by Daniel Lightman, barrister, Serle Court, London


The new statutory derivative claim

Quite understandably, courts are reluctant to interfere with a company's internal management or to grapple with issues of commercial judgment. 'The courts do not have the time,' explained Professor Les Sealy of Cambridge University, 'and the judges do not have either the training or the inclination to review every decision of policy and every exercise of business judgment taken in a boardroom.' Or as Lord Eldon put it, more colourfully, in Carlen v Drury (1812): 'This court is not to be required on each occasion to take the management of every playhouse and brewhouse in the kingdom.'



However, courts must enter the boardroom when faced with a derivative claim - one made by a shareholder on behalf of, and for the benefit of the company, typically concerning a breach of duty by a director (or former director). If the derivative claim succeeds, a remedy will be awarded to the company itself, rather than to the shareholder bringing the claim on its behalf.



The derivative claim has existed for centuries as common law, operating as an exception to what has been described as the 'elementary principle' that 'A cannot, as a general rule, bring an action against B to recover damages or secure other relief on behalf of C for an injury done by B to C'. A typical example is where a fraud has taken place which the company is improperly prevented from redressing because it is controlled by the wrongdoers.



Derivative claims have been revamped and put on a statutory footing by the Companies Act 2006. With effect from 1 October 2007, the Act has abolished the common law derivative claim: a derivative claim can now only be brought under part 11 of the Act, or in pursuance of an order of the court in proceedings under section 994 of the Act (the replacement for the familiar section 459 of the Companies Act 1985).



The key changes

While a full analysis of the changes to derivative claims to be brought about by the Act is beyond the scope of this article, some key features are summarised below:

l The scope of those with locus standi to bring a derivative claim has been widened. A derivative claim can now be brought not only by a member of a company, but also by a person who is not a member but to whom shares in the company have been transferred or transmitted by operation of law (for example, a member's trustee in bankruptcy, or the personal representative of a deceased member's estate);

l The Act has removed some of the barriers to bringing a derivative claim. Under the statutory derivative claim, wrongdoer control of the company need not be shown, and breach of duty (including negligence) on the part of a director (or shadow or de facto director) without any corresponding benefit to himself or herself is now actionable by means of a derivative claim;

l The Act has both put on a statutory footing and widened the scope of directors' duties, and accordingly has widened the scope of potential derivative claims. (The statutory derivative claim is, however, only available against non-directors where there has been a breach of duty or otherwise actionable misconduct by the company's directors.);

l While it remains a complete bar to a derivative claim that the alleged wrong has been effectively ratified by the company (and section 239 of the Act has tightened the law in relation to ratification), the mere fact that an alleged wrong is ratifiable (but has not actually been ratified) is no longer a complete bar to a derivative claim - although the court is required to take account of the fact that the alleged wrong could be, and in the circumstances would be likely to be, ratified by the company; and

l Courts have been encouraged to weed out unmeritorious derivative claims by means of a new two-stage procedure for the claimant obtaining court permission to continue a derivative claim. The new procedure is governed by new Civil Procedure Rules (parts 19.9 to 19.9F) and a new Practice Direction - Derivative Claims supplementing part 19.



At the first stage, the derivative claimant must satisfy the court that there is a prima facie case for permission being given. Otherwise, the court must dismiss the application (and the claim with it) at the outset. If a prima facie case is shown, a substantive inter partes hearing will take place, at which the court can only grant permission to continue the claim if (i) it is not satisfied that any of the three matters set out in section 263(2) of the Act apply, and (ii) it considers it appropriate to grant permission, taking into account in particular the matters set out in section 263(3), and having 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.



Finally, for the first time a member can apply for permission to continue as a derivative claim a claim brought by a company where the cause of action on which the claim is based could be pursued as a derivative claim, or to continue a derivative claim brought or continued by another member.



How much will it be used?

For many minority shareholders, presenting a section 994 petition is likely to remain a more attractive option. The reasons for this include:

l There is no need to seek the court's permission to proceed with it;

l The conduct which may constitute unfair prejudice is far more widely drawn than actions/omissions which may permit a derivative claim to be brought;

l Ratification or authorisation by the company is no bar to a section 994 petition;

l There is no need for a petitioner to show he/she is acting in good faith;

l The remedy awarded reflects the personal needs of the petitioning shareholder; and

l It is possible for a section 994 petitioner to obtain a corporate remedy, and it may now be possible for a section 994 petitioner to obtain a Wallersteiner v Moir costs indemnity order (see Clark v Cutland [2003] 2 BCLC 393).



In contrast, a derivative claim will in most cases be less attractive. Shareholders are likely to be put off by the costs (and potential to be ordered to pay the other parties' costs) without the case even going past the preliminary procedural filters. In addition, there is often little incentive for a shareholder to expose themselves to such financial risks, bearing in mind that all of the benefit of a successful action will go to the company, rather than the claimant personally.



However, the new statutory derivative claim is likely to have a role to play, especially in large public companies where the courts are reluctant to grant a winding-up remedy or to construe the shareholder's interests as going beyond the company's articles in order to grant relief under section 994. It may also be used by ideological shareholders to put pressure on directors to be more environmentally friendly, or by vulture funds conscious of the potential ransom value of a derivative claim. How successfully courts will weed out meritorious from unmeritorious derivative claims remains to be seen.