Watson & Ors v Watchfinder.co.uk Ltd  EWHC 1275 (Comm)
In this case the High Court considered a provision in an option agreement which purported to give the company’s board an absolute veto over the exercise of the option. The High Court considered whether there was an implied duty on the directors not to act unreasonably, capriciously or arbitrarily in deciding whether to give its consent.
What was the background to the case?
This was a claim brought by three individuals, Marcus Watson, Rob Hersov and Twysden Moore (the Claimants) for specific performance of a written share option agreement (the Option Agreement) made between them and the defendant company, Watchfinder.co.uk Limited (Watchfinder).
The Claimants were all directors of and shareholders in a company called Adoreum Partners (Adoreum) which was a business development consultancy. Adoreum was engaged by Watchfinder to provide various services, including introducing new prospects, investment investors and partners. Adoreum was paid a monthly retainer for this under a services agreement and the Claimants and Watchfinder separately entered into the Option Agreement, which entitled them to exercise options over Watchfinder shares.
By a letter dated 4 March 2016, the Claimants sought to exercise the option. It was common ground that all the formal steps required for the exercise of the option by the Claimants had been fulfilled. However, Watchfinder relied upon Clause 3.1 of the Option Agreement, which provided that the option could only be exercised with the consent of a majority of Watchfinder’s board of directors.
What were the issues in the case?
The key issues in the case were:
- whether the Watchfinder board had an unconditional right to veto the exercise of the option
- if not, whether there was a duty on the board not to act capriciously, arbitrarily or unreasonably when exercising its discretion
- if there was such a duty, how should the board have exercised its discretion
- how had the board exercised its discretion
Principles of construction
The High Court reminded itself of the following principles set out by Lord Neuberger in the Supreme Court decision in Arnold v Britton  AC 1619:
- commercial common sense should not be invoked to undervalue the importance of the language used
- the less clear the centrally relevant words are, the more readily the court can properly depart from their meaning
- commercial common sense should not be invoked retrospectively. The mere fact that a contractual arrangement has worked out badly, or even disastrously for one of the parties is not a reason to depart from the natural language
- a court should be slow to reject the natural meaning as correct simply because it appears be have been very imprudent for one party to have agreed it
- facts known only to one of the parties cannot be taken into account
- if an event occurs which had plainly not been intended by the parties, the court will give effect to what the parties would have intended if clear
The High Court also had regard to the Privy Council’s observations in BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266 that for a term to be implied, the following conditions (which may overlap) must be satisfied:
- it must be reasonable and equitable
- 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
- it must be so obvious that ‘it goes without saying’
- it must be capable of clear expression
- it must not contradict any express term of the contract
The High Court also referenced the Supreme Court’s comments in Marks & Spencer Plc v BNP Paribas  AC 742 that:
- the implication of a term is ‘not critically dependent on proof of an actual intention of the parties’ when negotiating the contract
- a term should not be implied into a detailed commercial contract merely because it appears fair or merely because one considers that the parties would have agreed it if it had been suggested to them. Those are necessary, but not sufficient grounds for including a term
Did Watchfinder have an unconditional right of veto?
The High Court held that Watchfinder did not have such a right. If it did, then the option was meaningless, because the grant of shares was entirely within the gift of Watchfinder. The Option Agreement was part of an overall contractual package for Adoreum and the Claimants in relation to their relationship with Watchfinder. The High Court suggested that an alternative construction might have been possible had the option been included within an agreement dealing with a number of other contractual matters. However, it had been included in a separate agreement whose only purpose was the option albeit part of a package with the services agreement.
Was the exercise of the veto subject to an implied duty?
The High Court held that there was a duty on the board to exercise its discretion in a way which was not arbitrary, capricious or irrational in the public law sense. Citing the Supreme Court decision in Braganza v BP Shipping  1 WLR 1661, it said that this ‘Braganza Duty‘ required the board to follow a proper process, including taking into account the material points and not taking into account irrelevant considerations. The duty also required the board not to reach an outcome which was outside what any reasonable decision-maker could decide.
The High Court noted that a key part of the commercial arrangement between the parties was the desire to find an investor to meet Watchfinder’s needs going forward. The High Court therefore held that when considering whether to give its consent to the exercise of the option, the board should have asked itself whether Adoreum and/or the Claimants had contributed to the growth or value or prospects of Watchfinder in some significant way.
What did the Court decide?
The High Court found that there had not been a proper exercise of the discretion by the board:
- there had been barely any considered exercise of the discretion at all: only the managing director spoke at the board meeting with the other directors merely concurring
- there was no evidence produced at the hearing from the other Watchfinder directors
- at the time of the board meeting, a number of the directors were under the impression (apparently fostered by a number of different legal opinions) that the board had an absolute right of veto over the exercise of the options
- some of the directors had been overly focussed on the fact that the Claimants had failed to deliver Richemont, the luxury good group, as an investor (one of the reasons for engaging the Claimants had been their connections with this company)
- there was no or no real consideration of the fact that the Claimants had introduced a 15% investor in the company with an investment of US$5m
The High Court found that there had been hardly any real exercise of the discretion at all, but in any event in no way could it be described as in compliance with the Braganza Duty. There was no real discussion at the board meeting, the board did not focus on the correct matters and proceeded on the mistaken view that it had an absolute veto.
Having found that there was the Braganza Duty and Watchfinder failed to comply with it, the Court held that it should proceed as if consent had been given and accordingly the Claimants succeeded on their claim for specific performance of the Option Agreement.
What are the practical implications of the case?
Although the Claimants were ultimately successful in their claim, they had the cost and uncertainty of litigation and the outcome could have been very different if the Watchfinder board had gone through a more measured process in deciding whether to consent to the exercise of the option. The High Court commented that Clause 3.1 was an unusual provision to see in a share option agreement and noted that it had been included in the first draft which had been prepared by Adoreum’s operations director. The case highlights the importance of seeking legal advice before entering into important commercial agreements. From the Claimant’s perspective it would have been preferable for Clause 3.1 to be deleted in its entirety or at the very least qualified in some way. Alternatively, if the intention was that the trigger for the exercise of the option would be the introduction of a significant investor, this should have been specified in the Option Agreement.
From Watchfinder’s perspective, the decision underlines the danger of relying on what purports to be an absolute veto right. The High Court criticised the directors for placing too much emphasis in their decision-making process on the fact that Adoreum/the Claimants had been unable to deliver Richemont as an investor. If Watchfinder’s intention was that the option would only become exercisable in these circumstances, this should have been made a condition of the Option Agreement.
Finally a different outcome might have been possible had the Watchfinder board gone through a proper process in deciding whether to consent to the exercise of the option. The case highlights the importance of establishing an appropriate documentary trail showing the range of factors that directors considered and the process gone through to arrive at that decision.