The recent High Court case of Watson and others v Watchfinder.co.uk Ltd has highlighted the importance of clearly defining exercise conditions in share option agreements.
Share option agreements give the right to acquire or sell shares at a future point in time and can often be conditional on the performance of a party to the agreement (perhaps with reference to targets or KPIs) or a certain event occurring (such as the sale of a business).
As a brief overview, the case involved the granting of share options from Watchfinder to 3 directors of a consultancy company who had a commercial relationship to introduce investment into Watchfinder. The agreement allowed for the purchase of a percentage of Watchfinder’s shares which could be exercised with the majority consent of Watchfinder’s board of directors. The claimants looked to exercise their option which was vetoed by the defendant who claimed the option was exercisable at their absolute discretion. The claimants sought specific performance of the agreement (asking the court to force them to grant the shares) arguing the defendant could not act in a way that was unreasonable.
The court disagreed with Watchfinder’s contention that their right of veto was unconditional as this would defeat the purpose of the particular commercial arrangement between the parties. Rather, the court determined that based on previous case law, that the discretion of the directors could not be “capriciously, arbitrarily or unreasonably” motivated. This was important due to the potential conflict of interest of a decision being made so not to dilute the board members’ shareholdings or not to limit shares being available for other investors at a higher price. The court made clear the onus was on the directors to not come to a conclusion that any reasonable decision maker would not come to.
The court then considered whether the board had complied with this duty. They disagreed with Watchfinder’s contention that their decision could be based upon whether a particular investor had been introduced and, rather, stated the board should have considered whether the option holders had made “a real or significant contribution” to growth.
The court found that this had not been properly considered and granted the claimants specific performance.
The standout development that can be drawn from the case is that a company should not simply rely on its own right to veto an exercise of share options. If it is intended that share options be triggered based upon a particular event, such as a specific investor coming into the company, then this must be clearly stated in the agreement.
This case clearly shows that it is important to seek proper legal advice before entering into commercial arrangements.
If you need any help with implementing share option agreements or schemes in your company, or if you are the recipient of a share option award and have any questions, please contact the BHW Corporate and Commercial team.