I have the power – but should I use it?
Both private and public companies will soon be required to seek the information needed to set up and maintain their PSC register (register of persons with significant control) and the power to impose restrictions on shares if this information is not forthcoming. (For further information on PSC registers, download our briefing paper.) This new power is similar to the power given to directors of many quoted companies by their articles of association, to place restrictions on shares for failure to comply with statutory disclosure notices seeking information about interests in shares. In both cases, the power is draconian: restrictions will prevent shares being voted or transferred, and no new shares can be issued to that shareholder whilst the restrictions remain in place.
Directors have a duty, codified in the Companies Act 2006, to exercise all their powers only for the purposes for which they are conferred. The scope of this duty in the context of their ability to restrict shares has recently been clarified by the Supreme Court in a judgment of relevance to all directors and shareholders.
The case concerned JKX Oil & Gas plc (JKX) and resolutions proposed at its 2013 annual general meeting to re-elect the chief executive, approve the directors’ remuneration report and empower the board to allot shares for cash, disapply existing shareholders' pre-emption rights on the allotment of shares, and make market purchases of the company’s shares. A minority shareholder, Eclairs Group Ltd, had published an advertisement in the Financial Times and an open letter to shareholders inviting them to oppose the resolutions.
The JKX board believed that Eclairs and another minority shareholder, Glengary Overseas Ltd, were mounting a corporate raid on the company. The board issued statutory disclosure notices under the Companies Act to various people thought to be involved with Eclairs and Glengary, and received responses admitting the existence of interests in the company's shares, but denying any agreement or arrangement between the holders of those interests.
The JKX board thought the responses to the disclosure notices were inadequate, and believed that there were undisclosed agreements or arrangements. It therefore resolved to exercise powers, conferred by the company's articles of association, to impose restrictions on the shares in JKX held by Eclairs and Glengary. As a result, the voting rights attached to the shares were suspended such that those shares could not be voted at the general meeting, when the resolutions were accordingly passed.
Eclairs and Glengary brought court proceedings challenging the restriction notices. They alleged the board had acted for an improper purpose, namely not to compel answers to be provided but to ensure the passing of the resolutions proposed at the annual general meeting.
It was clear that the board had power under the articles to impose restrictions on the shares held by Eclairs and Glengary, if it thought the responses to the disclosure notices were inaccurate. The questions were:
- Did the board have a duty to exercise the power to restrict only for the purpose for which the power had been conferred?
- If so, what was that purpose?
- Finally, had the board exercised the power for that purpose?
In answer to the first question, the Supreme Court concluded that the proper purpose duty was engaged. It overturned the Court of Appeal, which had taken the opposite view.
A power conferred on directors by a company's articles did not have to spell out whether the proper purpose rule applied, nor did a limitation on the exercise of the power have to be implied as a matter of construction of the wording of the articles. To quote Lord Sumption: "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. It is also fundamental to the constitutional distinction between the respective domains of the board and the shareholders."
In relation to the second question, JKX argued that, once the "raiders" had failed to respond adequately to the disclosure notices, the directors' power to impose restrictions on their shares could properly be exercised for the purpose of defeating the raiders' attempt to influence or control the company’s affairs, provided that this was believed in good faith to be in JKX's interests.
The Supreme Court disagreed. The articles conferred a power to impose restrictions on shares where inadequate responses had been received to disclosure notices and provided for those restrictions to be lifted automatically seven days after the information was subsequently supplied. The inescapable inference was that the power to impose restrictions was wholly ancillary to the power to call for information in the disclosure notices.
That power to call for information had three related purposes: to induce the shareholder to comply with the disclosure notice, to impose punitive sanctions on the shareholder while it was in default, and to protect the company and its shareholders against having to make decisions about their interests in ignorance of relevant information. These three purposes were all directly related to the non-provision of information requisitioned by a disclosure notice.
None of these proper purposes for imposing restrictions extended to influencing the outcome of resolutions at a general meeting. Since the primary purpose of the JKX board in imposing the restrictions on the shares held by Eclairs and Glengary had been to do precisely that, the restriction notices were set aside.
Of course, it is sometimes the case that the power to restrict is exercised for "dual" reasons – to compel answers to be produced, and to prevent those shares being voted or transferred. The Supreme Court recognised this, and some of the judges expressed the view that where there were several concurrent purposes, what mattered was the particular purpose without which the decision to restrict would not have been made: if that purpose was improper, the decision is ineffective.
JKX is now facing further shareholder action in the form of a requisition of a general meeting by another significant minority shareholder which wishes to reshape the company's board.
This case reinforces the obvious points that minutes of directors' meetings when a decision to restrict shares is taken should be both careful and accurate, and that all directors should be advised at the earliest opportunity of the nature, purpose, and effect of the restriction process so that they can conduct themselves accordingly.
A decision to restrict shares may also be more likely to be viewed as being for a proper purpose if it is part of a regular process undertaken by the company to obtain relevant information about its shareholder base and is not connected to any particular shareholder meeting or resolutions.
The case is also a broader reminder to directors that they exercise their powers in relation to the company as fiduciaries, and must be careful to base their decisions only on relevant considerations. The JKX directors had failed to do this in deciding to impose the restrictions on the shares held by Eclairs and Glengary and, despite the genuineness of their desire to benefit the company as a whole in so doing, they had not used their powers for a proper purpose.