When Shareholders Attack: Shareholder Derivative Action – The Story so Far…

Prior to the 2006 Act, the concept of derivative action was enshrined in case law.

The main change introduced by the 2006 Act is that the derivative action is expressly available for breach of duty of directors, even if the director has not benefited personally from the breach. Furthermore, unlike the position in case law, it is no longer necessary for the shareholder to show that those directors who carried out the wrongdoing controlled the majority of the company's shares.

Under the 2006 Act, shareholders must apply for permission to bring action in a two-stage procedure:

• First the shareholder must prove a prima facie case for permission to continue a derivative claim. The court is required to consider the issue on the basis of evidence filed by the shareholder (without requiring evidence from the company).
• Second the court must decide whether to give permission for a substantive case to be brought.

The court cannot give permission if it is satisfied that someone seeking to promote the success of the company would not continue the claim, or the act or omission has been authorised or ratified by the company (not counting the votes of the director(s) concerned or anyone connected with them).

In deciding whether to allow a substantive case to be brought, the court will seek evidence from the company and must pay particular regard to the views of independent shareholders and:

• whether the claim is being brought in good faith
• the importance of the claim to someone promoting the success of the company
• the likelihood of the act or omission being ratified
• if the company has decided not to bring the claim
• whether that shareholder could pursue the claim in their own right

What impact has the 2006 Act had in respect of derivative claims?

Two years on, the only reported case in the UK where a court has granted leave for a shareholder to raise a derivative claim against directors of a company is Wishart v Castlecroft Securities Limited and Others 2009 (“Wishart”). The Court of Session (Inner House) in Scotland granted leave in the derivative proceedings in July 2009.

Although Wishart is a Scottish case and there are differences in how Part 11 of the 2006 Act operates in the jurisdiction, the Scottish Court noted that the tests to be applied in assessing whether a derivative action should be allowed to be raised or continued in England will be substantially the same.

The court in Wishart considered that the prima facie test was in fact composed of two elements: (i) a prima facie case on the merits and (ii) a prima facie case that those responsible for the act or omission complained of were and remained in majority control. The court held that the second element was inherent in the nature of the derivative proceedings. This is a questionable approach as it imports into the 2006 Act the wrongdoer control limb of the common law test. 

With regards to the second stage for grant of permission, the court held that little emphasis should be placed on the merits of the claim, and instead consideration should be placed on the issue of permission. The court would have to consider whether a director acting in accordance with his duty to promote the success of the company would pursue the claim. Furthermore, the court would have to take into account the non-exhaustive list of factors above.

In deciding whether to allow a substantive case, the court in Wishart stated it was relevant to take into account whether the claimant honestly believed the cause of action existed and whether the claimant sought to bring the suit for a collateral purpose amounting to the abuse of process. It also considered factors which a director promoting the success of the company would assess when determining whether to continue the claim, such as time, expense and disruption in pursing the action to a conclusion. 

One of the concerns about Part 11 of the 2006 Act was that it would be much easier to sue directors because the requirement for fraud on the minority and wrongdoer control had been abolished. This concern has not been substantiated yet as the allegations in Wishart (which relate to the diversion of a business away from the company in breach of fiduciary duty) would have meant the more stringent test under the common law regime would be applied anyway.

Whether the English courts will adopt the approach in Wishart has yet to be determined.

For further advice on any aspect of shareholder disputes, please contact our Litigation Team:

John Abbott: jca@silvermansherliker.co.uk
Richard Pearlman: rhp@silvermansherliker.co.uk
James Robertson: jvar@silvermansherliker.co.uk
Stefan Arestis: sa@silvermansherliker.co.uk
Asil Albayaty: aa@silvermansherliker.co.uk

or +44 (0)20 7749 2700.