Where a share option agreement provided that the option could be exercised only with board consent, the High Court has ordered specific performance of the agreement despite the lack of board consent. The court held that the veto was discretionary, rather than an unconditional right, and such discretion could not be exercised capriciously, arbitrarily or unreasonably: Watson v Watchfinder.co.uk Ltd  EWHC 1275 (Comm).
The decision illustrates the court’s willingness to find that a contractual discretion is limited by reading into the relevant clause a duty not to exercise the discretion capriciously, arbitrarily or unreasonably. While such a limit will not apply in every case, it did here due to the potential conflict of interest arising from the board’s ability to grant or withhold consent.
Where parties are required to exercise a contractual discretion, they should be alert to the potential scrutiny of their decisions and ensure that any discussions at board meetings or otherwise are meaningful and are properly minuted so as to evidence that a proper decision-making process has been followed.
Contractual discretions are also considered in the fourth edition in our contract disputes practical guides series: How far can you act in your own self-interest?: The role of good faith in commercial contracts.
Gregg Rowan and Anthea Brookes, a partner and associate in our disputes team, consider the decision further below.
The claimants were three individuals who were directors and shareholders of a company (Adoreum). Adoreum had entered into a sales and marketing services agreement and a share option agreement with the Defendant (Watchfinder). The share option agreement contained a clause providing that the option could only be exercised with the consent of a majority of the board of directors of Watchfinder.
Under the sales and marketing services agreement, Adoreum agreed to facilitate introductions of potential customers, investors and partners to Watchfinder. In particular, as was made clear to Adoreum during negotiations, Watchfinder was interested in gaining the investment of a specific company (Richemont).
Despite efforts made by Adoreum, Richemont elected not to invest in Watchfinder. However, Adoreum did introduce another potential investor (Beringea) to Watchfinder. Beringea subsequently invested US$5m for a 15% shareholding in Watchfinder.
After termination of the sales and marketing services agreement, the claimants sought to exercise the option. Watchfinder refused to honour the option on the basis that board consent had not been obtained. The claimants then brought an action against Watchfinder for specific performance of the share option agreement.
The High Court (His Honour Judge Waksman QC sitting as a High Court judge) held in favour of the claimants and ordered specific performance of the share option agreement.
The court identified the following issues:
- Did the clause in the share option agreement requiring consent of the board amount to an unconditional right of veto in favour of Watchfinder?
- If not, was the discretion to refuse consent inherent in the clause subject to a qualification that it must not be exercised capriciously, arbitrarily or unreasonably?
- If so, what was the subject matter of the consideration of the right to veto?
- In consideration of the subject matter, was there a meaningful exercise of the discretion?
Addressing these issues in turn:
1. The court found that the clause could not amount to an unconditional right of veto as this would render the share option agreement meaningless: it would mean that the grant of shares was entirely within the gift of Watchfinder. The share option agreement was part of the overall contractual package for Adoreum and the claimants and it would be a “commercial absurdity” to conclude that one part of the package was worthless.
2. The board’s discretion to refuse consent was subject to a qualification that it must not be exercised capriciously, arbitrarily or unreasonably. This was true whether the qualification was read into the clause as a matter of construction or by reason of an implied term. Such a qualification was not inevitable in every case, but it was appropriate given that there was an obvious potential conflict of interest here (since the grant of further shares would dilute the existing shareholdings and restrict their availability for other investors). To fulfil the duty not to exercise the discretion capriciously, arbitrarily or unreasonably a proper process for the decision, including taking into account the material points and not taking into account irrelevant points, must be followed (Braganza v BP Shipping  1 WLR 1661 followed).
3. In assessing whether the duty was fulfilled, the court went on to consider the “target” of the discretion, being what the decision-maker should consider when choosing whether to exercise the discretion. The court considered that the board should be guided by whether the claimants had made a real or significant contribution to the progress or growth of Watchfinder. This target was preferable to the alternatives proposed, ie (i) whether Adoreum’s performance had been satisfactory in the opinion of Watchfinder, which would put the claimants too much at the mercy of Watchfinder; or (ii) whether Richemont had invested in Watchfinder, which was so specific that, if intended, it should have been drafted as an express condition of the share option agreement.
4. The court concluded that the board had not exercised the discretion in a meaningful way. While the matter was raised in a board meeting, it was raised very quickly and there was no evidence to suggest anything substantive was said regarding the consent sought. Further, in withholding consent, there was no consideration of the Beringea investment, which was “a manifestly relevant consideration” (and one which the court considered fulfilled the target).
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