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  • Kemp Little specialises in the technology and digital media sectors and provides a range of legal services that are crucial to fast-moving, innovative businesses.Our blend of sector awareness, technical excellence and responsiveness, means we are regularly ranked as a leading firm by directories such as Legal 500, Chambers and PLC Which Lawyer. Our practice areas cover a wide range of legal issues and advice.
  • Our Commercial Technology team has established itself as one of the strongest in the UK. We are ranked in Legal 500, Chambers & Partners and PLC Which Lawyer, with four of our partners recommended.
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Corporate raids and the proper purpose test

JKX Oil & Gas Plc (“JKX”) is an English company listed on the London Stock Exchange. In 2013, the directors of JKX believed that two British Virgin Island companies, Eclairs and Glengary, who together held 39% in JKX, were mounting a “corporate raid” on JKX - an attempt to exploit a minority shareholding in a company to obtain effective management or voting control without paying what other shareholders would regard as a proper price (Mann J).

Public companies have a statutory right under the Companies Act 2006 (the “Act”) to investigate the identity of their shareholders and can issue a notice (“Notice”) pursuant to section 793 of the Act to any person whom it knows, or has reasonable cause to believe, is interested in its shares, requiring that person to provide certain information about that person’s interests. The information requested can include information about agreements relating to the exercise of the rights attached to the shares.  The Act also entitles the company to seek to have restrictions imposed by the Court on any person who fails to comply with such a Notice. It is common for listed companies to supplement this statutory right in their articles, granting the board specific powers to impose restrictions similar to those available under the Act where a Notice has not been complied with, without applying to court. Article 42 of JKX’s articles of association provided that the board of directors could impose restrictions on shares if “they knew or had reasonable cause to believe that the information provided in response to a Notice was false or materially incorrect”.

In response to the corporate raid, JKX's directors served Notices seeking disclosure of information on Eclairs and Glengary and the persons connected with them in advance of its AGM. Responses were given to the Notices but the JKX board of directors determined that the responses were materially incorrect (believing that there were undisclosed agreements) and imposed restrictions on the voting of the shares held by Eclairs and Glengary on 3 June 2013, two days before the AGM, preventing Eclairs and Glengary from voting at the AGM. The issue in this case is that Eclairs and Glengary had previously given notice that they intended to oppose certain resolutions being proposed at the AGM, namely the re-election of certain directors and the raising of capital by the issue and allotment of shares. If Eclairs and Glengary could have voted, the resolutions would have failed, but without them, they were likely to be passed.  Whilst the directors used a power (restricting voting on shares) that they had available to them in JKX’s constitution, they were using this power for the purpose of ensuring the AGM resolutions were successful. 

Eclairs and Glengary brought court proceedings seeking to have their suspensions declared unlawful.  They alleged the board had acted for an improper purpose: not to compel answers about the shareholdings but to ensure the passing of the resolutions proposed at the AGM. In the High Court, the claimants were successful in having the voting restrictions imposed under Article 42 set aside on the basis that the directors of JKX had breached the “proper purpose” test, which is set out in section 171(b) of the Act: a director of a company must “only exercise powers for the purposes for which they are conferred”. They had acted for an improper purpose and not for the purpose for which the power to impose them had been vested. It made no difference that the directors had honestly believed themselves to be acting in the Company’s best interests (to fend off a corporate raid).

JKX successfully overturned this decision on appeal. The Court of Appeal took the view that the application of the proper purpose test was inappropriate in the context of Notices under the Act, or by extension, article 42, as it was within the shareholders’ control to lift the restrictions by providing the information requested.

On appeal to the Supreme Court, the decision of the High Court was restored. The Supreme Court unanimously found that directors who exercise powers contained in the company’s articles to impose restrictions on shareholders for non-compliance with a Notice must do so for the “proper purpose”. The proper purpose is the reason for which that power was conferred on the directors.  The Supreme Court found that the majority of JKX’s directors had acted with the purpose of preventing Eclairs and Glengary from voting at the AGM and the restrictions were set aside. The Supreme Court considered that the proper purpose rule was particularly important in the context of a corporate raid so as to preserve the balance of powers between the board of directors and the shareholders.

The courts did not rule on what the outcome would be if the directors had exercised a power for more than one purpose. Two of the five Supreme Court judges proposed a “but for” test i.e. 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. However, this test was expressly not endorsed by the other three judges.

The decision in this case highlights that directors must act with caution when they are exercising their powers, whether these are created by the company’s constitution or by legislation - they have a strict duty to act in accordance with their statutory powers and should not exercise any power for a reason other than that envisaged when the power was conferred thereby satisfying the proper purposes test. Identifying the “purpose” for which a power is actually being exercised is difficult and this case is likely to create uncertainty: it is a subjective test; board resolutions may not be unanimous; directors may have different purposes; and company articles do not usually express the purpose for which any power is given. A detailed record of the reasons for, and implications of, taking actions or steps for which the powers have been exercised is advisable.

This decision will be relevant to directors of both private and public companies when the “people with significant control” (“PSC”) regime comes into force. Under the PSC regime, companies will be required to seek the information needed to set up and maintain their PSC register and will have the statutory power to impose restrictions on shares on any person who fails to provide the required information. Any board which seeks to issue restrictions notices under the PSC regime will need to consider whether they are making that decision for a proper purpose.

For further information, please contact Deborah Angel.

The article above, current at the dates of publication, is for reference purposes only.It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.