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Philip Chapman

In Watson and others v Watchfinder.co.uk Limited, the court had to construe a clause in a share option agreement providing that the option could only be exercised with the consent of the company's board. A company (W) entered into a services agreement with another company (A), a business development consultancy. On the same date, W granted options over its own shares to three directors of A. The option agreement included the following clause:
"The Option may only be exercised with the consent of a majority of the board of directors of the Company."

When the option holders attempted to exercise the options, W refused to issue the shares, stating that its directors did not consent. The option holders sought specific performance of the allotment of shares.

The court held that it could not be the correct construction of the clause that the board had an unconditional right to veto the exercise of the options. If it was, the option would be meaningless because the grant of shares would be entirely within the gift of W and the position would be no different from when any person sought to buy shares in W. Moreover, the option agreement was always intended to be part of an overall contractual package for A and the option holders in relation to their relationship with W. In that context, it would be a commercial absurdity to conclude that objectively, one part of that package was in fact worthless. The option was a separate agreement whose only purpose was the option, although part of a package with the services agreement. This was not one of those cases where the importance of commercial common sense was being overstated or over-used.

However, the clause could not be disregarded entirely. Although such a provision was unusual in a share option of this kind, which usually contained an unqualified right to shares provided specific conditions were met, that did not mean it could be ignored. It clearly purported to act as some sort of restriction to the right. If there was to be a limit on the discretion, it was now well-established that, whether as a matter of construction or the implication of a term, the court may find such a discretion was to be exercised in a way which was not arbitrary, capricious or irrational in the public law sense. This was not inevitable in every case but was clearly so here where there was an obvious potential conflict of interest as far as the existing shareholders of W were concerned, since the grant of further shares would dilute their own holdings or restrict their availability for other investors who might have to pay much more (Braganza v BP Shipping [2015] UKSC 17). The exercise of the discretion would entail a proper process for the decision in question, including taking into account the material points and not taking into account irrelevant considerations. It would also entail not reaching an outcome outside what any reasonable decision-maker could decide, regardless of the process adopted.

To assess whether a discretion had been properly exercised it was necessary to know what the target of that discretion was, in the sense of what the decision-maker was meant to be considering when deciding whether or not to exercise it. Here there was no clear guidance in the clause itself. There were two broad possibilities: either the consideration was essentially forward- looking or it was backwards-looking. It could not be said the discretion was all about whether the option holders would make suitable shareholders in W: the class of unsuitable shareholders was so narrow that there would not be much of a discretion for W. Instead, on the evidence, the target was whether A or the option holders had made a real or significant contribution to the progress or growth of W.

Here there had been no proper exercise of the discretion. There had been barely any considered exercise by the board of the discretion at all. There had been no real discussion, it had not focussed on the correct matters, it had proceeded on a mistaken view of what it was about and it was arbitrary.

It was common ground that if the discretion was subject to a limit, and W had failed to comply with it, the court had to proceed as if consent had been given under the clause. It was also common ground that all the formal steps required for the exercise of the option by the option holders had been fulfilled. Accordingly, the claimants succeeded in their claim for specific performance.