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Statutory Derivative Action - Coggle Diagram
Statutory Derivative Action
Who can bring a claim
The rule in Foss v Harbottle has not been swept aside.
Statutory derivative claims remain subject to proper plaintiff and majority rule
Proper Plaintiff
The proper plaintiff in respect of a wrong allegedly done to a company is prima facie the company
Where there is no wrongdoer control preventing the company from bringing a claim, permission to bring a derivative claim may be refused by the court and they may require the claim to be brought by the company (Bamford v Harvey [2013] BCC 311 at [25]–[29]).
Minority shareholders have to show that the wrongdoers are the majority shareholders and the majority shareholders are in control of the company.
Permission was refused in this case when it became apparent that there was no objection to the claim being brought in the company’s name.
‘wrongdoer control’ (as required at common law) is not an absolute condition for a derivative claim (otherwise it would be a specific provision in the CA 2006, s 263(2)), the court held that where proceedings can clearly be brought in the name of the company and there is no objection raised on that ground, they should be brought in the name of the company ([2013] BCC 311 at [32])
If the company is in a position to pursue a claim vested in it, it is for the company to do so, not the shareholders.
Majority Rule
Under CA 2006, Pt 11, actual authorisation or ratification is required to bar a claim (s 263(2)(b), (c)). Otherwise, the possibility of authorisation or ratification is a matter to be taken into account by the court when deciding whether to give permission for a claim to proceed (s 263(3)(c) and (d)).
Under the statute where a cause of action arises from an act or omission that is yet to occur, permission is refused where the act or omission has been authorised by the company (s.263(2)(b) CA 2006).
Burland v Earle (cannot bring a claim on an action which can be ratified by majority)
Furthermore, permission is refused where the cause of action arises from an act or omission that has already occurred and was authorised by the company before it occurred (s.263(2)(c)(i) CA 2006) or the act or omission has been ratified by the company since it occurred (s.263(2)(c)(ii) CA 2006).
The claimant is any member. Action vested in the company, seeking relief on behalf of the company s260(1)
By any member, though not ordinarily by a majority shareholder
Claimant has to be a shareholder bringing a claim on behalf of the company.
Grounds for a claim
A derivative claim may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company (s.260(3) CA 2006).
Actual or proposed act or omission, this should be linked to breach of directors’ duties.
A claim for breach of duty against a number of directors must be particularised with respect to each director (Bridge v Daley [2015] EWHC 2121 at [76]; it is not sufficient to claim that ‘they are all in it together’).
The most common example is that the director did not look into the financial dealings of an employee that the director has hired, and the employee steals a lot of money from the company because director has not looked at the background of the employee.
The absence of profit or benefit may be something which the court would factor into its deliberations under s 263(3) when considering whether to grant permission.
Breach of trust – authorising illegal dividends
Stage 1
This stage takes place on paper. The company is not called to submit evidence.
At the first stage the question is whether the application and evidence filed by the applicant in support of their action disclose a prima facie case for giving permission to continue a derivative claim (s.261(2) CA 2006).
If it appears to the court that the application and the evidence filed by the applicant in support of it do not disclose a prima facie case ‘for giving permission’ to continue a derivative claim, the court must dismiss the claim (CA 2006, s 261(2)(a)).
If the court is satisfied that there is a prima facie case for giving permission, the case progresses to the second stage.
What does a prima facie case require?
In Iesini v Westrip Holdings Ltd, the court said this ‘necessarily entails that there is a prima facie case that the company has a good cause of action and that the cause of action arises out of directors’ default, breach of duty etc.’
Must show that there has been a clear breach of directors’ duties (primary) and the breach has caused a loss.
There has to be an action or omission, breach of directors duties, and this has to lead to damage to the company.
In Iesini v Westrip Holdings Ltd Lewison J held that this requirement for a prima facie case for giving permission necessarily entails a decision by the court that there is a prima facie case both that the company has a good cause of action and that the cause of action arises out of a director’s default, breach of duty, etc.
This stage takes place on paper and the company is not involved. The question is whether there is a ‘prima facie case for giving permission’ – if the facts alleged are true, would the court give permission – the actual decision on permission takes place at the second stage.
Stage 2
Stage 2 - s.263(3) CA 2006
In considering whether to give permission for a claim to proceed, the court must take into account, in particular, a number of factors which are set out in CA 2006, s 263(3) as follows
Where the cause of action results from an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be authorised by the company before it occurs (s.263(3)(c)(i) CA 2006) or ratified by the company after it occurs (s.263(3)(c)(ii) CA 2006).
Most directorial actions can be ratified. Court has to check whether authorisation or ratification or if it is available.
Where the cause of action arises from an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company (s.263(3)(d) CA 2006).
Most directorial actions can be ratified. Court has to check whether authorisation or ratification or if it is available.
The importance that a person acting in accordance with section 172 (duty to promote the success of the company) would attach to continuing it (s.263(3)(b) CA 2006).
The court has to look at the matter from the perspective of the hypothetical director acting in accordance with his duty under s 172 and assess the importance he would attach to continuing the claim.
That director would look to the same considerations as are relevant to s 263(2)(a) and to which Lewison J drew attention in Iesini v Westrip Holdings Ltd,
A hypothetical director may consider it appropriate to continue a claim where the case against the director seems very strong, even if the likely level of recovery is not so large, since the claim may provoke a settlement or summary judgment and, likewise, a director may consider it appropriate to continue a claim where the case is less strong, if the amount of potential recovery is very large (Brannigan v Style [2016] EWHC 512 at [90]–]91]).
Whether the company has decided not to pursue the claim (s.263(3)(e) CA 2006).
Under this heading, the court considers any decision which may have been taken by the company not to pursue the claim (as opposed to authorising or ratifying any breach of duty).
If the company has not actually considered the matter, the court may adjourn proceedings so that a properly authorised organ of the company, whether that be the board or the shareholders, can consider the practical desirability of the claim going forward (Smith v Croft (No 2) [1987] 3 All ER 909 at 955–6).
In Kleanthous v Paphitis refusing permission to continue the claim, the court attached considerable weight to the fact that a committee made up of the two directors (chief executive and the finance director) who were not defendants to the claim, who had taken legal advice and reviewed the matter at the request of the board, was against the claim proceeding.
The committee had concluded that it would not be in the company’s commercial interests (in terms of management disruption, damage to the company’s performance as a result of the loss of experienced and high profile directors, damage to reputation and to the brand) to continue the claim against the company’s major shareholders and directors.
The court noted that those independent directors were better placed than the court to assess where the company’s commercial interests lay ([2012] BCC 676 at [75]). Of course, little weight will attach to a decision taken by the directors where the defendants are in the majority (Cullen Investments Ltd v Brown [2016] 1 BCLC 491 at [57]).
Whether the (minority) member is acting in good faith (s.263(3)(a) CA 2006).
Are they trying to slow down certain procedure or create a cost for the company?
Is there any ill feeling between minority and majority?
The motives of the claimant is an important filter and it is for the shareholder seeking permission to establish to the satisfaction of the court that he is a person acting in good faith and that he should be allowed to sue on behalf of the company (Barrett v Duckett [1995] 1 BCLC 243 at 250)
It may be helpful to show that the claimant has the support of other minority shareholders, see Stainer v Lee [2011] 1 BCLC 537 at [49] (applicant for permission could show letters of support and a financial contribution from 35 other small shareholders).
Once there is a real purpose in bringing the claim in the company’s interest, the court is unlikely to consider the claimant to be in bad faith (Mission Capital plc v Sinclair [2010] 1 BCLC 304 at [42]) even though there may be some collateral benefit or advantage to the claimant (Iesini v Westrip Holdings Ltd [2011] 1 BCLC 498 at [121]).
A claimant will not be in good faith, however, if motivated to litigate by personal considerations rather than in the interests of the company (Barrett v Duckett [1995] 1 BCLC 243)
Barrett v Duckett [1995] 1 BCLC 243
Claimant not pursuing claim bona fide in the interests of the company, but for personal reasons to do with the divorce of the company’s sole director and the claimant’s daughter
Abouraya v Sigmund [2015] BCC 503
one of the reasons for refusing permission was that the claimant’s purpose was to advance his interests as a creditor of the company.
A separate consideration at common law which the court can take account of under Part 11 also, given that the factors listed in s 263(3) are not exhaustive, is whether the claimant is a proper person to bring the claim forward, which he would not be if he had participated in the wrong of which he complains (Iesini v Westrip Holdings Ltd [2011] 1 BCLC 498 at [122]).
Whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company (s.263(3)(f) CA 2006).
A cause of action that a member could pursue in his own right—s 263(3)(f)
The existence of an alternative personal claim arising from the same act or omission is not a bar to a derivative claim, it is just one of the factors to be considered by the court (Iesini v Westrip Holdings Ltd [2011] 1 BCLC 498).
In most cases, the issue is whether the potential availability of relief under the broad unfairly prejudicial jurisdiction in CA 2006, s 994 is ‘a cause of action’ that a member could pursue in his own right
Langley Ward Ltd v Trevor [2011] EWHC 1893 at [13]
The language of ‘cause of action’ is not very apt for petitions under CA 2006, s 994, but since the factors listed in s 263(3) are not exhaustive, the court can have regard to the availability of relief under s 994 regardless of whether, strictly speaking, it falls within a ‘cause of action’ and s 263(3)(f).
In some situations, a derivative claim may be the most effective remedy (typically resulting in assets being restored to the company) rather than a personal remedy under s 994
The factor which the court needs to consider is the nature of the alleged wrongdoing and whether there are other ways in which it can be addressed effectively rather than by a derivative claim.
Stage 3 - s.263(4) CA 2006
When considering whether to to give permission the court shall have particular regard to any evidence before it as to the views of members of the company who have no personal interest, direct or indirect, in the matter (s.263(4) CA 2006).
Court should look into what independent shareholders who are not part of the majority who have no interest think.
In Iesini v Westrip Holdings Ltd Lewison J noted, obiter, that s.263(4) is not easy to understand since, in theory, all shareholders have an obvious interest in any claim brought on the company’s behalf as the value of their shareholdings will increase or diminish depending on the outcome.
He considered that the provision was probably intended to encompass those members not implicated in the alleged wrongdoing and who do not stand to benefit otherwise than in their capacity as members of the company ([2011] 1 BCLC 498 at [129]–[130]).
In Iesini the shareholders who were being held out as having no personal interest in the matter turned out to have an informal understanding with the defendant director which gave them a financial interest in the outcome of the litigation. The court did not consider that they were persons to whom the court had to have particular regard, at [130].
Stage 1 - s.263(2) CA 2006
The courts must refuse permission where the company has authorised (ex ante) an act or omission that is yet to occur (s.263(2)(b) CA 2006).
The courts must refuse permission where the cause of action arises from an act or omission that has already occurred and was authorised by the company before it occurred (s.263(2)(c)(i) CA 2006) or where the act or omission has been ratified (ex post) by the company since it occurred (s.263(c)(ii) CA 2006).
Court has to look into whether this alleged breach can be ratified by majority then derivative action cannot be forwarded.
The courts must refuse permission if a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim (s.263(2)(a) CA 2006).
Test = would a hypothetical director bring a claim on behalf of the company.
Franbar Holdings Ltd v Patel: ‘The court is only required to refuse permission if it is satisfied that the hypothetical director would not seek to continue the claim’. If the director could seek to continue it, the court does not have to dismiss the application
Court must dismiss if a person acting in accordance with s172 (hypothetical director) would not seek to continue the claim
Hypothetical director would look at the following (taken from the Iesini v Westrip Holdings Ltd):
Company’s ability to fund the proceedings
Disruption to company’s activities (can the company go bankrupt)
Cost of proceedings
Whether prosecution may damage company in other ways
Strength of the claim (any chance of succeeding)
This is a non exhaustive list
Size of the claim
In Iesini v Westrip Holdings Ltd, the court said it would only be required to dismiss the action where it ‘is satisfied that no director acting in accordance with section 172 would seek to continue the claim. If some directors would, and others would not… the case is one for the application of s263(3)(b)’.
Even if one director wants to go ahead with the derivative action the courts will go ahead with the action.
Case gave us hypothetical directors test.
Second stage: court hears the permission request in full and has to form a view of the strength of the claim. At this stage, the court can order the company to provide evidence
What about wrongdoer control? This was a requirement under common law – does it remain? In Stimpson v Southern Private Landlords’ Association: court said it would be very likely to refuse permission where no wrongdoer control.
A member of a company who brings a derivative claim must apply to the court for permission (in Northern Ireland, leave) to continue it (s.261(1) CA 2006).
Who can a claim be brought against
A claim can also be brought against former directors (s.260(5)(a) CA 2006).
A claim against former director might arise, for example, where directors have resigned in order to exploit an opportunity which came to their attention while they were directors in a situation of a conflict of interest
A claim can also be brought against a shadow director (s.260(5)(b) CA 2006).
A derivative claim may be brought against a director or another person or both (CA 2006, s 260(3)).
The intention behind permitting derivative claims against ‘another person’ is to allow a claim to be made on behalf of the company, for example, against a person who has assisted a director in a breach of duty or who is a recipient of corporate assets in circumstances where he knows the director is acting in breach of his duties (See Law Commission Report, paras 6.35, 6.36; 679 HL Official Report (5th series)).
A derivative claim cannot be brought where the breach of duty etc is solely that of the third party, such as a negligent auditor (Iesini v Westrip Holdings Ltd [2011] 1 BCLC 498 at [75]).
The decision whether to sue a third party (i.e. someone who is not a director and where the claim is not closely connected with a breach of duty by a director) is one for the board (Law Commission Report, n 26, paras 6.34, 6.35)
Konamaneni v Rolls-Royce Industrial Power (India) Ltd [2002] 1 BCLC 336 where the substance of the proposed derivative claim was to bring an action against a third party who had allegedly bribed a director—permission was refused on a variety of grounds, but the case illustrates the circumstances in which a derivative claim against a third party might be relevant.
In derivative action the shareholders are attempting to bring an action in the name of the company. Shareholder is not trying to bring a claim saying that their right is being violated. Shareholder bringing a claim on behalf of the company by arguing it is the company’s rights which are being violated.
Remedy in derivative action flows to company; still not much incentive for minority shareholders to bring
Court can make indemnity order against the company for costs in permission application, the claim or both
Iesini: once court has decided claim should proceed, normally order company to indemnify the claimant against his costs (this is just an example though)
However, courts aware of threat to company’s existence, so may review costs order at various stages of proceedings once strength of claim becomes clearer: in Kiani v Cooper costs order made, but only covered proceedings up to discovery of documents.
During first stage the courts may or may not give costs, unlikely to give costs unless you can prove prima facie case.
If you can prove prima facie case and move to second stage, chances of getting indemnity or the costs of running the suit increases.
Remedies under derivative action goes to company
Compensation goes to company rather than shareholder who brings the claim.
Derivative action two step and cumbersome, uncertainty about costs.
Uncertainty whether company can be compelled to pay the cost, even if there is a prima facie case against the company.
Uncertainty whether courts would allow costs for shareholder bringing a claim against the company management.