Derivative claims are a way that shareholders can seek to enforce rights vested in a company where the company is not taking any action. In these cases, the claim is brought in the name of the individual but on the behalf of the company (Wallersteiner v Moir).
The rule in Foss v Harbottle is that where a wrong is done to a company, the company is the proper claimant. Common law derivative claims are an exception which occur when the wrong done amounts to equitable fraud or if the wrongdoer is in control of the company (Prudential Assurance Co Ltd v Newman Industries Ltd). The common law derivative action was seen as ‘complex and arcane’ (S Watkins, ‘The Common Law Derivative Action: An Outmoded Relic?’ (1999) 30 Cambrian Law Review 40) and the Law Commission recommended replacing the existing derivative action with a ‘new derivative procedure with more modern, flexible and accessible criteria’ (FIND THE REF).
As such a statutory derivative claim was brought in under Part 11 CA 2006. This adopted most of the recommendations of the Law Commission (Law Commission, Shareholder Remedies) but common law statutory claim has not been replaced as suggested by the Law Commission and is still available for UK companies with multiple derivative claims and derivative claims in respect of foreign companies.
The statutory claim extended the scope of who could bring a derivative claim to a person whom shares in the company have been transferred by operation of law (CA 2006, s250(5)(c)) in addition to members. This prevents directors from exercising a power under the articles to refuse to admit new members so they may not bring a claim (Professors P Davies and S Wortington, Gower’s Principles of Modern Company Law (10th edition, 2016), p 600 para 17-16).
Statutory derivatives claimants no longer need to show that the wrongdoer benefitted from their wrong or that the wrongdoer was in charge. Statutory claims can be brought in respect of an action arising from an actual or proposed act or omission involving negligence, default, breach of duty, or breach of trust by a director, former director or shadow director of the company (REF in CA 2006). These are now readily identifiable as directors’ duties were codified under CA 2006.
The statutory procedure is made up of a two-stage process. In the first, the court must dismiss the application if the supporting evidence filed by the applicant does not disclose a prima facie case for giving permission (CA 2006, s261(2)). This stage was not recommended by the Law Commission as they thought it could result in a time consuming and expensive mini trial (REF). The test was included by Parliament as they believed that an adequate front-line defence should be in place for derivative claims (HL Deb 9 May 2006, vol 681, col 885 (Lord Sharman)). In Iesini v Westrip Holdings Ltd, Lewison J took a strict approach to the matter and expressed the view that a prima facie case for giving permission needed a good cause of action by the company and that the cause of action arose from the listed actions (CA 2006, REF). This is an onerous task for an applicant at such an early stage as they may not have access to all the necessary information.
During the second stage there are three complete bars to granting permission to continue a derivative claim (CA 2006, s263(2)). One of which is that a person acting in accordance with CA 2006, s172 would not seek to continue the claim. Therefore, the court must ask if a hypothetical person acting in accordance with the duty to promote the success of the company would not seek to continue the claim. It does not matter whether some would if some directors wouldn’t (Iesini v Westrip Holding Ltd). Permission can also be barred if the company has authorised an action yet to occur or if they ratify it since it has occurred (REF, CA 2006).
There are six particular matters which the court is mandated (CA 2006, s263(3)) to take into account (Franbar Holdings Ltd v Patel). These include assessing the importance a hypothetical director acting in the benefit of the company would place on continuing the claim (as opposed to not continuing claim in the the bars to permission), whether the shareholder is acting in good faith, the likelihood of prior approval or subsequent ratification and the views of those who have no personal interest in the matter.
The statutory principles appear to have made derivative claims easier to bring but this does not occur in practice. It was also not intended as the Law Commission (REF) said that shareholders should only be able to bring an action in exceptional circumstances so as not to interfere with business management. The courts have put tight judicial control when granting permission to continue a claim (My book). This has led to criticism that CA 2006 does not go far enough to make courts more inclined to permit derivative claims to proceed (My book).
Often a s994 petition may be seen as the better option as there is no need to seek the court’s permission to proceed, the conduct to bring a claim is wider than the actions or omissions which may permit a derivative claim. Ratification or authorisation by the company is no bar to a 994 petition and there is no need to show the petitioner is acting in good faith. The remedy awarded will reflect the personal needs of the petitioning shareholder as the court’s powers under s996 are extremely wide-ranging and flexible (D Lightman, The Flexible Friend (2017)).
Shareholders may also be put off by the costs incurred (and the risk of being ordered to pay the other parties’ costs) before the case has even got past the preliminary procedural filters. The expansion of the actions which can be claimed for is clearly dwarfed by the obstacles which are needed for permission to continue the claim to be granted. There is little incentive for shareholders to expose themselves to such financial risks as even with a successful action the benefit will go to the company. The action may even cause the value of their shares in the company to drop.
However, derivative claims are still likely to be used in large public companies where the court are reluctant to grant a winding-up order or to construe the minority shareholder’s interests as going beyond the articles. Derivative claims are also useful where the minority shareholder wishes to remain a member of the company and has good reasons for why he does not wish to be subject to a share purchase order under s994 (the remedy most often granted by the courts where unfair prejudice is established). Being brought out would only benfit those members whereas a derivative claim aims to benefit the company as a whole (Keay and Loughry ‘Derivative Proceedings in a Brave New World for Company Management and Shareholders’).
Personal claims limitation
Personal claims open to shareholders are restricted due to the principle of ‘no reflective loss’. The origins of the principle come from Prudential Assurance v Newman Industries (No 2) where the court would not allow a claim as the only loss was through the diminution of his shares. Reflective loss in this context is any loss which would be made good if the company were to enforce in full its rights against the wrongdoer (Barnett v Creggy).
The irrecoverable loss was extended beyond the diminution of the value of shares and loss of dividends to ‘all other payments which the shareholder in the company obtained from the company if it had not been deprived of its funds’ (Neuberger LJ in Garner v Parker).
The principle is, moreover, absolute in its application. As Lord Millett confirmed in Johnson v Gore Wood & Co, the court has no discretion to disapply the no reflective loss principle. The onus is on the defendant who seeks to shelter behind the no reflective loss principle to demonstrate that it applies (Shaker v Al-Bedrawi).
An exception to the principle from Giles v Rhind that reflective loss does not bar a shareholder form bringing an action against a wrongdoer where the company is unable to pursue an action itself was considered in Servilleja. The court decided in this case that the exception was a narrow one and only applies where the company no longer has a cause of action due to the actions of the wrongdoer.
Derivative claims do not constitute an exception to the no reflective loss principle. The rule in Foss and Harbottle concerns actions to recover losses for damage to the company (O’Neill v Ryan) but derivative claims permits a shareholder to enforce the company’s claim on behalf of the company. It does not permit the shareholder to recover personal losses for himself.
Just and equitable winding up
Just and equitable winding up is a remedy that has been available since the Companies Act 1862. It provides that a company may be wound up by the court if the court believe it is just and equitable to do so. This statutory remedy is currently in force under the Insolvency Act 1986, s122(1)(g).
‘Contributories’ are entitled to petition (IA 1986, s79) if they fulfil the criteria in IA 1986, s124. A holder of fully-paid shares would be a contributory (Re Angleasea Colliery Co) if he is a member of a company which he alleges and proves that he has a sufficient interest in winding up (Re Rica Gold Washing Co Ltd.). A sufficient interest exists where, after payment of the company’s creditors, there will remain monetary surplus for distribution amongst the company’s members. This surplus must be more than negligible (Re Rica Gold Washing Co Ltd).
There is a limited exception when the company withholds accounts and other information. In this case it is not fatal to the petition to be unable to prove the likelihood of a surplus (Re Newman and Howard Ltd). The court has wide discretion with regard to a petitioner’s standing (Alipour v Ary).
The term ‘company’ in IA in IA 1986, s 122(1)(g) encompasses a company registered under CA 2006 (IA 1986, s 73(1)) and an unregistered company (IA 1986, s 220(1)). These provisions confer jurisdiction on the court to order the winding up of foreign companies (Alipour v Ary for example).
There are three main situations in which a winding up petition is particularly useful: if there is a quasi-partnership and the shareholder is excluded from management, there is a deadlock which prevents company decisions being made or if there is a loss of stratum.
In the leading case of Ebrahimi v Westbourne Galleries Ltd, the House of Lords gave guidance as to when quasi-partnerships could be wound up. In this case a quasi-partnership was formed from an established partnership which then formed a company. Lord Wilberforce said that while just and equitable winding up did not allow the petitioner to disregard the articles of association, the court is not limited to considerations of the parties’ strict legal rights. The question is whether the exercise of the legal rights created by the articles, or other agreements is subject to equitable considerations and if so, where the exercise used is inequitable.
In this case, Ebrahimi had a legitimate expectation to remain involved in management, so when the other directors voted to remove him, the court granted a just and equitable winding up. This is an important remedy in quasi-partnerships because where the shareholder will no longer have a managerial role, they will not receive dividends and so does not receive return on this capital investment. If it is a private company their money will be locked in as the shares are not quoted on any market. Even if they can find a private buyer it is unlikely, they would want to pay much as the shares come with no income, no control and no managerial participation. It is for these reasons it is just and equitable in a quasi-partnership specifically. The share lock in problems will not occur in a public company and so it is unlikely to work in these circumstances (Lord Wilberforce, Ebrahimi),
Deadlock may lead to a winding up where there is a complete breakdown in relations between the parties, making it impossible for decisions about the company’s business to be made (Re Yenidje Tobacco Co Ltd). A petition will fail if the deadlock is attributable to the petitioner’s fault (Hawkes v Cuddy).
Winding up may also be available where the original purpose of the company has been achieved or may no longer be pursued. It is not sufficient to show the main commercial purpose cannot be pursued; all commercial pursuits contemplated must be incapable of being achieved. (Re Perfectair Holdings Ltd). The court may still decline to wind up the company if the majority shareholders and creditors wish to conduct an orderly winding up rather placing the company in liquidation.
Just and equitable winding up will not however, be satisfactory where the business makes its profits from business contracts and ‘know-how’ as there are less assets to be divided among the shareholders.
No matter the grounds being relied on, a winding up order will not be made if the court thinks that there is another remedy available and it is unreasonable to seek the winding up of the company rather than pursuing that other remedy (s124(2), IA 1986).
The relationship between just and equitable winding up and the unfair prejudice regime set out in CA 2006, s994 has generally been assumed to be overlapping although not identical (My book). The Court of Appeal in Re Neath Rugby Limited noted that, in O’Neil v Phillips, Lord Hoffmann made it clear the requirements were parallel, but not the same. He said in many cases the conduct of the respondent may give rise both to the jurisdiction under s 994 and to that under s 122(1)(g) but there may be cases which satisfy requirements of one jurisdiction but not the other. For example, unfair conduct is not needed for just and equitable grounds and hence loss of substratum is grounds for winding up such as in Re German Date Coffee Co.
An unfair prejudice petition may be presented by non-members to whom shares in the company have been transferred pre-registration of the transfer whereas a winding up petition may only be brought by shareholders satisfying the above criteria. A petitioner for winding up must also demonstrate a tangible benefit with the result that petitions for the winding up of insolvent companies will in general be struck out, conversely unfair prejudice petitions may be brought in respect of insolvent companies where the unfairly prejudicial conduct has caused the insolvency or where harm will be occasioned to the interests of the petitioning member in some other capacity.
An unfair prejudice petition allows petitioners to claim for actual or proposed acts or omission of the company which constitute the conduct of the company’s affairs in a manner that is unfairly prejudicial to the petitioner’s interests as a member (REF).
Members of a company and persons to whom shares have been transferred (either voluntarily or by operation of law) (s994(1-2) CA, 2006) may claim for unfair prejudice petition in respect of companies incorporated under the Companies Act 1985, the CA 2006 or which were existing company’s for the purposes for CA 1985 (s994(3) CA 2006). This provision excludes members of foreign companies (s 1044, CA 2006) from obtaining unfair prejudice relief unlike the winding up of companies. Unfair prejudice jurisdiction remains available even if the company is insolvent (Gamlestaden Fastigheter AB v Baltic Partners Ltd), in liquidation (Edgerley v PW Edgerley Ltd), or in administration (Thakrar v Ciro Citterio Menswear plc In Administration).
The affairs of the company are extremely wide and should be construed liberally (Re Neath Rugby Ltd (No 2), Hawkes v Cuddy). They encompass all matters that can come before the company board for consideration (Rackind v Gross). In R v Board of Trade, ex p St Martin Preserving Co Ltd, Phillimore J held that the company’s affairs included its goodwill, its profits or losses, its contracts and assets including its shareholding in and ability to control the affairs of a subsidiary. The court will not adopt a technical or legalistic approach to what constitutes the affairs of the company but will look at business realities (Re Coroin Ltd (No 2), McKillen v Misland (Cyprus) Investments Ltd).
This includes breaches of fiduciary duty by directors (Rock (Nominees) Ltd v RCO (Holdings)plc), mismanagement (Re Marco (Ipswitch) Ltd), failure to pay proper dividends (Re Gate of India (Tynemouth) Ltd) or payment of excessive remuneration (Re Halt Garage), breaches of the articles or shareholders’ agreements (Re Woven Rugs), exclusion from management (Re I Fit Global Ltd). But did not include the theft by a director of money belonging to the company, although constituting breach of fiduciary duty, as it did not relate to the affairs of the company (Re Stewarts (Brixton) Ltd).
The conduct must also be prejudicial to the members’ interests as members. Although the primary source of rights as a member are in the articles of association and collateral agreements (O’Neill v Phillips) authorities will give a ‘generous interpretation’ to the concept of member’s interests (Re Neath Rugby Ltd Hawkes v Cuddy (No 2)), which are not limited to the member’s strict legal rights (Re A Company (No 00477 of 1986). Lord Hoffman explained in O’Neill v Phillips this is not to be too narrowly or technically construed. This approach is particularly evident in quasi-partnership cases (Re a Company (No 0877 of 1986).
In Re a Company (No 00477 of 1986), Hoffman J held that the word ‘unfairly’ enables the court to regard wider equitable considerations, for instance a managing director of a large public company has clear differences between this role and owning a small shareholding in the company. However, in the case of a small private company with only a couple of members who earn their living by working as a director, the distinction is more elusive. In this case his dismissal from office and exclusion from management may be unfairly prejudicial to his interests as a member. The interests of members have now been held to include employment or office as director (Re a Company (No 00477 of 1986), participation in management (Re a Company (No 003160 of 1986), and the right to be consulted about policy decisions affecting the company (Re Elgindata Ltd).
There must always be a causal link between the conduct complained of and the unfair prejudice suffered by the shareholder (Re BSB Holding Ltd (No 2). The petitioner cannot succeed unless he can show that the conduct complained of is both prejudicial and unfair (Re Neath Rugby Ltd, Hawkes v Cuddy (No 2)).
A member will be able to establish prejudice where he can show that the economic value of his shareholding has been seriously diminished or put in jeopardy by the conduct of which complaint is made (Bovey Hotel Ventures Ltd) or that he has suffered or may suffer economic prejudice in come capacity connected with his shareholding (Gamlestaden Fastigeheter v Baltic Partners Ltd). Prejudice is also capable of being established otherwise than in a pure economic sense (RA Noble & Sons (Clothing) Ltd).
Fairness is contextual, so what is fair between competing businessmen may not be regarded as fair as between members of a family running a family business (O’Neill v Phillips). However, despite the flexibility of the concept of fairness, CA 2006, s994 does not permit a judge to make whatever order he thinks is fair in the circumstances of the particular case (O’Neill v Phillips): the concept of fairness must be applied judicially and the content which it is given by the courts must be based on rational principles.
The only case on statutory unfair prejudice provisions to have reached the House of Lords, O’Neill v Phillips, addressed what unfair means. In this case, O’Neill was the de facto managing director with an agreement to have a 50% share of the profit and discussions for him to gain 50% of the shareholding. Phillips, the majority shareholder, started to doubt his management and consequently took back control of the company and repudiated the profit-sharing agreement. O’Neill brought a 994 petition but this was unsuccessful because Phillips had not agreed that the profit-sharing agreement would continue in all circumstances and so it was not unfair.
Lord Hoffman concluded that unfairness may consist in a breach of the rules of the company or in using the rules in a manner which equity would regard as contrary to good faith. Breach of contract is not necessarily unfair if it does not relate to the conduct of the company’s affairs (Sikorski v Sikorski) or if it is a trivial or technical infringement (Irvine v Irvine (No 1)). Whether equitable considerations arise should be determined using the background and context of the petitioner’s relationship with the company (O’Neill).
The question of whether equitable considerations arise between the parties has to be determined in the context and background of the whole relationship between the petitioner and the other members of the company (O’Neill). Lord Hoffman emphasised in O’Neill v Phillips that the elements identified by Lord Wilberforce in Ebrahimi v Westbourne Galleries Ltd in relation to quasi-partnership can also lead to equitable considerations for 994 petitions.
In Re Saul D Harrison & Sons plc Hoffmann LJ (as he then was) confirmed that unfairness must be judged on an objective basis. Jonathan Parker J held in Re Guidezone Ltd that it was effectively resolved in O’Neill v Phillips when it established that ‘unfairness’ is not to be judged by reference to subjective notions of fairness, but rather by testing whether, applying established equitable principles, the majority has acted, or is proposing to act, in a manner which equity would regard as contrary to good faith. As such it is not necessary for the petitioner to prove that the majority acted in bad faith (Re Sunrise Radio Ltd), or that they had a subjective intent to conduct the company’s affairs in an unfairly prejudicial manner (Re a Company (No 00789 of 1987), ex p Shooter).
A s994 does not allow a remedy where there is no fault. Therefore, the petitioner does not gain an entitlement to ‘put’ his shares on the company at full value (Amin v Amin). This is also applicable to deadlock between shareholders. It is only when the deadlock is brought about by independent unfairly prejudicial conduct on the part of the respondent (as was the case in Re Phoneer Ltd) that the court has power to grant relief under s 996.
Ca 2006, s996(1) provides that is the court is satisfied that a petition under CA 2006, Part 30 is well founded it may make such order as it thinks fit for giving relief in respect of the matters complained of.
Because relied under CA 2006, s994 is discretionary, the onus is on the petitioner to establish that relief ought to be granted to him, and even if he is successful in demonstrating unfair prejudice, he may still find he is denied a remedy (Amin v Amin). In Antoinades v Wong unfair prejudice was found to have occurred but a remedy was refused on the grounds that a winding up order would have been the proper relief. Other bars to relief include refusal by the petitioner of a fair offer to purchase his share, express provisions for an exit route in the company’s articles of association or in a shareholder agreement, misconduct on the part of the petitioner and delay in presenting the petition and/or acquiescence in the alleged unfairly prejudicial conduct
The relief available is any such order as the court thinks fit to remedy the unfair prejudice. This includes ordering the purchase/sale of the petitioner’s shares at a price and on terms to be determined by the court, regulating the conduct of the company’s future affairs, requiring the company to refrain from, or carry out, an act or authorising proceedings to be commenced in the name of the company (s 996(2) CA, 2006).
- Use this to check the arguments made for the statutory claims.
- Maybe look at the remedies a little bit more??
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