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Proper Purpose Test clarified by the Supreme Court

09 December 2015

It is often thought that the court will not interfere with decisions of directors which are within the range of decisions which directors could, acting reasonably, make. However, the new decision of the Supreme Court in Eclairs Group Ltd (Appellant) v JKX Oil & Gas plc (Respondent); Glengary Overseas Ltd (Appellant) v JKX Oil & Gas plc (Respondent), reminds us that directors must, in reaching their decision, not subjectively act for an improper purpose.

In this case, JKX issued notices to each Appellant under sections 793-797 Companies Act 2006 (the Act) calling for information about persons interested in its shares, and received responses. However, when one of the Appellants, Eclairs, subsequently publicly invited shareholders to oppose resolutions at JKX’s AGM (including those for re-election of certain directors), the board considered that agreements or arrangements existed between the addressees of the disclosure notices which had not been included in the responses. The board resolved to issue notices pursuant to article 42 of its Articles, to suspend the right to vote and to restrict transfers of the shares held by each of the Appellants.

At first instance, the Appellants were successful in arguing that the directors had not complied with their duty under section 171 (b) of the Act. Broadly, this section requires directors to “only exercise powers for the purposes for which they are conferred” (the so-called “proper purposes rule”) and in this case it was held that the purpose was to influence the result of the relevant resolutions.  The Court of Appeal reversed this by majority.

The Supreme Court allowed the appeals, holding that the rule applied to the exercise of the power under article 42 and that the directors of JKX had acted for an improper purpose. All five Supreme Court judges agreed on this conclusion. The rule was said to be the principal means by which equity enforces directors’ proper conduct and is fundamental to the distinction between boards and shareholders. A “but for” test proposed by two of the judges, that where directors have more than one purpose, the relevant purposes are those but for which the decision would not have been made (so that if the relevant purposes are improper, the decision will be ineffective) was expressly not endorsed (or rejected) by the remaining three.

You can read the full judgment of the Supreme Court in Eclairs Group Ltd (Appellant) v JKX Oil & Gas plc (Respondent); Glengary Overseas Ltd (Appellant) v JKX Oil & Gas plc (Respondent) [2015] UKSC 71 on the Supreme Court's website.

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