consequence of serving a restriction notice, it was no part of its proper purpose. Once satisfied that the information requested had not been provided, a majority of the JKX board was interested only in the effect that the restriction notices would have on the outcome of the forthcoming general meeting.
As the Supreme Court found that the powers had been used at least partly in order to prevent Glengary and Eclairs from attending and voting at a meeting, it decided that the restriction had not been imposed for a proper purpose and should be set aside. The Court emphasised that directors were under a strict duty to act in accordance with their statutory powers. Lord Sumption was clearly influenced by the importance of maintaining the balance of power between directors (who owe a duty of loyalty to the company) and shareholders (who do not).
Acting within powers
This case informs us that directors may impose sanctions for non-compliance with s.793 notices only for the three purposes set out by the Supreme Court.
The broader message, however, is that directors should always ensure that they are acting within their powers, and should not exercise any power for a reason other than that envisaged when the power was created.
It is good board practice for directors to ensure that they properly reflect upon the reasons for, and implications of, taking actions or steps and maintain a record of their decision-making process.
If you are interested in finding out more about directors’ responsibilities or any other corporate issue, please contact Victoria Robertson, an Associate in the Corporate department, on 0113 213 4107 or email email@example.com.