Meaning
Equitable rule mandating that directors use their delegated powers only for the reasons for which those powers were originally granted. The duty of proper purpose applies most frequently to the issuance of new shares where the intent is to dilute a majority shareholder or to block a hostile takeover. It focuses on the subjective motivation of the board members rather than the objective legality of the act itself.
Issuance Restriction
Directors must show that a capital raise was intended to benefit the company through new funding. If the primary motive behind the duty of proper purpose is to entrench the existing management, the court may set aside the resolution. Even if the board believes they are acting in the best interests of the company, using a power for a collateral reason remains a breach.
Control Contest
Tactics used during a proxy fight or a merger negotiation are scrutinized to ensure they do not unfairly disenfranchise voters. A power granted to manage the business is not a power to determine who shall be the owners of the business. The integrity of the corporate structure relies on the board respecting the boundary between management and ownership.
Legal Consequence
Decisions made in violation of this principle are voidable at the instance of the company. Shareholders can bring a derivative action to challenge the board if the company itself fails to act against the offending directors. The remedy usually restores the parties to the position they occupied before the improper exercise of power.
This doctrine protects the voting equilibrium of the entity.
