The directors of JKX Oil & Gas plc suspected that two shareholders, Eclairs Group Ltd and Glengary Overseas Ltd, were planning to destabilise the company and carry out a corporate raid. Eclairs had blocked JKX's proposals to raise capital and sought to remove its chief executive and commercial director. The JKX board issued disclosure notices under section 793 of the Companies Act 2006 to Eclairs and Glengary, requesting information about the beneficial owners of the shares that they held (see box "Disclosure and restriction notices").

Article 42 of JKX's articles of association gave the directors the power to impose restrictions on the exercise of rights attaching to shares where there was reasonable cause to believe that the information provided was false or materially incorrect. Unsatisfied with the responses to the disclosure notices, and after Eclairs publicly urged shareholders to oppose resolutions at the upcoming AGM, the directors resolved to issue restriction notices on Eclairs and Glengary that would suspend their voting rights.

Eclairs and Glengary successfully challenged the restriction notices in the High Court on the basis that they were imposed for the improper purpose of preventing the shareholders from voting at the AGM ([2013] EWHC 2631 (Ch)). However, the Court of Appeal disagreed, finding that the proper purpose rule had no application in this context ([2014] EWCA Civ 640). The Supreme Court reinstated the High Court ruling, finding that the directors' predominant purpose was the improper one of preventing the resolutions from being blocked at the AGM rather than the proper purpose of making Eclairs and Glengary produce the information requested in the disclosure notices.

The proper purpose rule is an equitable principle that is codified in section 171(1)(b) of the Companies Act 2006 and provides that a director must only exercise powers for the purposes for which they were conferred. The Supreme Court in Eclairs emphasised that the rule is concerned with an abuse of power rather than an excess of power; that is, acts that are within the scope of a power but which are done for an improper reason. Therefore, the test is subjective.

Article 42 of JKX's articles of association had three proper purposes:

These inter-related purposes all related directly to the non-provision of the information requested in the disclosure notices. They did not extend to influencing the outcome of shareholder resolutions. The court found that although the directors genuinely wanted to obtain the information requested, once it was clear that the information would not be provided, their primary purpose in imposing the restrictions was to affect the outcome of the upcoming AGM. As the only consideration that influenced the board's decision was an improper one, the decision could not be sustained. Although a restriction notice might affect the outcome of shareholder resolutions, that consequence is not part of its proper purpose.

Disagreeing with the Court of Appeal's conclusion that the proper purpose rule should have no application in these circumstances, the court said that a battle over the control of a company is the very situation in which the proper purpose rule has the most valuable part to play. The ability of directors to impose restriction notices is a draconian power, which should be limited by something more than the directors' duty to act in the company's interests.

The court also gave short shrift to the argument that the power to impose restrictions is not a unilateral power, in that the recipients of the notice merely need to provide the information requested in order to bring the restrictions to an end. It is not always straightforward to establish the existence of an interest in shares or an alleged failure to disclose a relevant agreement or arrangement. In addition, the proper purpose rule is fiduciary in character, so any abuse of it cannot be remedied by asserting that the person against whom it is directed only has himself to blame.

When a board exercises a power, it may not have only one single purpose in doing so. The court considered how the proper purpose rule should apply where directors have a mixture of purposes, some of which are proper purposes and others are not. Lord Sumption, with whom Lord Hodge agreed, concluded that the focus must be on whether the decision would have been made if the directors had not been moved by the improper purpose; in effect, a "but for" test. However, as this was not subject to full argument, the remainder of the court preferred not to come to a conclusion at this stage, although there was some sympathy with Lord Sumption's view on the "but for" test.

The decision gives helpful guidance on the three proper purposes for which directors may impose sanctions for non-compliance with section 793 disclosure notices. It also sends a clear message to directors that it is not enough to act within the express terms of a power and to act honestly and in a genuine attempt to promote the success of the company. Directors must be very careful to ensure that they have identified the proper purpose for which a power is given before exercising it, and that they exercise the power predominantly for that purpose. Directors also need to understand the sometimes subtle difference between the purpose of a power and its incidental consequences. The court noted that this will call for directors to take particular care and, in some circumstances, may require legal advice.

The subjective nature of the proper purpose test also creates uncertainty, as it means that board decisions may be open to challenge even where there is no suggestion of bad faith. The practical consequences of needing to examine the subjective motives of each director are significant, as illustrated by the High Court in Eclairs having to cross-examine six of the directors and running out of time to question the seventh. To reduce this risk, directors should be advised to look at the purpose of a power separately from the company's interests, and record their decision-making process in writing.

While Eclairs concerned a public company, it will also be relevant to private companies when new provisions to maintain a register of people with significant control come into force, currently planned for April 2016, along with the proposed ability for private companies to apply restrictions on shares for non-compliance with a disclosure notice (see News brief "Small Business, Enterprise and Employment Act 2015: changes and challenges").