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Analysis of the Proper Purpose Rule

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Critical analysis of the proper purpose rule and directors’ duties in light of Eclairs Group Limited v JKX Oil & Gas plc [2015] UKSC 71 (with referencing)

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  • May 26, 2023
  • 12
  • 2022/2023
  • Essay
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Module Name : COMPANY AND COMMERCIAL LAW

QUESTION

“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.”

Eclairs Group Limited v JKX Oil & Gas plc [2015] UKSC 71 [37] (Lord Sumption)

Critically analyse the above statement in light of Directors’ duties. Consider if a stricter
application of the proper purpose rule conflicts with any other directors’ duty codified in
Company Law Act 2006.




INTRODUCTION
In the early part of the 20th century, the courts adopted a stricter standard of care and skill
expected of directors in the performance of their management roles, which subsequently led to
the courts of equity and common law developing a corpus of rules and duties designed to
prevent directors from abusing their considerable powers.1 Following the recommendations
made by the Law Commission and the Company Law Review, the Companies Act (CA) 2006
embodied a statutory restatement of directors’ duties to replace the common law rules and
equity principles with the intention of increasing accessibility, visibility and clarity in this area
of company law. 2


These ‘general duties’ are owed to the company by directors, who are described in Lord
Cranworth LC's classic statement as ‘a body to whom is delegated the duty of managing the
general affairs of the company…[who] have duties to discharge of a fiduciary nature’.3


The proper purpose rule, first formulated by Lord Greene MR in Re Smith & Fawcett Ltd4,
was codified in s171(b) of the 2006 Act and recently received the spotlight in the case of Eclairs



1
Alan Dignam and John Lowry, Company Law (12th edn, OUP) Ch 13.
2
Ibid.
3
Aberdeen Railway Co v Blaikie Brothers 1854 UKHL 1.
4
Re Smith and Fawcett Ltd [1942] Ch 304.

, v JKX (Eclairs Group case) 5 wherein the Supreme Court reaffirmed its fiduciary character,
relevance in enforcing the proper conduct of directors, and its significant role in maintaining
the constitutional balance between the board of directors and the different organs of the
company. This essay will critically analyse how effectively the proper purpose rule achieves
the above two objectives, specifically through the lens of the Supreme Court's ruling in the
Eclairs Group case.


PROPER PURPOSE RULE


CA 2006, s171(b) requires a director to ‘only exercise powers for the purposes for which they
are conferred’ and not for any improper, extraneous or collateral purpose. Where the directors
act for an improper purpose, such acts are voidable at the company’s instance, and the director
in breach may be required to compensate the company for any loss sustained unless the
members ratify the breach of duty. 6


In Eclairs Group, Lord Sumption indicated that ascertaining the purpose of the power depends
on ‘an inference from the mischief of the provision conferring it, which itself is deduced from
its express terms, from an analysis of their effect, and from the court's understanding of the
business context’. 7 The power may be specific (as in Howard Smith8), or general (as in CAS
(Nominees) Ltd v Nottingham Forest9), and the limits of the power will depend upon the
breadth of the power itself.


This duty has been applied in areas as diverse as entering into agreements (Lee Panavision Ltd
v Lee Lighting10) and dealing with company assets (Extrasure Travel Insurances Ltd v
Scattergood [2003] 1 BCLC 59811), but a substantial body of case law reflects the relevance of
the proper purpose rule upon the directors’ powers to issue shares in the context of a takeover
bid as illustrated in the Supreme Court's decision in Eclairs Group.




5
Eclairs Group Ltd v JKX Oil and Gas plc [2015] UKSC 71.
6
Lee Roach, Card and James’ Business Law (4th edn, OUP) Ch 22.
7
(n 5) at [30].
8
Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821.
9
CAS (Nominees) Ltd v Nottingham Forest FC plc [2002] 1 BCLC 613.
10
Lee Panavision Ltd v Lee Lighting Ltd [1992] BCLC 22.
11
Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598.

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