One year on from the introduction of a new derivative claim by the Companies Act 2006 and consequential amendment to the Civil Procedure Rules on 1 October 2007, little use has been made of the new procedure. There have been just two cases reported where a derivative claim has been brought, and in both the High Court refused permission for shareholders to continue with the claims. A third case involving a derivative claim has been adjourned while the court deals with a separate and preliminary issue in the case.
A derivative claim is a claim against one or more directors of a company brought by a shareholder on behalf of the company. Such claims are brought when a wrong has been committed against the company, which the company itself does not pursue (usually because the company is managed by the very directors who are alleged to have committed the wrongdoing). The new derivative claim allows shareholders to bring claims for any actual or proposed act or omission involving negligence, breach of duty or breach of trust by a director, including breach of those duties that have been codified for the first time in the Act. Before proceeding with its claim, the shareholder must first seek permission from the court to continue with the claim. The court will decide by reference to a number of factors set out in the Act whether to grant permission. Further details can be found in our previous Law-Now (click here to access).
Mission Capital PLC v Sinclair
In the first case, heard in March 2008, two executive directors of Mission Capital were removed from the board and their service contracts were terminated. The company subsequently brought proceedings against the former directors, who launched a counterclaim seeking to be reinstated to the board. In addition, the former directors, who also held shares in the company, issued a derivative claim against the continuing directors and, as required by the new procedure, applied for permission to continue that claim.
In considering the permission application, the court reviewed the mandatory factors that would have required it to refuse permission, namely whether:
- a person acting in accordance with the duty to promote the success of the company would not seek to continue the claim; or
- the act or omission complained of had been authorised or ratified by the company.
The court considered carefully whether the derivative claim simply duplicated the shareholders’ counterclaim, holding that if it did, the court would be bound to refuse permission under the first mandatory factor. The court concluded that there were some differences between the derivative claim and the counterclaim and that neither mandatory factor was made out. Accordingly, it went on to consider the discretionary factors to be taken into account by the court. Those factors are:
- whether the shareholder is acting in good faith in seeking to continue the claim;
- the importance that a person acting in accordance with the duty to promote the success of the company would attach to continuing it;
- whether the act or omission complained of could be and, in the circumstances would be likely to be, authorised or ratified by the company;
- whether the company has decided not to pursue the claim; and
- whether the act or omission complained of gives rise to a cause of action that the shareholder could pursue in its own right rather than on behalf of the company.
The court considered each factor, but concluded that the second and last factors were most relevant here, deciding that a notional director acting in accordance with his duties would attach little weight to continuing the claim and that the shareholders could recover everything they were seeking by a petition made pursuant to Part 30 of the Companies Act 2006 (unfair prejudice). Bearing in mind those factors in particular and all the circumstances of the case, the court exercised its discretion to refuse permission to continue the claim.
Franbar Holdings v Patel & others
In the second case, heard in July 2008, the claimant was a shareholder of the corporate defendants and the other defendants were directors. Disputes arose as to the way the business was being conducted and to the proper operation of a shareholders’ agreement. The shareholder launched a claim for breach of the shareholders’ agreement, an unfair prejudice petition and a derivative claim against all three defendants.
In dealing with the derivative claim, the court first considered the two mandatory factors and found that neither was made out. Going on to consider the five discretionary factors outlined above, following a consideration of the claimant’s good faith and the possibility of ratification, the court again focused on the fact that a notional director would not have attached great importance to the continuation of the derivative claim, as the matters complained of were also covered under the claim based on the shareholders’ agreement and the unfair prejudice petition, and that considerable weight had to be given to the fact that the shareholder could achieve all that it could properly want through the unfair prejudice petition and breach of shareholders’ agreement action. The court considered that justice was best served by exercising its discretion to refuse permission to continue the claim.
Comment:
The new derivative claim has been available to shareholders and third parties since 1 October 2007. The cases referred to above are the first known cases where such a claim has been brought. Admittedly, in the two decided cases the merits of the derivative claims do not appear to have been particularly strong, but the court’s refusal to give permission to continue them on discretionary grounds perhaps indicates that the courts are adopting a restrictive approach to these claims, particularly where they are brought in conjunction with other claims, like unfair prejudice petitions. Although the derivative claim certainly increases the risk of more claims against directors, that risk has not yet materialised. Looking forward, the current turmoil in the financial markets may lead to increased interest in the derivative claim as a possible option for shareholders seeking to recoup losses for their companies, suffered as a result of what they regard as poor management or investment decisions. If the courts’ approach to date is anything to go by, however, such claims will not be a panacea for the recovery of such losses.
Case references:
Mission Capital Plc v Sinclair and another [2008] EWHC 1339 (Ch)
Franbar Holdings Ltd v Patel and others [2008] EWHC 1534 (Ch)
Fanmailuk.com Ltd and another v Cooper and others
[2008] EWHC 2198 (Ch)
