Veto rights in contracts: can they be exercised freely?


Author: Jamie Hamilton


Parties to commercial contracts generally assume that the express written terms of a contact will be given effect relatively strictly under English law.

However, recent court decisions illustrate the courts’ willingness to look beyond the written terms of contracts and to imply unwritten terms in order to give effect to what they consider to have been the parties’ intentions.

Overview

In one recent case, the High Court decided that a clause in a share option agreement – which stated that the option could only be exercised with the consent of the board of directors of the granting company – did not give the board an unequivocal veto.

The judge decided that the veto right in question was subject to an implied qualification that it must not be exercised capriciously, arbitrarily or unreasonably. Since there was no evidence that the board had properly considered the matter, the judge ordered specific performance of the share option agreement despite the required board consent not having been obtained.

This case serves as an important reminder for banks, lenders, investors – and indeed any company or individual who benefits from consent rights in a contract – to beware of placing too much reliance on their ability to refuse consent freely and without good reason, particularly if to do so could frustrate the purpose of the contract.

The case in question was Watson, Hersov & Moore v Watchfinder Ltd [2017] EWHC 1275 (Comm), and the full judgment is available here.

Brief facts

The claimants were (and are) senior members of Adoreum Partners, a business development and marketing consultancy which specialises in introducing clients to investors and other useful contacts, with a particular focus on the luxury goods sector. One such client was Watchfinder.co.uk, a retailer of luxury pre-owned watches which Adoreum assisted in its early stage fundraising activities.

A part of the remuneration arrangement, Watchfinder granted Adoreum an option to acquire 5% of its share capital at a fixed price of £150,000. The option agreement contained the following clause, on which the case focused:

3.1   The Option may only be exercised with the consent of a majority of the board of directors of the Company.

 3.2    If the consent specified in Clause 3.1 has not been obtained by the Investors before the Options Expiry Date the Option shall lapse and neither party to this agreement shall have any claim against the other under this agreement except in relation to any breach occurring before that date.

By the time that Adoreum attempted to exercise its option, Watchfinder’s business had grown considerably and it had secured investment from two venture capital houses (one of which was introduced by Adoreum) at the price of US$5 million for a 15% stake each, representing a very significant increase in the value of the option shares.

Adoreum sought to exercise the option and the board of Watchfinder refused in reliance on clause 3.1. Adoreum applied to court for specific performance.

Court’s analysis and decision

The court reviewed previous case law and noted the two particularly relevant requirements for when an unwritten term can be implied into a contract. These are worth reprinting here:

it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it;” (Lord Simon in BP Refinery (Westernport) Pty Ltd v Shire of Hastings [1977] 180 CLR 266); and

a term can only be implied if, without the term, the contract would lack commercial or practical coherence” (Lord Sumption in Marks & Spencer Plc v BNP Paribas [2016] AC 742).

The court decided that:

  • if the consent requirement in clause 3.1 provided the Watchfinder board with an unconditional veto, it would effectively make the share option agreement meaningless as Watchfinder would be able to escape from its obligations at will;
  • it was therefore necessary and appropriate (in light of the principles noted above) to imply into the option agreement (i) a term that, in deciding whether to give consent, the board of Watchfinder should be guided by whether Adoreum had made a real or significant contribution to the progress or growth of Watchfinder, and (ii) a further term that the board’s discretion to refuse consent must not be exercised capriciously, arbitrarily or unreasonably;
  • Watchfinder had not given the exercise of the option due consideration (noting amongst other things that there were no minutes of the relevant board meeting);
  •  there was a conflict of interests in that several of the Watchfinder directors were also shareholders and the exercise of the option would dilute their shareholdings;
  •  Adoreum had in fact contributed to Watchfinder’s growth including by introducing a major investor;
  •  Adoreum had therefore satisfied the implied conditions permitting it to exercise the option; and
  •  accordingly, Watchfinder was obliged to issue the option shares to Adoreum at the option price.

Consequences

The analysis in this case will not apply to every contract which contains a consent or veto right. However, contracting parties and their lawyers should be aware that, even where such a right may appear absolute, the courts may be willing to imply terms into the contract in order to ensure that the exercise of the right does not frustrate the contract’s overall purpose.

Jamie Hamilton, Senior Associate, Fladgate LLP (jhamilton@fladgate.com)

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