Analysis of Directors' Duties, Success, and Proper Purpose: Law Essay

This essay provides a detailed analysis of the duties of company directors, primarily focusing on the legal framework established by the Companies Act 2006. It explores the classic formulation of directors' duties, emphasizing the need to act in good faith and in the best interests of the company, as highlighted in cases like Re Smith and Fawcett and Dorchester Finance Co Ltd v Stebbing. The essay delves into the key provisions of the CA 2006, particularly section 172, which mandates directors to promote the success of the company, considering factors such as long-term consequences, employee and customer relationships, and community impact. The analysis also examines the 'proper purpose rule' as codified in section 171(b) of the CA 2006, with a detailed discussion of the landmark case Eclairs Group v JKX Oil and Gas Plc, where the Supreme Court clarified the scope and application of this rule. The essay critically evaluates the subjective nature of good faith, the challenges in measuring company success, and the potential conflicts directors face when balancing various factors. The essay concludes by highlighting the complexities and uncertainties surrounding the application of the proper purpose test, particularly in cases of mixed purposes, and the ongoing debate about the appropriate legal tests to be applied in such situations, referencing various academic journals and legal scholars.

The classic formulation of director’s duties is found in the statement of Lord Greene
MR in Re Smith and Fawcett1 that directors must exercise their discretion bona fide
in what they consider is in the interests of the company, and not for any other
collateral purposes. It also means that directors are to exercise their powers with a
reasonable standard of skill and care in order to discharge their duties to the
company (Dorchester Finance Co Ltd v Stebbing, 1989)2. In section 172 of the
Companies Act 20063 (CA) it is stated that a director’s duty is to promote the
success of the company. This section states that a director of a company must act in
the way he considers, in good faith, would be most likely to promote the success of
the company for the benefit of its members. We will also be discussing the case
Eclairs Group v JKX Oil and Gas Plc4.
The general duties of directors are now provided in section 171 to 177 of the
Companies Act 20065 (CA). In the CA 2006 in section 171 (b)6 the proper purpose
rule is stated and this rule states that a director must only exercise powers for the
purposes for which they are conferred. This is known as the proper purpose rule, this
rule is an equitable principle that is codified in section 171 (b) of the CA 20067. The
director’s duty to act within powers is stated in s.171 CA 20068. Section 171 of the
CA 20069 states that directors are required to act in accordance with the company’s
constitution, and only exercise powers for the purposes for which they are conferred,
1 [1942] Ch 304
2 [1989] BCLC 498
3 S.172 Companies Act 2006
4 [2015] UKSC 71
5 S.171, S.177 Companies Act 2006
6 S.171 (b) Companies Act 2006
7 S.171 (b) Companies Act 2006
8 S.171 Companies Act 2006
9 S.171 Companies Act 2006

which is to say, in simple terms, that directors are required to advance the objectives
of the company, not their own agenda.
In addition to the two key considerations under section 172 of the CA 200610 namely
(a) good faith, and (b) success of the company, directors also pay attention to
several other factors including (i) long term consequences of their decisions, (ii)
relationships with employees, (iii) customers relationships, (iv) community and
environmental factors, (v) maintaining high standard of business conduct, and (vi)
fair and equal treatment with the shareholders. However, the parliament gave
emphasis on the duty of success. This new pragmatic approach that the directors
would do whatever they consider is best for the company and its success thus
bringing the company interest in line with the shareholders. In Re West Coast Capital
(LIOS) Ltd11 and Cobden Investment Ltd v RWM Langport Ltd12 the court held that
the codification did little more than just setting out pre-existing common law. We will
now consider the two key considerations.
Directors are required to act in good faith. In this section I will discuss Jonathan
Parker J’s judgement in Regentcrest plc v Cohen13, Jonathan Parker J held that if the
directors acted bona-fide for the company and gave unequivocal evidence that they
honestly believed that they acted in the best interests of the company then there
would be no breach14. In other word the court applied subjective test. In Cobden
Investments Ltd v RWM Langport Ltd15 to explore the true meaning of the term “good
faith” and held that the duty in s.172 of the CA 200616 was subjective17. This means
10 S.172 Companies Act 2006
11 [2008] CSOH 72
12 [2008] EWHC 2810 (Ch)
13 [2001] 2 BCLC 80
14 HC Standing Committee D, Fifteen Sitting, 11th July 2006, Cols 591-593
15 [2008] EWHC 2810 (Ch)
16 S.172 Companies Act 2006
17 [1942] Ch 304

that if the directors act in good faith but unreasonably, they will not be liable for
breach.
The second key consideration is the director’s duty to promote the success of the
company. However, this is a vague term like its predecessor common law term of
“best interest”18. The confederation of British industry was also concern about the
mechanism to measure success19. The government intention was to leave it to the
director’s good faith judgement. But the difficulty is that whatever a director has done
to promote success, could not be impugned until it was proved that he did not have
good faith belief in his approach. Lord Goldsmith in an address to the House of Lords
said that success would entail long-term increase in value20.
There is a list of factors directors must consider in order to discharge their duties.
Margaret Hodge MP made it clear in the House of Commons that directors do not
need to consider the factors if in conflicts with the overriding interest of promoting the
company’s success21. It is argued that if directors considered the interest of the
stakeholders such as workers, customers, it would contribute to the prospect of the
company.
However, directors may face several problems when they consider the factors set
out in section 172 (1) CA 200622. First, how directors should respond when there are
conflicts between the factors. Perhaps they should dismiss them for overall success
of the company. Second, what directors should do when there are conflicts between
the factors and the interests of the members. Third, what weight directors should
attach on each of the factors and whether balancing act is required when favouring
18 J Edelman, “When Do Fiduciary Duties Arise?” (2010) 126 LQR 302 at 322.
19 The Confederation of British Industry’s submission to DTI. June 2005 at 25.
20 Lord Grand Committee, 6th February 2006, column 256.
21 HC Standing Committee D, Fifteen Sitting, 11th July 2006, Cols 591-593
22 S.172 (1) Companies Act 2006

one of the factors would promote success of the company. Some fear that directors
may investigate account in their own interest while exercising balancing act. We
have seen time and again that when directors acted in good faith, the court would
not question director’s action. Perhaps directors will take into consideration interests
of the stakeholders to promote success of the company so long it benefits the
shareholders as well23.
It is not only the duty of the director to act within the scope of its power, but also
exercise the power for “proper purpose”. The proper purpose rule is codified in
section 171 (b) of the Companies Act 200624 (CA). The case of Eclairs Group Ltd v
JKX Oil and Gas Plc25 is a leading case in the proper purpose test.
The directors of JKX Oil, the respondent of this case, perceived that the company
had become the target of “corporate raids” by its shareholders, Eclairs and Glengary,
the appellant of this case. Therefore, the directors issued disclosure notices, a power
conferred by the Article 42 of the constitution of JKX Oil and Gas Plc26. The directors,
believed that the information from the shareholders is incorrect, restricted the
shareholder’s voting rights in the Annual General Meeting also prevented the
shareholders from influencing the outcome of the meeting27. The appellant sought
that the respondent was exercising its power for an improper purpose.
In the High Court, the court ruled in the appellant’s favour, ruling that the respondent
exercised the power for an improper purpose28. In the Court of Appeal, the court
ruled that the proper purpose test was not applicable because the respondents can
23 Andrew R. Keay, “The Duty to Promote the Success of the Company: Is it Fit for Purpose?
24 S.171 (b) Companies Act 2006
25 [2015] UKSC 71
26 S.793-797 of The Companies Act 2006
27 Article 42 provided the directors power to restrict voting rights.
28 Eclairs Group Ltd v JKX Oil & Gas Plc [2013] EWHC 2631 (Ch)

avoid the restriction by complying the disclosure notices29. The Court of Appeal
distinguished it from the case of Howard Smith Ltd v Ampol Petroleum Ltd30 and
ruled that the proper purpose rule was not applicable to non-unilateral power while
applying the proper purpose rule will undermine the power of the company’s
statutory instrument31. The appellant appealed to the Supreme Court on the grounds
that the proper purpose test was applicable.
The Supreme Court allowed the appeal and dismissed the restrictions. The Supreme
Court discussed three issues. First, is the proper purpose rule applicable to the
case? According to Lord Sumption, there were no authority in relation to the
distinction between unilateral and non-unilateral power. Furthermore, he noted that
there was imbalance of power32. Lord Sumption clarified that the proper purpose rule
is an equitable principle that control the exercise of a fiduciary’s powers33. On
contrary to the Court of Appeal’s judgment, Lord Sumption noted that proper purpose
rule was applicable in the situation of a battle for control of the company because the
directors will tend to use their powers to take control of the company34. Second,
identifying the proper purpose. Even though the purpose of a power was rarely
expressed, as it was obvious from the context. By examining the context of the
Article 42, the court was able to identify three purposes of the provision while none of
the three purposes involved influencing of the meeting35. Therefore, the court ruled
that the respondent’s purpose was improper. The third is about obiter, mixed
purposes. Lord Sumption suggested an alternative “but for” test instead of the
29 Eclairs Group Ltd v JKX Oil & Gas Plc [2014] EWCA Civ 640
30 [1974] AC 821
31 Eclairs (n5) [142]
32 Eclairs (n1) [39]
33 Eclairs (n1) [30]
34 Eclairs (n1) [37]
35 Eclairs (n1) [32]

“weightiest” purpose test. According to Lord Sumption, a new “but for” test is a
simpler test while also in accordance to the substantial purpose test in Howard
Smith36. However, other judges refused to give conclusion as it is not the subject of
full argument and consideration37.
In the situation of mixed purposes, it is unjust to apply subjective test on a director’s
decision-making process as different individual will make different decision in the
same situation. There will always be a proper purpose behind every decision if the
director is acting within its power and vice versa. As pointed out by Worthington, if
the directors emphasised on their proper purposes, the court might be unable to
prove the improper purpose in the case38. Moreover, it is worth noting that the but for
test may not be applicable in come circumstances. By applying the but for test in the
Eclairs, the directors might still issue the restriction without the improper purpose.
According to Pollard, the causation test will eventually lead to a defence if the
directors were able to prove that they would have reached the decision regardless of
the improper purpose39. In this case, although the directors are in breach of section
171 (b) of the CA 2006, it can be argued that they are fulfilling their duties under
section 172 of the CA 2006 which is to promote the success of the company. When
both duties are overlapping, the court clearly took favour of section 171 (b) over
section 172. The court also emphasised that the shareholders are entitled to act in
their personal interest40. Furthermore, the court did not give a clear interpretation of
the section 171 (b) of the CA 2006. In the case of mixed purposes, a narrow
interpretation of section 171 (b) will prevent directors from exercising power with
36 Eclairs (n1) [23-24]
37 Eclairs (n1) [46]
38 Sarah Worthington, ‘Directors’ Duties and Improper Purposes’ (2016) 75 Cambridge LJ 213, 214
39 David Pollard, ‘Exercising powers; proper purposes rather than best interests: fiduciaries and
Eclairs’ (2016) 30 (2) Tru. L.I. 71, 97.
40 Eclairs (n1) [40], See also Extrasure Travel Insurance Ltd v Scattergood [2003] 1 BCLC 598

mixed purposes. Subsequently, this will further restrict the director’s autonomy. As
pointed out by Nolan, it is likely that section 171 (b) allow mixed purposes as it was
meant to codify the existing law41. Unfortunately, the court created uncertainty as the
court did not decide on a single applicable test on mixed purposes.
In this case, the Supreme Court reaffirmed the principle of proper purpose rule. The
Supreme Court clarified the scope of proper purpose rule and provided further
guidance for the proper purpose test. It is for the future court to decide which mixed
purposed test will be adapted.
Word: 1792
Bibliography:
Books:
Davies P and others, Gower’s Principles of Modern Company
McLaughlin S, Unlocking Company Law (2018)
Kershaw D, Company Law in Context (Oxford University Press 2012)
41 Richard Nolan, ‘Proper Purposes in the Supreme Court’ (2016) 132 LQR 369, 371

Journals:
Andrew R. Keay, “The Duty to Promote the Success of the Company: Is it Fit for
Purpose?
David Pollard, ‘Exercising Powers: proper purposes rather than best interests:
fiduciaries and Eclairs’ (2016) 30 (2) Tru. L.I. 71.
J Edelman, “When Do Fiduciary Duties Arise?” (2010) 126 LQR 302 at 322.
Richard Nolan, ‘Proper Purposes in the Supreme Court’ (2016) 132 LQR 369.
Sarah Worthington, ‘Directors’ Duties and Improper Purposes’ (2016) 75 Cambridge
LJ 213
The Confederation of British Industry’s submission to DTI. June 2005 at 25.
Legislations:
S.171, S.177 Companies Act 2006
S.171 (b) Companies Act 2006
S.171 Companies Act 2006
S.172 Companies Act 2006
S.172 (1) Companies Act 2006
S.793-S.797 of The Companies Act 2006
Article 42 provided the directors power to restrict voting rights.
HC Standing Committee D, Fifteen Sitting, 11th July 2006, Cols 591-593
HC Standing Committee D, Fifteen Sitting, 11th July 2006, Cols 591-593
Lord Grand Committee, 6th February 2006, column 256
Cases:
Cobden Investments Ltd v RWM Langport Ltd and others [2008] EWHC 2810 (Ch)
Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498
Eclairs Group Ltd v JKX Oil & Gas Plc [2013] EWHC 2631(Ch)
Eclairs Group Ltd v JKX Oil & Gas Plc [2014] EWCA Civ 640
Eclairs Group Ltd v JKX Oil & Gas Plc [2015] UKSC 71
Extrasure Travel Insurance Ltd v Scattergood [2003] 1 BCLC 598
Eclairs Group Ltd v JKX Oil and Gas plc [2015] UKSC 71
Howard Smith Ltd v Ampol Petroleum [1974] AC 821
Regentcrest plc v Cohen [2001] 2 BCLC 80
Re Smith and Fawcett Ltd [1942] Ch 304
Re West Coast Capital (LIOS) Ltd [2008] CSOH 72