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Discretion: you actually own it and you have to exercise it properly

Jason Rix

In Watson v Watchfinder.co.uk, a refusal to consent to a share option entailed an improper exercise of a contractual discretion.

Watchfinder buys and sells luxury pre-owned watches. It granted an option in its shares to Watson and others who were directors of a company that was providing services to Watchfinder. The relevant provision stated “The Option may only be exercised with the consent of a majority of the board of directors of the Company”.

Watchfinder argued that the board had an unconditional right to veto the exercise of the option. The court rejected this argument. Instead, following the Supreme Court’s decision in Braganza, the right of veto was discretionary and was to be exercised in a way that was not arbitrary, capricious or irrational in the public law sense. There was an obvious potential conflict of interest as far as the existing shareholders of Watchfinder were concerned since the grant of further shares would dilute their own holdings and restrict their availability for other investors who may have to pay much more. In order to exercise the discretion properly the board had a duty to undertake a decision-making process, which included taking into account material points and disregarding irrelevant considerations, and reaching an outcome that was not unreasonable.

The agreement had no guidance about what might be a reasonable basis to refuse consent. The court decided that it would have been possible to veto the option if the board could say that Watson and others did not demonstrate a real or significant contribution to the progress or growth of Watchfinder. However the evidence, or more accurately lack of it, pointed to there being barely any considered exercise of the discretion at all.

Having a veto on a share option is, perhaps, unusual, but the decision is a reminder of the importance of properly exercising a contractual discretion and a rare example of the duty not being met.

Comments published on Compact Contract do not necessarily reflect the views of Allen & Overy or its clients.

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