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The “proper purpose” rule

On 2 December 2015, the Supreme Court gave judgment in Eclairs Group Ltd v JKX Oil & Gas plc and Glengary Overseas Ltd v JKX Oil & Gas plc [2015] UKSC 71.

Section 793 of the Companies Act 2006 allows a company to serve a statutory notice on a person calling for information about that person's interests in the company’s shares. JKX has in its articles (Article 42) provisions empowering the board in certain circumstances to impose restrictions to the exercise of rights attaching to shares if the recipient fails to comply with the notice.

In 2013, the directors of JKX perceived that it had become the target of a “corporate raid” by two minority shareholders, Eclairs and Glengary. JKX issued disclosure notices requesting information. The responses admitted the existence of interests in the shares but denied that there was any agreement or arrangement. Subsequently the JKX board considered that there were agreements or arrangements between the addressees of the disclosure notices which had not been disclosed in the responses. It resolved to exercise the powers under article 42 to issue restriction notices affecting Eclairs and Glengary, suspending their right to vote at general meetings and restricting the right of transfer. The recipients challenged the restriction notices, relying on the proper purpose rule at s.171(b) of the Companies Act 2006.

The Supreme Court (Lord Sumption giving the leading judgment) allowed the appeals, holding that the proper purpose rule applies to the exercise of the power under article 42, and that the directors of JKX acted for an improper purpose. Under article 42 in this case, the power to restrict the rights attaching to shares is ancillary to the statutory power to call for information under s 793. Article 42 has three closely related purposes: (i) to induce a shareholder to comply with a disclosure notice; (ii) to protect the company and its shareholders against having to make decisions about their respective interests in ignorance of relevant information; and (iii) as a punitive sanction for a failure to comply with a disclosure notice. Seeking to influence the outcome of shareholders’ resolutions or the company’s general meetings is no part of those proper purposes.

The proper purpose rule is the principal means by which equity enforces directors’ proper conduct, and is fundamental to the constitutional distinction between board and shareholder.

Lord Sumption and Lord Hodge considered that where the directors have multiple concurrent purposes, the relevant purpose or purposes are those without which the decision would not have been made. If that purpose or those purposes are improper, the decision is ineffective.

Matthew Winn-Smith / 11th Feb 2016


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