“Reasonable” Discretions In Share Option Plans

Many share option plans contain a range of different types of discretions, usually vested in the board of directors, and, occasionally, their effectiveness has been tested in the courts.

The most recent case is that of Watson and others v Watchfinder.co.uk Limited [2017] EWHC 1275 (Comm). Although the share options in this case were not typical the decision is still useful in identifying how the courts are likely to approach such an issue in a wider context.

The defendant company (W) entered into an option agreement with three directors of another company.

The relevant provision in the option agreement was as follows:

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

The optionholders tried to exercise their options, but the board of W refused to allow this. As a result, the optionholders sought to enforce the options exercise.

W claimed that the option agreement conferred on its directors an unconditional right to reject any exercise of options. The court was not persuaded by this argument on the basis that, if this was correct, the optionholders had no contractual rights under the option agreement other than a right to request W to issue shares to them only if W felt inclined to do so.

Nevertheless, the court did not feel able to strike out the clause as having no effect at all.  In its view, the clause must have been intended to have some effect, even if this would have a narrower application than that claimed by W. The court considered the decision of the Supreme Court in Braganza v BP Shipping Ltd [2015] UKSC 17, and, in the light of this, found that the exercise of the discretion had to be “reasonable”, following a proper procedure and considering all relevant issues.

In this particular case, W failed to satisfy the court that it had acted in accordance with these requirements. It was unable to produce any evidence, such as board minutes, to demonstrate that the decision to refuse to accept the exercises of the options was anything other than arbitrary. The decision of the court, therefore, was to permit the option exercises.

It is not unusual for private companies, in particular, to wish to include some form of discretion in their share option plans to provide additional flexibility and to deal with unforeseen circumstances. This case, however, is another example of how important it is for discretions to have a clearly understood purpose and to be operated reasonably and consistently.