Claims from Shareholders

Claims from Shareholders

Derivative Actions under the Companies Act 2006. Sara McPhillips examines the likely impact for directors.

Derivative Actions

When Part 11 of the Companies Act 2006 (the "Act") comes into effect in October of this year, it will widen the circumstances in which a shareholder can bring proceedings on behalf of, and for the benefit of, a company for a wrong done to the company (a derivative action). Given that the Explanatory Notes to the new legislation envisage that these provisions will operate mainly where the harm suffered by the company arose from a breach of duty by a director, all directors should be alert to the increased risk of their actions, omissions and decisions being challenged in court.

New Law

The new provisions aim to promote accountability by the officers of a company to the members of a company and will allow a derivative action to be brought on the basis of negligence, default, breach of trust or breach of duty by a director. The latter cause of action will be of particular concern to directors, especially when the changes to directors' duties under the Act are taken into account. In a change to the existing common law, there will no longer be a requirement for the wrongdoing director to have personally benefited from the wrongdoing and the simple majority of shareholders can no longer absolutely bar a derivative action by ratifying the disputed conduct.

New Procedure

In procedural terms, an applicant shareholder must overcome certain hurdles before leave will be given for an action to proceed to substantive hearing. The first stage requires the applicant to submit sufficient evidence to establish a prima facie case, without any input from the wrongdoing director. If a prima facie case is established, the court can require evidence to be provided by the company. If not, the action will be dismissed. Courts must consider a number of factors in deciding whether leave should be granted including, in particular, whether or not the applicant member is acting in good faith; the importance that a person acting in accordance with the duty to promote the success of the company would attach to continuing the claim; and the views of uninterested shareholders.

Concerns & Safeguards

Concern has been expressed that the new law and procedure could be abused by activist shareholders seeking to bring derivative actions for inappropriate motives, for example to challenge in the public arena a policy or course of action adopted by a company. The government points to the following safeguards against vexatious or unmeritorious actions:

• Courts have the opportunity to examine each claim at an early stage, before the company is even involved, and take into account factors such as the views of the disinterested shareholders.
• The relief sought must be sought on behalf of the company and the applicant shareholder will not personally benefit.
• Ability of court to make a costs order against an applicant.

In light of the above restrictions it is far from clear that the new regime will have as significant an impact as was first anticipated.

Practical Implications

Boards of directors should consider taking the following precautionary measures to minimise the potential risks associated with derivative actions:

• Review its Directors & Officers indemnity insurance policies to ensure that defence of derivative claims is covered.
• Review directors' service contracts or letters of appointment to establish whether they are indemnified by the company for any derivative claims taken against them.
• Seek letters of support from shareholders where appropriate when making decisions.
• Properly document the decision making process including keeping a record of all factors considered and the weight given to each.
• Take expert advice where appropriate.

Ultimately, the Act offers shareholders more opportunity to bring derivative actions against directors, although the number of safeguards in place may limit the use of these provisions in practice. It will be up to the courts to adopt a sensible approach going forward, balancing the need for accountability with the need to minimise the risk of unmeritorious actions.

Sara McPhillips is a Solicitor in the firm's Corporate Department advising on a range of corporate and commercial issues.

Quote: new ..... procedure could be abused