Derivative Actions

Question 1

What is derivative action?

Answer 1

This is where minority shareholders can bring a claim on behalf of a company for wrong done to it.

Question 2

What is the first rule in Foss v Harbottle

Answer 2

The Proper Plaintiff Rule: company can sue for wrongs committed against it (such as breach of directors duties) - not its individual members

Question 3

What is the second rule in Foss v Harbottle

Answer 3

The Majority Approval Rule: where alleged wrong is one that is binding on a company through a majority approval, no individual member is allowed to bring an action in respect of it

Question 4

What is the first exception to derivative action?

Answer 4

Ultra Vires Actions - the company did something it was not legally empowered to do

Question 5

What is the second exception to Foss v Harbottle

Answer 5

Non compliance with special procedures outlined in constitution

Question 6

What is the third exception to Foss v Harbottle?

Answer 6

Personal rights were infringed

Question 7

What is the fourth exception?

Answer 7

Fraud on the minority - the majority of members who control the company had perpetrated some fraud

Question 8

What are the 2 conditions to the rule in Foss v Harbottle?

Answer 8

1) Fraud has been perpetrated by the directors of the company
2) those who are guilty of fraud are in control of the company

Question 9

What were the reasons for reforming derivative actions?

Answer 9

1) Court approach too restrictive
2) Exceptions poorly defined
3) Vast body of case law
4) Suboptimal enforcement

Question 10

Where are derivative actions covered?

Answer 10

Ss 260-269 of CA, supplemented by the amended Civil Procedure rules.

Question 11

What does reform allow?

Answer 11

1) It expands the grounds on which a derivative action can be brought
2) Multi-state procedure to filter frivolous claims

Question 12

What does s260 under CA 2006 hold?

Answer 12

A derivative action can only be bought in respect or a cause of action arising from actual or proposed act or omission, involving negligence, default, breach of duty or breach of trust by a director of the company.
Cause of action may be against director or another person

Question 13

What is stage 1?

Answer 13

S261(1) A claimant must apply for court’s permission to continue the action; if not established case must be dismissed 261(2).

Question 14

What is the test for 261(1)?

Answer 14

Evidence submitted by claimant must show that at first sight the company has a cause of action arising out director default. The test for demonstrating prima facie case, has a low threshold and virtually all applications are heard thus far have passed this test.

Question 15

What is stage 2?

Answer 15

S263(2) court must refuse permission if following conditions met:
1- no person acting accordance with s172 Duty to promote the success of the company would continue the action
2 - where it relates to an act or omission yet to occur, which has been authorised by the company
3 - where is related to an act or omission that has already occurred, and was authorised before or after it occurred.

Question 16

What is stage 3?

Answer 16

S263(3) and (4) Factors to consider - there are 5

Question 17

1

Answer 17

Is the member acting in good faith?

Question 18

2

Answer 18

Would a person acting in accordance with s172 duty promote the success of the company attach much importance to continuing the claim?

Question 19

3

Answer 19

Is it likely that the company will authorise the act or omission in question?

Question 20

4

Answer 20

Has the company already decided not to pursue the claim?

Question 21

5

Answer 21

Does the act or omission given rise to a cause of action that the member could pursue his own right rather than on behalf of the company (does it give rise to a UPP)

Question 22

6

Answer 22

263(4) requires court to consider: what are the views of the members of the company who have no personal interest in the matter. This is the question of ratification by disinterested minority (neither the wrongdoers nor the members pursuing the claim)

Question 23

What is the hypothetical director?

Answer 23

S263 CA 2006 forces the court to consider the hypothetical director (that acts in accordance with the duty to promote the success of the company) when deciding whether or not a derivative action should proceed.

Question 24

How does the court consider the hypothetical director?

Answer 24

1) Under 263(2), the court must dismiss the claim if not hypothetical director would continue it
2) Under 260(3) the court must be satisfied that a hypothetical director would attach some importance to continuing the claim

Question 25

What is the problem with the hypothetical director?

Answer 25

Restrictive approach due to its high threshold

Question 26

What cases illustrate the court's restrictive approach?

Answer 26

1) Mission Capital Plc v Sinclair Applying s263, court found although a director might continue claim (that former directors had been wrongfully dismissed and dismissal would harm the company), but they would not attach importance to it. Alleged harm to the company is speculative, and hypothetical director more likely to replace directors, not reinstate them.

Question 27

What other case illustrates court's restrictive approach with the hypothetical director?

Answer 27

2) Franbar Holdings Ltd v Patel: Hypothetical director will not just consider breach of directors duties, but also cost of proceedings; potential award of damages; disruptions to business operations etc. Considering there other causes of action available e.g. Breach of shareholders' agreement or UPP, he felt a hypothetical director would attach little importance to the claim.

Question 28

What is the relevance of Stimpson v Southern Private Landlords?

Answer 28

Deliberations of hypothetical director acting under s172: more complex because 172(2) requires non profit purposes to be borne in mind. So this and 171(1) had to be considered. Also, where non profit purposes of the company and benefits of the members are equivalent, unlikely that hypothetical director would continue the claim as it would have disruptive effect on membership.

Question 29

Why may it be difficult to say how much importance would be attached to the claim?

Answer 29

It would be difficult to say if much important ace would be attached to the claim as we do not know the potential value of whether act profitable move or not.

Question 30

Where derivative action stems from personal conflict, what is best solution?

Answer 30

In many cases, derivative action stems from personal conflicts between directors, who are also members. Unless there is serious wrongdoing involved, the best resolution tends to be UPP, not derivative action.

Question 31

Should alternative action be an absolute bar?

Answer 31

No. Kiani v Cooper, Stainer v Lee - just because an action can also be brought on behalf of the company through a UPP, it doesn't mean that the applicant should be blocked from bringing a derivative action.

Question 32

What is the distinction between authorisation and ratification?

Answer 32

Authorisation comes before the fact (before alleged wrong doing) whereas ratification comes after the fact.

Question 33

What is ratification covered by?

Answer 33

It is covered by s239 of CA 2006. Acts must be ratified at a general meeting. However; any votes from director (or any member associated) whose acts are being ratified have their votes discounted. Therefore, wrong doers control the board and the general meeting, their votes cannot be taken to ratify the wrong doing.

Question 35

What does s263(4) hold?

Answer 35

Court needs to consider when deciding whether or not to grant permission to continue derivative action is the views of members with no directs or indirect personal interests in the matter. This is to prevent majority shareholders connected to wrongdoing having control.

Question 36

What is the enforcement problem?

Answer 36

When director breaches his duties, they have wronged the company; the company would be claimant. However, directors decide whether or not to litigate. So while a company had the right to sue director in breach, it is whether directors to sue. Also, directors are unlikely to initiate proceedings against himself and co-directors.

Question 37

Even though Fraud on the Minority was effectively abolished by the CA 2006, what three things are still relevant?

Answer 37

1) Fraud has a broad definition 2) When considering wrongdoer control, necessary to distinguish De Facto v De Jure Control. DJC when the wrongdoers legally control majority of the shares. DF when wrongdoers control voting but not legal majority.

Question 38

Give an example of a case where courts are willing to grant permission to a derivative action:

Answer 38

In Kiani v Cooper - whether there is strong evidence of wrong doing and a lot of money to potentially be recovered, a claim is more likely to be permitted