Majority Rule and Wrongs against the Company Flashcards
Foss v Harbottle (1843) 2 Hare 461
In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself. This is known as “the proper plaintiff rule”, and the several important exceptions that have been developed are often described as “exceptions to the rule in Foss v Harbottle”. Amongst these is the “derivative action”, which allows a minority shareholder to bring a claim on behalf of the company. This applies in situations of “wrongdoer control” and is, in reality, the only true exception to the rule. The rule in Foss v Harbottle is best seen as the starting point for minority shareholder remedies.
The rule has now largely been partly codified and displaced in the United Kingdom by the Companies Act 2006 sections 260–263, setting out a statutory derivative claim.
Foss v Harbottle (1843) 2 Hare 461, 67 ER 189 is a leading English precedent in corporate law. In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself. This is known as “the proper plaintiff rule”, and the several important exceptions that have been developed are often described as “exceptions to the rule in Foss v Harbottle”. Amongst these is the “derivative action”, which allows a minority shareholder to bring a claim on behalf of the company. This applies in situations of “wrongdoer control” and is, in reality, the only true exception to the rule. The rule in Foss v Harbottle is best seen as the starting point for minority shareholder remedies.
The rule has now largely been partly codified and displaced in the United Kingdom by the Companies Act 2006 sections 260–263, setting out a statutory derivative claim.
Facts
Richard Foss and Edward Starkie Turton were two minority shareholders in the “Victoria Park Company”. The company had been set up in September 1835 to buy 180 acres (0.73 km2) of land near Manchester and, according to the report,
enclosing and planting the same in an ornamental and park-like manner, and erecting houses thereon with attached gardens and pleasure-grounds, and selling, letting or otherwise disposing thereof.
This became Victoria Park, Manchester. Subsequently, an Act of Parliament incorporated the company.[1] The claimants alleged that property of the company had been misapplied and wasted and various mortgages were given improperly over the company’s property. They asked that the guilty parties be held accountable to the company and that a receiver be appointed.
The defendants were the five company directors (Thomas Harbottle, Joseph Adshead, Henry Byrom, John Westhead, Richard Bealey) and the solicitors and architect (Joseph Denison, Thomas Bunting and Richard Lane); and also H. Rotton, E. Lloyd, T. Peet, J. Biggs and S. Brooks, the several assignees of Byrom, Adshead and Westhead, who had become bankrupts.
Judgment
Wigram VC dismissed the claim and held that when a company is wronged by its directors it is only the company that has standing to sue. In effect the court established two rules. Firstly, the “proper plaintiff rule” is that a wrong done to the company may be vindicated by the company alone. Secondly, the “majority rule principle” states that if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not interfere (legal term).
Developments
The rule was later extended to cover cases where what is complained of is some internal irregularity in the operation of the company. However, the internal irregularity must be capable of being confirmed/sanctioned by the majority.
The rule in Foss v Harbottle has another important implication. A shareholder cannot generally bring a claim to recover any reflective loss – a diminution in the value of his or her shares in circumstances where the diminution arises because the company has suffered an actionable loss. The proper course is for the company to bring the action and recoup the loss with the consequence that the value of the shares will be restored.
Because Foss v Harbottle leaves the minority in an unprotected position, exceptions have arisen and statutory provisions have come into being which provide some protection for the minority. By far and away the most important protection is the unfair prejudice action in ss. 994-6 of the Companies Act 2006 (UK) (s 232 Corporations Act 2001 in Australia). Also, there is a new statutory derivate action available under ss 260–269 of the 2006 Act (and s 236 Corporations Act 2001 in Australia).
Exceptions to the rule
There are certain exceptions to the rule in Foss v. Harbottle, where litigation will be allowed. The following exceptions protect basic minority rights, which are necessary to protect regardless of the majority’s vote.
- Ultra vires and illegality
The directors of a company, or a shareholding majority may not use their control of the company to paper over actions which would be ultra vires the company, or illegal.
s 39 Companies Act 2006 for the rules on corporate capacity Smith v Croft (No 2) and Cockburn v. Newbridge Sanitary Steam Laundry Co. [1915] 1 IR 237, 252–59 (per O'Brien LC and Holmes LJ) for the illegality point
- Actions requiring a special majority
If some special voting procedure would be necessary under the company’s constitution or under the Companies Act, it would defeat both if that could be sidestepped by ordinary resolutions of a simple majority, and no redress for aggrieved minorities to be allowed.
Edwards v Halliwell [1950] 2 All ER 1064
- Invasion of individual rightsPender v Lushington (1877) 6 Ch D 70, per Jessel MR
…and see again, Edwards v Halliwell [1950] 2 All ER 1064
- “Frauds on the minority”Atwool v Merryweather (1867) LR 5 EQ 464n, per Page Wood VC
Gambotto v WCP Limited (1995) 182 CLR 432 (Aus)
Daniels v Daniels (1978)
fraud in the context of derivative action means abuse of power whereby the directors or majority, who are in control of the company, secure a benefit at the expense of the company
…and see Greenhalgh v Arderne Cinemas Ltd for an example of what was not a fraud on the minority
Edwards v Halliwell [1950] 2 All ER 1064
FACTS: Rule 19 of the union constitution required a ballot and a two-thirds approval level by members. Instead a delegate meeting had purported to allow the increase without a ballot.
if a simple majority can make an action binding, then no case can be brought. But there are exceptions to the rule. First, if the action is ultra vires a member may sue. Second, if the wrongdoers are in control of the union’s right to sue there is a “fraud on the minority”
a company should not be able to bypass a special procedure or majority in its own articles. This was relevant here. And fourth, as here, if there is an invasion of a personal right. Here it was a personal right that the members paid a set amount in fees and retain membership as they stood before the purported alterations.
Edwards v Halliwell [1950] 2 All ER 1064 is a UK labour law and UK company law case about the internal organisation of a trade union, or a company, and litigation by members to make an executive follow the organisation’s internal rules.
Facts
Some members of the National Union of Vehicle Builders sued the executive committee for increasing fees. Rule 19 of the union constitution required a ballot and a two-thirds approval level by members. Instead a delegate meeting had purported to allow the increase without a ballot.
Judgment
Jenkins LJ granted the members’ application. He held that under the rule in Foss v Harbottle the union itself is prima facie the proper plaintiff and if a simple majority can make an action binding, then no case can be brought. But there are exceptions to the rule. First, if the action is ultra vires a member may sue. Second, if the wrongdoers are in control of the union’s right to sue there is a “fraud on the minority”, and an individual member may take up a case. Third, as pointed out by Romer J in Cotter v National Union of Seamen[1] a company should not be able to bypass a special procedure or majority in its own articles. This was relevant here. And fourth, as here, if there is an invasion of a personal right. Here it was a personal right that the members paid a set amount in fees and retain membership as they stood before the purported alterations.
Jenkins LJ gave the following reasons.
The rule in Foss v Harbottle, as I understand it, comes to no more than this. First, the proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself. Secondly, where the alleged wrong is a transaction which might be made binding on the company or association and all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company or association is in favour of what has been done, then cadit quaestio. No wrong has been done to the company or the association and there is nothing in respect of which anyone can sue. If, on the other hand, a simple majority of members of the company or association is against what has been done, then there is no reason why the company or association itself should not sue. In my judgment, it is implicit in the rule that the matter relied on as constituting the cause of action should be a cause of action properly belonging to the general body of corporators or members of the company or association as opposed to a cause of action which some individual member can assert in his own right. The cases falling within the general ambit of the rule are subject to certain exceptions. It has been noted in the course of argument that in cases where the act complained of is wholly ultra vires the company or association, the rule has no application because there is no question of the transaction being confirmed by any majority. It has been further pointed out that where what has been done amounts to what is generally called in these cases, a fraud on the minority and the wrongdoers are themselves in control of the company, the rule is relaxed in favour of the aggrieved minority who are allowed to bring what is known as a Minority Shareholder's action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievance would never reach the court because the wrongdoers themselves being in control, would not allow the company to sue. Those exceptions are not directly in point in this case, but they show, especially the last one, that the rule is not an inflexible rule and it will be relaxed where necessary in the interests of justice. There is a further exception which seems to me to touch this case directly. That is the exception noted by Romer J. in Cotter v National Union of Seamen. He pointed out that the rule did not prevent an individual member from suing if the matter in respect of which he was suing was one which could validly be done or sanctioned, not by a simple majority of the members of the company or association, but only by some special majority, as, for instance, in the case of a limited company under the Companies Act, a special resolution duly passed as such. As Romer J. pointed out, the reason for that exception is clear, because otherwise, if the rule were applied in its full rigour, a company, which, by its directors, had broken its own regulations by doing something without a special resolution which could only be done validly by a special resolution could assert that it alone was the proper plaintiff in any consequent action and the effect would be to allow a company acting in breach of its articles to do de facto by ordinary resolution that which according to its own regulations could only be done by special resolution. That exception exactly fits the present case inasmuch as here the act complained of is something which could only have been validly done, not by a simple majority, but by a two-thirds majority obtained by ballot vote. In my judgment, therefore, the reliance on the rule in Foss v Harbottle in the present case may be regarded as misconceived on that ground alone.[2]
MacDougall v Gardiner (1875) 1 ChD 13
Judgement for the case Macdougall v Gardiner Chairman of a meeting of shareholders wrongfully (i.e. in breach of articles) refused to call a poll when one was requested by a shareholder (C). Shareholder sued. Held: ·
- Refusal did not infringe personal right of C. ·
- Therefore C was not entitled to bring personal action
- Rather the proper claimant was company.
Judgement for the case Macdougall v Gardiner
Chairman of a meeting of shareholders wrongfully (i.e. in breach of articles) refused to call a poll when one was requested by a shareholder (C). Shareholder sued. Held:
· Refusal did not infringe personal right of C.
· Therefore C was not entitled to bring personal action
Ø Rather the proper claimant was company.
MacDougall v Gardiner [1875] concerns the legality of the chairman’s refusal to accept a request for a poll.
Keywords:
Company law – Articles of association – General meeting – Adjournment – Company’s internal mechanisms – Court of Appeal
Facts:
In the case of MacDougall v Gardiner [1875], a company’s articles of association gave the chairman of the general meeting power to adjourn with the consent of the meeting. The articles also provided that a poll should be taken if it was demanded by five or more members. During a general meeting, a member proposed the adjournment of the meeting. When this resolution was passed on a show of hands, the chairman declared it to be carried. Five members demanded that a poll be taken on the question of whether there should be an adjournment, but the chairman refused to hold the poll and immediately left the room. Then the members brought an action, asking for, inter alia, a declaration that the conduct of the chairman was illegal and improper.
Issue:
Whether the refusal of the chairman to accept a request for a poll was illegal?
Held:
The Court of Appeal dismissed the action. The court found that there was no point in litigation. The present matter could be remedied by the company’s own internal mechanisms. In particular, the majority of the members of the company were entitled to put right this matter by a resolution to that effect. Thus, in these circumstances the matter was not enforceable by personal action.
Sharp v Blank [2019] EHWC 3096 (Ch)
- Court rejects shareholder claim against directors for improper takeover recommendation
- The High Court has rejected a claim by a group of shareholders of a company against its directors for improperly recommending a reverse takeover and failing to disclose material information.
Court rejects shareholder claim against directors for improper takeover recommendation
The High Court has rejected a claim by a group of shareholders of a company against its directors for improperly recommending a reverse takeover and failing to disclose material information.
The case is fiercely complex. The judgment is very long (994 paragraphs) and fact-heavy (the first 609 paragraphs are a detailed explanation of the build-up to and aftermath of the takeover), but it is interesting reading for anyone keen to know more about how the transaction unfolded.
We have attempted to distil the key points below.
What happened?
Sharp v Blank [2019] EWHC 3096 (Ch) concerned the 2009 takeover of HBOS plc (formerly Halifax Bank of Scotland) by Lloyds TSB Group plc to create what would become the Lloyds Banking Group.
Lloyds and HBOS jointly announced the proposed takeover in mid-September 2008. The deal was structured as an all-share offer, with HBOS shareholders to receive 0.83 shares in Lloyds for each share they held in HBOS. This naturally had a dilutive effect on Lloyds’ existing shareholders.
The acquisition constituted a “reverse takeover” under the Listing Rules. This required (among other things) Lloyds to send a circular to its shareholders explaining the transaction and seeking shareholder approval for it.
The takeover arose during the tail end of the global financial crisis of 2007/2008. Lloyds and HBOS were both particularly affected by the crisis. They engaged with the Bank of England, Treasury and Financial Services Authority (as the FCA was then called) to discuss a series of recapitalisations to bolster their balance sheets.
The result was a decision that (assuming the takeover succeeded) the combined group would raise a further £17 billion from recapitalisations, of which Lloyds would bear £5.5 billion. Initially, Lloyds would raise £1 billion through an issue of preference shares to the UK Government and a further £4.5 billion through an open offer. There would be a further capitalisation round in 2009. Were Lloyds not to proceed with the takeover, it would need to recapitalise to the tune of £7 billion.
The key point here is that capitalisations would further dilute existing Lloyds shareholders. However, having conducted due diligence on HBOS (particularly its loan book), Lloyds’ directors continued to view the takeover as a value-generative transaction for shareholders as a whole.
The directors issued a second announcement in mid-October 2008 confirming again that they intended to proceed with the takeover, albeit at a lower offer price, and setting out the recapitalisation proposals.
In early November 2008, the Lloyds board sent a circular to the company’s shareholders, unanimously recommending the takeover and inviting them to vote in favour. As required, the circular contained a significant amount of financial and non-financial information on Lloyds and HBOS.
Lloyds’ shareholders approved the takeover in mid-November 2008. 52.2% of shareholders (by value of shares held) attended the general meeting. 96% of those shareholders voted in favour. HBOS’ shareholders approved the takeover in mid-December. The acquisition completed in January 2009.
What was the claim?
Some years later, a group of 5,803 current and former shareholders of Lloyds (the claimants) launched a claim against most of the executive directors of Lloyds at the time of the takeover.
In a nutshell, the claimants alleged that the takeover had overvalued HBOS and that their shareholdings in Lloyds had been disproportionately diluted, in turn bringing their value down.
They put forward two separate but interlinked claims:
The recommendation claim. By recommending the offer and providing advice on how to vote on it, the directors had assumed a duty of care to shareholders. That duty required them to use reasonable care and skill when deciding whether to make the recommendation. Based on what they knew, the directors should not have recommended the takeover, because it represented a “dangerous and value-destroying strategy which involved unacceptably risky decisions”. They said this applied not only when the directors sent the circular to shareholders, but also when they made the announcements to the market. The disclosure claim. The directors had included information in the circular on which they knew shareholders would rely and so were under a duty to ensure it was accurate. In addition, because the circular was published in connection with a shareholder meeting, the directors were obliged to ensure it contained sufficient information to help shareholders decide how to vote at that meeting. However, the circular had omitted material information. For example, it did not disclose emergency facilities to HBOS provided by Lloyds, the Bank of England and the US Federal Reserve. It did not explain that the level of HBOS’ losses would require the combined group to raise further capital in 2009. And it suggested there had been no significant change in HBOS’ financial or trading position in the four months prior to its publication.
Both of these errors artificially inflated the price of HBOS’ shares. Had the directors not recommended the offer and had the circular been accurate, the value of HBOS would have been clear to the market. The shareholders would have rejected the offer and the claimants would not have been unduly diluted.
These were both detailed claims that required a lot of analysis. We discuss the recommendation claim below. We will cover the disclosure claim next week.
Was there a duty of care, and when did it arise?
The directors had published the circular specifically to help Lloyds shareholders decide whether to approve the takeover. The circular contained a statement by each director that the information in it was “in accordance with the facts” and did not “omit anything likely to affect [its] import”. This placed the directors under a duty to shareholders to exercise reasonable care and skill when deciding whether to recommend the offer.
However, the directors had not been under a similar duty when making the announcements to the market. The purpose of those announcements was merely to comply with regulatory obligations, unlike the circular, which had been prepared specifically for the purpose of eliciting support for the offer. Moreover, the announcements had been made to the public generally, unlike the circular, which had been sent to specific intended recipients.
The judge thought it would be a “big leap” to make directors personally liable for an announcement to the market. To do that, the claimants would need to show that there had been something more than “routine involvement” by the directors in producing the announcements.
A regulatory announcement at the outset of a transaction was “distinctly and immediately recognisably different” from providing advice to shareholders about how to respond to the transaction. And the announcements in this case had specifically advised shareholders to read the formal documentation in due course before making a decision. They had not assumed any duty to shareholders.
Did the directors breach their duty to shareholders?
It is important to note at this point that the duty of care which the Lloyds directors owed to its shareholders was distinct from their “directors’ duties”, which they owed to Lloyds itself. The duties owed by the directors to Lloyds arose out of the Companies Act 2006 and applied at all times.
The duty they owed to shareholders, however, came about as a matter of common law solely because the directors voluntarily assumed responsibility for issuing advice to shareholders about the takeover.
However, the directors’ duty to shareholders to exercise reasonable care and skill was, in the judge’s view, “consonant” with the statutory duty they owed to the company under section 174, Companies Act 2006 to use exercise care, skill and diligence, and so he approached the issue in the same way.
The question also merged into the directors’ general duty to the company (Lloyds) to promote its success for the benefit of its shareholders as a whole. In exercising their duty to use reasonable care and skill, the directors needed to consider what was in the best interests of shareholders.
With this in mind, the judge made the following comments:
Although the directors owed a duty of care to the company’s shareholders at the time the circular was sent, they had to discharge that duty by considering the interests of the company’s shareholders from time to time. That meant taking a long-term view of the benefit of the takeover to the company, rather than its short-term impact on the shareholders at the time. The directors had honestly to believe that the takeover was in the shareholders’ best interests (the “subjective test”). But that belief also had to be one that a reasonable director would hold (the “objective test”). If those tests were met, the directors would not be liable for “errors of judgment”. The fact that the directors obtained and acted on expert advice went a long way towards satisfying their duty to exercise reasonable care and skill, although it was not a complete substitute for it. Having obtained advice, the directors still needed to reach their own decision.
In the judge’s view, a reasonably competent chairman or executive director of a large bank could reasonably have reached the view that the takeover was beneficial to Lloyds’ shareholders. This was supported by various pieces of evidence:
The Lloyds board – including its highly regarded and widely experienced senior non-executive directors – had unanimously approved the takeover. The acquisition was also supported by the UK Government and the IMF. There was no basis for assuming that HBOS was “worthless”. The fact that it had sought emergency funding did not deprive HBOS of “all value” (or else that funding would never have been forthcoming). Nor did it follow that HBOS’ shares had no value merely because it was hard to value its business. The question was whether HBOS held any value to Lloyds. There was a rational basis for believing that the takeover had an “upside” in the form of synergy value. There was no evidence that Lloyds had undertaken inadequate due diligence of HBOS. Severe impairments made by HBOS did not mean the transaction was unwise. They had to be considered in the context of the proposal as a whole. The board received working capital reports from two accounting firms and advice from three investment banks. It carefully reviewed them and a recent FSA analysis before reaching its decision. Nothing suggested there was so significant a risk of a dilutive capital raise that the acquisition was not beneficial to Lloyds’ shareholders. This detailed part of the judgment (paras 698-745) focusses on several technical regulatory issues and will be an interesting read for those working at financial institutions. Lloyds faced a choice of proceeding with the takeover and raising £5.5 billion of capital, or abandoning it and raising £7 billion. The directors had been advised that the former was “less dilutive”. The takeover entailed risks, and the judge saw a “strong case” that the directors had misjudged the decision, but there was no evidence they had weighed those risks up inadequately.
He therefore refused to find that the defendants had breached their duty when recommending the offer.
For company directors, this decision is helpful and should be of great comfort. The backdrop to this case was a large, high-profile public takeover that took place at speed during a time of unprecedented economic turmoil.
But the principles the judge applied are no less relevant to any other public takeover, or (indeed) when reaching out to shareholders on a private company takeover. Courts will judge directors’ actions by a reasonable standard and will be reluctant to step in and re-evaluate their commercial decisions.
When recommending or commenting on the merits of a proposed transaction, the directors of a company may well incur obligations directly towards shareholders. It is therefore critical to seek to fully evaluate the proposals before issuing advice. Steps boards can take include the following:
Conduct extensive due diligence into a potential target or acquirer to understand fully the dynamics and effects of any potential proposal. Seek appropriate professional advice. Critically challenge and scrutinise that advice to ensure it accords with and supports the board’s views on the proposal. In deciding whether a transaction will benefit their company, consider the interests of the shareholders as a whole in the medium to long term. Document the reasons why a particular proposal is in the company’s interests. The board will need to be able to show that a reasonable director would have reached the same decision. Ensure that any communications or announcements make it clear whether advice or a recommendation is being given or is to follow separately.
Wallersteiner v Moir (No.2) [1975] 2 QB 373
Wallersteiner v Moir (No 2) [1975] QB 373 is a UK company law case, concerning the rules to bring a derivative claim. The updated law, which replaced the exceptions and the rule in Foss v Harbottle, is now contained in the Companies Act 2006 sections 260-264, but the case remains an example of the likely result in the old and new law alike.
Wallersteiner v Moir (No 2) [1975] QB 373 is a UK company law case, concerning the rules to bring a derivative claim. The updated law, which replaced the exceptions and the rule in Foss v Harbottle, is now contained in the Companies Act 2006 sections 260-264, but the case remains an example of the likely result in the old and new law alike.
This case followed on from a previous decision, Wallersteiner v Moir,[1] that concerned piercing the corporate veil.
Facts
Mr Moir, a minority shareholder, in the course of an ongoing battle over a company owned Dr Wallersteiner, applied for money to continue a claim against Dr Wallersteiner for fraud. Dr Wallersteiner had bought a company called Hartley Baird Ltd using money from the company itself, in contravention of the prohibitions on financial assistance (under Companies Act 1948 s 54 and 190). He had got 80% of the company. Mr Moir was one of the 20% remainder shareholders. Wanting to expose Dr Wallersteiner’s various dealings, he circulated a letter to shareholders. Dr Wallersteiner sued for libel.
Mr Moir counterclaimed, and joined two of his companies as defendants, for £500,000 to be repaid. In a first judgment (Wallersteiner v Moir) the Court of Appeal held that the libel action would be struck out for deliberate delay and awarded £235,000 in damages to Mr Moir, but gave Dr Wallersteiner leave to defend the remaining issues, including fraud. Dr Wallersteiner claimed that interest could not be awarded under Law Reform (Miscellaneous Provisions) Act 1934. As this was going on, Mr Moir was running out of money and made an application for funds to continue the action.
Judgment
The Court of Appeal held, after noting that interest was awardable under the court’s equitable jurisdiction, that Mr Moir could be indemnified by the company for his costs. Since the derivative claim meant the company was proceeding against Dr Wallersteiner, Mr Moir was ineligible for legal aid. Moreover, contingency fee arrangements with Mr Moir’s lawyers could not be sanctioned (although Lord Denning MR opined that public policy might approve it in some derivative claims). Hence, the costs of litigation for minority shareholders would be indemnified by the company.
On the problem of a derivative claim, and the question of funding by the company, Lord Denning MR said the following.[2]
It is a fundamental principle of our law that a company is a legal person, with its own corporate identity, separate and distinct from the directors or shareholders, and with its own property rights and interests to which alone it is entitled. If it is defrauded by a wrongdoer, the company itself is the one person to sue for the damage. Such is the rule in Foss v Harbottle (1843) 2 Hare 461. The rule is easy enough to apply when the company is defrauded by outsiders. The company itself is the only person who can sue. Likewise, when it is defrauded by insiders of a minor kind, once again the company is the only person who can sue. But suppose it is defrauded by insiders who control its affairs - by directors who hold a majority of the shares - who then can sue for damages? Those directors are themselves the wrongdoers. If a board meeting is held, they will not authorise the proceedings to be taken by the company against themselves. If a general meeting is called, they will vote down any suggestion that the company should sue them themselves. Yet the company is the one person who is damnified. It is the one person who should sue. In one way or another some means must be found for the company to sue. Otherwise the law would fail in its purpose. Injustice would be done without redress. In Foss v Harbottle, 2 Hare 461, 491-492 , Sir James Wigram V.-C. saw the problem and suggested a solution. He thought that the company could sue "in the name of some one whom the law has appointed to be its representative." A suit could be brought
"by individual corporators in their private characters, and asking in such character the protection of those rights to which in their corporate character they were entitled...."
This suggestion found its fulfilment in the Merryweather case which came before Sir William Page Wood VC on two occasions: see (1864) 2 Hem. & M. 254 (sub nom. East Pant Du United Lead Mining Co Ltd v Merryweather) and LR 5 Eq 464n. It was accepted there that the minority shareholders might file a bill asking leave to use the name of the company: see 2 Hem & M 254, 259; L.R. 5 Eq. 467-468n . If they showed reasonable ground for charging the directors with fraud, the court would appoint the minority shareholders as representatives of the company to bring proceedings in the name of the company against the wrong doing directors. By that means the company would sue in its own name for the wrong done to it. That would be, however, a circuitous course, as Lord Hatherley L.C. said himself, at any rate in cases where the fraud itself could be proved on the initial application...
Now that the principle is recognised. it has important consequences which have hitherto not been perceived. The first is that the minority shareholder, being an agent acting on behalf of the company, is entitled to be indemnified by the company against all costs and expenses reasonably incurred by him in the course of the agency. This indemnity does not arise out of a contract express or implied, but it arises on the plainest principles of equity. It is analogous to the indemnity to which a trustee is entitled from his cestui que trust who is sui juris: see Hardoon v Belilios [1901] AC 118 and In re Richardson, Ex parte Governors of St. Thomas's Hospital [1911] 2 KB 705 . Seeing that, if the action succeeds, the whole benefit will go to the company, it is only just that the minority shareholder should be indemnified against the costs he incurs on its behalf. If the action succeeds, the wrongdoing director will be ordered to pay the costs: but if they are not recovered from him, they should be paid by the company. and all the additional costs (over and above party and party costs) should be taxed on a common fund basis and paid by the company: see Simpson and Miller v British Industries Trust Ltd (1923) 39 TLR 286 . The solicitor will have a charge on the money recovered through his instrumentality: see section 73 of the Solicitors Act 1974.
But what if the action fails? Assuming that the minority shareholder had reasonable grounds for bringing the action - that it was a reasonable and prudent course to take in the interests of the company - he should not himself be liable to pay the costs of the other side, but the company itself should be liable, because he was acting for it and not for himself. In addition, he should himself be indemnified by the company in respect of his own costs even if the action fails. It is a well known maxim of the law that he who would take the benefit of a venture if it succeeds ought also to bear the burden if it fails. Qui sentit commodum sentire debet et onus. This indemnity should extend to his own costs taxed on a common fund basis.
In order to be entitled to this indemnity, the minority shareholder soon after issuing his writ should apply for the sanction of the court in somewhat the same way as a trustee does: see In re Beddoe, Downes v Cottam [1893] 1 Ch 547, 557-558. In a derivative action, I would suggest this procedure: the minority shareholder should apply ex parte to the master for directions, supported by an opinion of counsel as to whether there is a reasonable case or not. The master may then, if he thinks fit, straightaway approve the continuance of the proceedings until close of pleadings, or until after discovery or until trial (rather as a legal aid committee does). The master need not, however, decide it ex parte. He can, if he thinks fit, require notice to be given to one or two of the other minority shareholders - as representatives of the rest - so as to see if there is any reasonable objection. (In this very case another minority shareholder took this very point in letters to us). But this preliminary application should be simple and inexpensive. It should not be allowed to escalate into a minor trial. The master should simply ask himself: is there a reasonable case for the minority shareholder to bring at the expense (eventually) of the company? If there is, let it go ahead.
Prudential Assurance Co Ltd v Newman Industries Co Ltd (No.2) [1980] 2 All ER 841; [1982] Ch 204 CA
A plaintiff shareholder cannot recover damages merely because the company in which he has an interest has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His only ‘loss’ is through the company, in the diminution in the value of the net assets of the company, in which he has (say) a 3 per cent, shareholding. The plaintiff’s shares are merely a right of participation in the company on the terms of the articles of association. The shares themselves, his right of participation, are not directly affected by the wrongdoing. The court rejected the notion that there is any general discretion to ignore the ‘proper plaintiff’ rule whenever the justice of the case so requires. ‘A derivative action is an exception to 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. C is the proper plaintiff because C is the party injured, and, therefore, the person in whom the cause of action is vested.
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2): CA 1982
A plaintiff shareholder cannot recover damages merely because the company in which he has an interest has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His only ‘loss’ is through the company, in the diminution in the value of the net assets of the company, in which he has (say) a 3 per cent, shareholding. The plaintiff’s shares are merely a right of participation in the company on the terms of the articles of association. The shares themselves, his right of participation, are not directly affected by the wrongdoing. The court rejected the notion that there is any general discretion to ignore the ‘proper plaintiff’ rule whenever the justice of the case so requires. ‘A derivative action is an exception to 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. C is the proper plaintiff because C is the party injured, and, therefore, the person in whom the cause of action is vested.’
‘What [a shareholder] cannot do is to recover damages merely because the company in which he is interested has suffered damage. He cannot recover a sum equal to the diminution in the market value of his shares, or equal to the likely diminution in dividend, because such a ‘loss’ is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss. His only ‘loss’ is through the company, in the diminution in the value of the net assets of the company, in which he has (say) a 3 per cent shareholding.’
If the fraud was not admitted by the insiders, how was it to be proved? ‘It cannot have been right to have subjected the company to a 30-day action (as it was then estimated to be) in order to enable him to decide whether the plaintiffs were entitled in law to subject the company to a 30-day action. Such an approach defeats the whole purpose of the rule in Foss v. Harbottle and sanctions the very mischief that the rule is designed to prevent. By the time a derivative action is concluded, the rule in Foss v. Harbottle can have little, if any, role to play. Either the wrong is proved, thereby establishing conclusively the rights of the company; or the wrong is not proved, so cadit quaestio.’ and answered: ‘In our view, whatever may be the properly defined boundaries of the exception to the rule, the plaintiff ought at least to be required before proceeding with his action to establish a prima facie case (i) that the company is entitled to the relief claimed, and (ii) that the action falls within the proper boundaries of the exception to the rule in Foss v. Harbottle.’
Cumming-Bruce, Templeman and Brightman LJJ
[1982] Ch 204, [1982] 1 All ER 354, [1982] 2 WLR 31
England and Wales
Citing:
Explained – Foss v Harbottle 25-Mar-1843
A bill was lodged by two of the proprietors of shares in a company incorporated by Act of Parliament, on their own and the other shareholders’ behalf. They claimed against three bankrupt directors, a proprietor, solicitor and architect charging them . .
See Also – Prudential Assurance Co Ltd v Newman Industries Ltd ChD 1979
Members of the defendant company had approved in general meeting, of an acquisition of the assets of another company in which its directors were substantially interested. The shareholders’ approval was given on the basis of a circular. The action . .
Cited by:
Cited – Barings Plc and Another v Coopers and Lybrand and Others; etc ChD 23-Nov-2001
The applicant company employed a trader who, through manipulation of trading systems ran up losses sufficient to bankrupt the company. They sought recovery from the defendant auditors for failing to spot the mis-trading and prevent continuing . .
Cited – Konamaneni v Rolls Royce Industrial Power (India) Limited ChD 20-Dec-2001
The claimants founded their action on the assertion that the defendants had been corrupt in obtaining contracts in India. The defendants argued that the English courts had no jurisdiction. The claimants held various small shareholdings in a company . .
Cited – Johnson v Gore Wood and Co (A Firm) ChD 3-May-2002
The respondent firm acted on behalf of the claimant’s companies in land transactions. An option had been taken to purchase land, and he instructed the defendants to exercise it. The landowner claimed the notice to exercise the option was invalidly . .
Cited – Johnson v Gore Wood and Co (a Firm) CA 12-Nov-1998
The claimant had previously issued a claim against the defendant solicitors through his company. He now sought to pursue a claim in his own name. It was resisted as an abuse of process, and on the basis that no personal duty of care was owed to the . .
Cited – Stein v Blake and others CA 13-Oct-1997
The defendants challenged leave to appeal given to the plaintiff against dismissal of his claim following the Prudential Assurance case.
Held: The issue was whether the plaintiff can recover the loss which he has allegedly sustained by reason . .
Cited – Heron International v Lord Grade, Associated Communications Corp. Plc. and Others CA 1983
In the course of a contested take-over bid, the directors of the target company who owned a majority of the company’s voting shares were alleged, in breach of their duties both to the company and to its shareholders, to have accepted proposals which . .
Cited – Cabvision Ltd v Feetum and others CA 20-Dec-2005
The company challenged the appointment of administrative receivers, saying there had been no insolvency.
Held: No question arises of a derivative action arose here. The claimant had standing to apply for declaratory relief since they were . .
Cited – Johnson v Gore Wood and Co HL 14-Dec-2000
Shareholder May Sue for Additional Personal Losses
A company brought a claim of negligence against its solicitors, and, after that claim was settled, the company’s owner brought a separate claim in respect of the same subject-matter.
Held: It need not be an abuse of the court for a shareholder . .
Cited – Christensen v Scott 1996
(New Zealand Court of Appeal) Thomas J said: ‘the diminution in the value of Mr and Mrs Christensen’s shares in the company is by definition a personal loss and not a corporate loss. The loss suffered by the company is the loss of the lease and the . .
Cited – Barclays Bank Plc v Kufner ComC 10-Oct-2008
barclays_kufnerComC2008
The bank sought summary judgment under a guarantee to secure a loan to purchase a luxury yacht which was to be hired out in business. The loan had been charged against the yacht, but when the yacht was re-registered, the bank failed to re-establish . .
Cited – Barclays Bank Plc v Kufner ComC 10-Oct-2008
barclays_kufnerComC2008
The bank sought summary judgment under a guarantee to secure a loan to purchase a luxury yacht which was to be hired out in business. The loan had been charged against the yacht, but when the yacht was re-registered, the bank failed to re-establish . .
Cited – Webster v Sandersons Solicitors (A Firm) CA 31-Jul-2009
The claimant apealed against refusal of permission to amend his claim for negligence against his former solicitors by adding claims from 1993 and 1994 . .
Cited – Emerald Supplies Ltd and Another v British Airways Plc ChD 8-Apr-2009
The claim was for damages after alleged price fixing by the defendants. The claimants sought to recover for themselves and as representatives of others who had similarly suffered. The defendants sought that the representative element of the claim be . .
Cited – Iesini and Others v Westrip Holdings Ltd and Others ChD 16-Oct-2009
The claimants were shareholders in Westrip, accusing the Defendant directors of deliberately engaging in a course of conduct which has led to Westrip losing ownership and control of a very valuable mining licence and which, but for their . .
Lists of cited by and citing cases may be incomplete.
Smith v Croft (No.2) [1988] Ch 114
Smith v Croft (No 2) [1988] Ch 114 is a UK company law case concerning derivative claims. Its principle that in allowing a derivative claim to continue the court will have regard to the majority of the minority’s views has been codified in Companies Act 2006, section 263(4).
Facts
Minority shareholders claimed to recover money paid away contrary to the financial assistance prohibition (now found at section 678 of the Companies Act 2006) and being ultra vires. They had 14% of the company’s shares, the defendants held 63%, and another shareholder, who did not want litigation, held 21%.
Judgment
Knox J held that if the claimants were a minority even after the wrongdoers were taken out of the equation, then there is no right to sue, even with a Foss v Harbottle exception. Independence is a question of fact. He followed Burland v Earle in Lord Davey’s dicta that shareholders cannot have a bigger right to sue than the company with its procedural and substantive limitations.
Significance
The case was cited in the Law Commission Shareholder Remedies Report[1] in regards to the amount of court time involved:
In the consultation paper we identified two main problems. The first is the obscurity and complexity of the law relating to the ability of a shareholder to bring proceedings on behalf of his company. He may wish to do so to enforce liability for a breach by one of the directors of his duties to the company. Generally it is for the company itself, acting in accordance with the will of the majority of its members, to bring any such proceedings. This is as a result of principles commonly known as the rule in Foss v Harbottle (1843) 2 Hare 461. However, if the wrongdoing director(s) control the majority of votes they may prevent legal proceedings being brought. There are therefore exceptions to the rule which enable a minority shareholder to bring an action to enforce the company’s rights. But our provisional view was that the law relating to these exceptions is rigid, old fashioned and unclear. We pointed out that it is inaccessible save to lawyers specialising in this field because, to obtain a proper understanding of it, it is necessary to examine numerous reported cases decided over a period of 150 years. We also explained that the procedure is lengthy and costly, involving a preliminary stage which in one case took 18 days of court time to resolve.
Johnson v Gore Wood & Co [2001] 1 All ER 481
Johnson v Gore Wood & Co [2000] UKHL 65 is a leading UK company law decision of the House of Lords concerning (1) abuse of process relating to litigating issues which have already been determined in prior litigation or by way of settlement, (2) estoppel by convention, and (3) reflective loss of a shareholder with respect to damage which was done to the company in which he holds shares.[1]
Facts
Mr Johnson was a director and majority shareholder in a number of companies, including Westway Homes Limited (referred to in the judgment as “WWH”). Gore Wood & Co were a firm of solicitors who acted for the companies and also occasionally for Mr Johnson in his personal capacity. In 1998 Gore Wood were acting for WWH and served notice under an option to acquire land from a third party upon the solicitors for that third party. The third party alleged that this was not proper service, and refused to convey the land. Legal proceedings ensued and ultimately WWH succeeded. However, because the third party was impecunious and funded by legal aid WWH was unable to recoup the full amount of its losses and legal costs. Accordingly, WWH issued proceedings against Gore Wood for professional negligence alleging, broadly, that their losses would have been averted entirely if Gore Wood had properly served the original notice on the third party instead of on the third party’s solicitors.
Gore Wood ultimately settled those claims, and the settlement agreement included two provisions which were later to prove important. Firstly, it included a clause stating that any amount which Mr Johnson wished to subsequently claim against Gore Wood in his personal capacity would be limited to £250,000 excluding interest and costs. Secondly, the confidentiality clause contained an except which permitted the settlement agreement to be referred to in any action which Mr Johnson might bring against Gore Wood.
Mr Johnson then subsequently issued proceedings against Gore Wood in his personal name, and Gore Wood made applications to strike out some or all of the claims on the basis that (i) it was an abuse of process to seek to relitigate issues which had already been compromised in the settlement agreement, and (ii) some or all of the claims which Mr Johnson was making were for losses sustained by WWH, and his personal claims should be disallowed as reflective loss.
At first instance Mr Johnson succeeded as Pumfrey J in the High Court held that Gore Wood was estopped by convention from contending that the claims were an abuse of process as both parties had tacitly agreed that such claims could be brought when they entered into the settlement agreement. The Court of Appeal held that there was no estoppel by convention, and that the proceedings were an abuse under the rule in Henderson v Henderson (1843) 3 Hare 100. The Court of Appeal held that just one of Mr Johnson’s claims should be struck out for reflective loss.
Judgment
The leading judgment was given by Lord Bingham, although all five Law Lords gave speeches of varying lengths.
Abuse of process
Their Lordships considered at some length previous decisions of the English courts in relation to abuse of process, and stressing that the courts strive to find a balance between proper administration of justice and avoiding defendants being vexed by duplicative litigation, and the need to ensure that persons with a proper claim were able to have those claims heard and determined. The court stressed that what was known as “the rule in Henderson v Henderson” had now actually evolved a very long way from the original judgment after which it was named. The rule against abuse of process was similar to rule relating to cause of action estoppel (or res judicata) and issue estoppel, but they were not the same. However both were concerned with the same underlying public interest. The court was reluctant to set down hard and fast rules as to what would amount to abuse of process when claims which might conveniently have been brought at an earlier were only made at a later time. Courts need to be mindful not to confuse the fact that a litigant could have brought his claims at an earlier stage with the proposition that he should have done so. Only in the latter case would it be an abuse of process to subsequently litigate those claims.
In this case Mr Johnson had given a number of reasons why he did not pursue his personal claims at an earlier time, including impecuniosity, the availability of legal aid, and personal circumstances. The court indicated that impecuniosity was not normally a good ground, although in this case the impecuniosity was alleged to have been caused by the defendant. The court also noted that Mr Johnson had from a very early stage made clear his intention of bringing a personal claim separate from the claim of WWH. Taken as a whole their Lordships was satisfied that there was no abuse, although they declined to lay down a definitive test. Their Lordships felt that the courts should take a broad, merit-based approach to account for the public and private interests involved (including a citizen’s right of access to the court).[2]
Estoppel by convention
The House of Lords felt that the point relating to estoppel by convention (i.e. that the parties had contemplated such further action might be brought in the earlier settlement agreement) was tied up in the issue of abuse of process. They noted that the litigation between Mr Johnson and Gore Wood had been ongoing for nearly four and half years before the defendant firm of solicitors sought to strike out the claims on this basis, which was reflective of the parties common understanding that those claims might be pursued, and during that time pleadings had been considerably advanced and they had even made a payment into court. Their Lordships determined that the key issues was whether (i) the settlement of WWH’s action proceeded on the basis of an underlying assumption that Mr Johnson would be bringing further claims, and (ii) whether it would be unfair or unjust to now allow Gore Wood to go back on that assumption. Their Lordships held that both grounds were made out.
Reflective loss
In relation to the issue of reflective loss, Lord Bingham summarised the existing case law in three key propositions:
Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder's shareholding where that merely reflects the loss suffered by the company. Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it. Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other.
Applying these tests, the House of Lords held that one of Mr Johnson’s claimed heads of loss should be struck-out (diminution in the value of his shareholding in WWH, and amounts which WWH would otherwise have paid into his pension), and the remaining claims were allowed to proceed (these included the cost of personal borrowing by Mr Johnson to fund his outgoings and those of his business, the value of shares lost when the bank foreclosed upon security which he provided, and additional tax liability). The court held that the claims for cost of borrowing would need to be scrutinised carefully at trial to ensure that they were not merely claims for lost dividends (which were not allowable) in disguise. The court also allowed a claim for losses on other investments which Mr Johnson made based upon advice from Gore Wood. The court also struck out claims for mental distress and aggravated damages on other grounds. The rule against reflective loss is justified by the need both to prevent double recovery and to provide protection for the company’s creditors, who might be prejudiced if the shareholder’s claim were to succeed.[3]
Commentary
The case has generally been accepted as correctly decided and stands as an authoritative proposition of the law.[4][5]
Ellis v Property Leeds (UK) Ltd [2002] 2 BCLC 175
Ellis and Another v Property Leeds (UK) Ltd: CA 31 Jan 2002
Norman Barry Ellis and David Clayton each claimed damages against Property Leeds (UK) Ltd (Eddisons) for the alleged fraudulent and/or negligent misrepresentations of one Thorpe acting as Eddisons servant or agent.
On 21st June 2001 Rougier J gave summary judgment to Eddison’s in respect of the greater part of both claims. He did so on the basis that any losses suffered by Mr Ellis and Mr Clayton simply reflected losses sustained by companies of which each was a director. Alternatively the judge held that, with regard to such losses as were represented by the diminished value of trust funds in which each claimant had a beneficial interest, the right to sue lay not with the claimants but with the trustees.
[2002] EWCA Civ 32, [2002] 2 BCLC 175
Re Singh Brothers Contractors (North West Limited) [2013] EWHC 2138 (Ch)
Derivative claim on behalf of the company under section 261 of the Companies Act 2006 against the first defendant, a director of the second defendant, for breach of director’s duty, breach of fiduciary duty and breach of trust. The claimant sought orders for damages, an account, further or other relief and costs. The claimant also sought an order that he be indemnified out of the company’s assets in respect of the legal costs of the derivative claim. It was said that the claimant expected to recover more than andpound;800,000.
Singh
Mandatory Bar
No director would continue the claim if acting in accordance with s.172; fides of the claimant in question; s.994 more appropriate
Sevilleja v Marex Financial Ltd [2020] UKSC 31
judgment has narrowed the scope of reflective loss carve out to shareholder claims in respect of a fall in the value of shares (or distributions) where the loss to the company is caused by a wrong by the defendant.
In a landmark decision, the Supreme Court confirmed that the principle of reflective loss restricted the ability of shareholders to claim damages in respect of a reduction in the value of their shares due to loss suffered to company, but that this principle did not extend to claims made by individuals in other capacities, such as creditors.
Sevilleja v Marex Financial Ltd [2020] UKSC 31
The law of reflective loss
The law relating to the principle of “no reflective loss” is one which has developed significantly through case law and it has traditionally prevented shareholders from bringing claims for the diminution in share value where the loss merely reflects the loss suffered by the company. This was found to be the case, even if a wrong had been committed in part against the shareholder, and even if no proceedings had been brought by the company. (Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204).
Over time, the scope of the rule in Prudential has been widened to include claims brought by a shareholder in their capacity as creditor or employee of the company, and in the current case in respect of claims brought solely as creditor of the company. An exception to the principle was also found where the Court perceived that a wrongdoer’s act had caused the company’s impecuniosity, which prevented the company from bringing an action.
Facts of the case
Marex, a creditor of 2 BVI Companies controlled by the Respondent appealed to the Supreme Court. Marex had been awarded damages in respect of earlier English Commercial Court proceedings. Following judgment in Marex’s favour, the Respondent, Mr Sevilleja allegedly dissipated the companies of money, and liquidated the companies to the effect that the judgment was unable to be paid.
Marex claimed damages against Mr Sevilleja personally for violating the company’s rights rights and for intentionally causing loss to Marex by unlawful means. On appeal, the Court of Appeal found that that 90% of Marex’s claim as a creditor of the company was restricted by the doctrine of reflective loss and struck it out.
Supreme Court decision
The key issue the Supreme Court had to decide was whether the reflective loss principle applied in the case of claims by company creditors and not solely to claims by shareholders.
The Supreme Court lamented the expansion of the reflective loss principle, which they noted had “unwelcome and unjustifiable effects on the law”. The Court reaffirmed the approach in Prudential, but departed from judgments in later cases which expanded the principle, on the basis that these were wrongly decided. It drew distinction between “claims brought by a shareholder in relation to loss which he or she has suffered in the capacity of shareholder, such as a diminution in share value or in distributions, and claims which a shareholder or anyone else may bring in any other capacity, for example as a creditor or employee of the company.”
The former is a claim for reflective loss as it concerns the loss sustained by a company “even though that loss may be reflected in a fall in share value, the claim belongs to the company and not the shareholder” whereas the principle of reflective loss did not apply to claims made in other capacities, such as by a creditor or an employee. As a result, Marex’s claim was not limited by the reflective loss principle and it was permitted to pursue the entirety of its claim. The Court also held that there was no exception to the principle where the defendant had caused the company’s impecuniosity.
What does this decision mean?
This judgment has narrowed the scope of reflective loss carve out to shareholder claims in respect of a fall in the value of shares (or distributions) where the loss to the company is caused by a wrong by the defendant. Claims made by individuals acting in other capacities will now be considered outside the scope of the principle. This is particularly important in the current climate where many companies are facing financial pressures, as the decision reinstates creditors’ ability to bring claims against wrongdoers whose actions have diminished a company’s financial position.
Mission Capital plc v Sinclair [2008] EWHC 1339 (Ch)
Permission to continue with a derivative action under the Companies Act 2006 s.261 was refused where a notional director was unlikely to attach much importance to the claim and the alleged damage was speculative.
Mission Capital PLC v Sinclair (2008)
Summary
Permission to continue with a derivative action under the Companies Act 2006 s.261 was refused where a notional director was unlikely to attach much importance to the claim and the alleged damage was speculative.
Facts
The applicant former executive directors (S) sought permission to continue a derivative claim against the respondent company (M) and a mandatory injunction to force M to re-employ them and restore them to the board of directors. M had terminated S’s employment and required them to resign from the board on the basis that they had failed to meet financial forecasts and submit important financial information to the board. The board was made up of S and three non-executive directors. M obtained an injunction excluding S from company premises and requiring them to deliver documents. S counterclaimed and brought a derivative claim against M, the non-executive directors and their replacement director (P), claiming that M would suffer damage from their wrongful dismissal, and that P would act improperly. The issues to be determined were whether (1) permission should be granted under the CPR r.19.9A for S to continue with the derivative action; (2) there should be specific performance of S’s employment contracts and directorships.
Held
(1) When considering whether to grant permission for a party to continue with a derivative action it was necessary to apply the two-stage process set out in the Companies Act 2006 s.261 and s.262. Section 263(2)(a) was mandatory in character. If it was established that a notional director would not seek to continue the claim, the court had to refuse leave. S’s derivative action might succeed where the counterclaim failed and the company would be able to claim damages against the directors for damage suffered by the company as a result of S’s wrongful dismissal. Damages of that kind would not be available to S as shareholders. S had therefore passed the first stage of the test and it was necessary to consider the discretionary factors in s.263(3). S had brought the action in good faith. However, while a notional director might continue the claim, he would not attach much importance to it, especially as the damage that the company would suffer from S’s wrongful dismissal was speculative. It was more likely that the company would replace S than take action against those responsible for the damage caused by their wrongful dismissal. In addition, S could recover what they sought by means of an unfair prejudice petition under s.994. S’s application for permission to continue with the derivative claim was refused. (2) It was not necessary or appropriate to finally determine the issue of S’s termination on the instant applications. However, it was necessary to consider whether S had a real prospect at trial of successfully persuading the court that their case fell within the exception to the general rule that a contract for personal services would not be specifically enforced. It was plain that it could not seriously be argued that a high degree of confidence existed between the parties. Evidence of a sufficient degree of mutual trust was simply not present, Hill v CA Parsons & Co (1972) Ch 305 CA (Civ Div) and Powell v Brent LBC (1988) ICR 176 CA (Civ Div) considered, and Zockoll Group Ltd v Mercury Communications Ltd (No1) (1998) FSR 354 CA (Civ Div) cited. It was therefore unlikely that S would succeed in their claim for injunctive relief regarding the termination of their employment. The balance of justice was plainly in favour of refusing injunctive relief. To restore S to their executive positions under the control of a board of directors with whom they were locked in litigation was a recipe for strife at the workplace. While the concern which S felt about the future of the company was genuine, it was by no means certain that M would not manage satisfactorily without them. (3) Courts were reluctant to grant specific performance in relation to orders requiring a company to allow a director to continue to act in that capacity, Callard v Pringle (2007) EWCA Civ 1075, (2008) 2 BCLC 505 considered. M had offered to provide an undertaking not to sell the business or its assets and not to wind up the company without giving notice to S, and it was appropriate to take that into account when considering the balance of justice. To restore S to form a minority group on the board would not give them power to prevent impropriety, although it would give them advance notice of it. Therefore, although S’s case was arguable, the balance of justice was against the grant of an injunction to restore S to their directorships.
Applications refused
Franbar Holdings v Patel [2008] EWHC 1534 (Ch)
- Then, Franbar and Casualty Plus entered into a shareholders’ agreement. According to this agreement, Casualty Plus appointed two directors to Medicentres and Franbar appointed one. Franbar brought derivative proceedings against Casualty Plus and Medicentres, claiming various breaches of duty of care
- The court held that there were alternative modes of redress that would enable Franbar to claim what it was seeking. Thus, in these circumstances, the appropriate remedy for the applicant would be an action under Section 994 of the Companies Act 2006 (protection of members of company against unfair prejudice).
Franbar Holdings v Patel [2008] EWHC 1534
Company Law
Franbar Holdings v Patel [2008] concerns the continuation of derivative proceedings brought by the applicant company.
Keywords:
Company law – Directors – Sale of shares – Companies Act 2006 – Shareholders’ agreement – Derivative claim – Appropriate remedy
Facts:
In the present case, Medicentres was a company established to provide primary health care and medical service. The company was wholly owned by Franbar until July 2005. At that time, Franbar sold 75% of the shares it owned in Medicentres to Casualty Plus. Then, Franbar and Casualty Plus entered into a shareholders’ agreement. According to this agreement, Casualty Plus appointed two directors to Medicentres and Franbar appointed one.
Franbar brought derivative proceedings against Casualty Plus and Medicentres, claiming various breaches of duty of care. In particular, it argued that one of the directors, Mr Ketam Patel, reduced the cost Medicentres’ shares by driving business away from it.
Issue:
Continuation of the derivative claim.
Held:
The court dismissed Franbar’s application for permission to continue the derivative action. The court noted that there was substance in Franbar’s complaint that could give rise to breaches of duty by Mr Ketam Patel. However, Franbar’s motive to continue derivative proceedings was to ensure that the value of its shares in Medicentres was full and fair. The court held that there were alternative modes of redress that would enable Franbar to claim what it was seeking.
Thus, in these circumstances, the appropriate remedy for the applicant would be an action under Section 994 of the Companies Act 2006 (protection of members of company against unfair prejudice).
Applied: Austintel Ltd, Re [1996] 1 W.L.R. 1291, [1996] 5 WLUK 92.
Read our cases and notes on Company Law to learn more!
Kleanthous v Paphitis [2011] EWHC 2287 (Ch)
UK: England and Wales: permission refused to continue derivative claim
The High Court gave judgment yesterday in Kleanthous v Paphitis [2011] EWHC 2287 (Ch) and refused permission to continue a derivative claim under Part 11 of the Companies Act (2006) in respect of alleged breaches of directors’ duties. The decision provides a useful reminder that even where there may be an arguable case of breach of duty, it does not follow that permission will be granted because of the factors to which the court must have regard in determining whether to grant permission.
There is much else of interest in this decision, including, for example, discussion of whether the court must be satisfied that the claimant has a strong case in order for permission to continue to be granted. The trial judge thought not, referring to Stainer v Lee [2010] EWHC 1539 (Ch) and Wishart v Castlecroft Securities Ltd. [2009] CSIH 65, to support his view that there was no threshold test. Indeed, the factors which led him to decline permission - [a] opposition to the claim by a directors’ committee formed to consider the claim in the light of professional advice, [b] the availability of relief under Section 994 and [c] the fact that much of the money that would be recovered from the directors would probably be returned to them as a distribution - were such that he would have declined permission even if he had been persuaded that the claim against the directors was a strong one.
Further Commentary
New derivative claim fails to take off
United Kingdom 01.10.2008
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)
