Derivative claims: where are we?

One of the key objectives of the derivative claims reform, formulating in the statutory codification under Part 11 of the Companies Act 2006, was to allow more claims to proceed in appropriate circumstances.

My published articles in the Company Lawyer earlier this year demonstrated that despite six claims in England and Wales being brought before the courts, only in the case of Kiani [2010] EWHC 577 had there been permission to continue and here it was down to disclosure. (The other five cases where Franbar [2008] EWHC 1534, Mission Capital [2008] EWHC 1339; Fanmailuk [2008] EWHC 2198; Stimpson [2009] EWHC 2072; and Iesini [2009] EWHC 2526)

From these six cases all passed the initial hurdle that there was a prima facie case. However, two were dismissed for a mandatory bar, primarily on the fact that no director would continue the claim if acting in accordance with s172 (duty to promote the success of the company). The three remaining cases dismissed appeared to come up against a reluctant court to allow the claim to proceed since the final stage of the permission hearing leaves permission to continue to the judge's discretion. Although guidance as to what to consider under their discretion is given under s263(3), it is not an exhaustive list. None of these six cases considered anything beyond these factors under s263(3) though (although in the case of Stimpson the judge suggested he had done so, but in fact the interests of employees, I argued, should be considered under s263(3)(b) anyway).

Where permission was allowed down to disclosure, it appeared the only reason it got that far was the fact the other side had produced no evidence to the contrary. Comparing the Kiani position to the case of Franbar where they produced some rudimentary evidence to the contrary and permission was refused, it seems likely that Kiani would have failed if they had produced very little evidence to the contrary.

Since these six cases, four more derivative claims have been heard. These claims are Seven Holdings [2011] EWHC 1893; Kleanthous [2011] EWHC 2287; Stainer [2010] EWHC 1539; and Cinematic Finance [2010] EWHC 3387. 

Three have been dismissed and one, Stainer, has been allowed subject to various conditions. Cinematic Finance involved a rare instance of a majority shareholder bringing a derivative claim. Demonstrating it is technically incorrect to refer to derivative claims and unfair prejudicial petitions as minority shareholder protection. However, the judge quite rightly demonstrated that a majority shareholder would only be able to bring a derivative claim in very exceptional circumstances and the claim was denied.

The case of Kleanthous was a useful reminder that part 11 does not assert some sort of threshold test to allowing permission. Even if there is a strong, arguable case of breach of duty it does not necessarily mean permission will be allowed to continue. Thus, it is conceivable (although unlikely in this author's opinion) that permission could be allowed where the court in not convinced there is a strong case.

The case of Stainer was referred to by Kleanthous which originally highlighted the fact that there was no threshold test to allowing permission, i.e. if the case is very strong but recovery very small it may be appropriate to continue and vice versa.

In Seven Holdings permission was refused. The court acknowledged that derivative claims under s260(3) could only be pursued for 'a cause of action arising from an act or omission involving negligence, default or breach of duty by a director of the company'. It was held that some claims did not fall within this scope and those that did, no director would consider prosecuting them.

More importantly, Seven Holdings at [12] confirms my point that when considering to allow permission under s263(3)(b) 'whether a director acting in accordance with s172 would attach weight to continuing the claim' that the subsections to s172 should also be included in that consideration.

The judge in Seven Holdings also discussed the importance of the ex parte application stage i.e. establishing that there is a prima facie case without involving the company. He established that it was important that this stage was not ignored or removed. Although, contrary to what I said in my articles, I would now agree that this is the correct approach, although with some slight qualifications as to its standard. The judge at [6] appeared highly critical that this preliminary stage had been bypassed, and that he had to deal with the second stage despite no evidence or presumption that the application supported a prima facie case.

The fact that the stage has been bypassed demonstrates that despite a transparent statutory procedure it is by no means followed rigidly. This perhaps demonstrates the flexibility of the new claim to filter out unnecessary formalities and reduce costs, but in cases such as Seven Holdings where it was quite apparent that there was not even a prima facie case, the process should be followed.

Another objective of the reform was to reduce the cost of derivative claims as they had previously been a costly procedure. The judge in Seven Holdings at [61-3], however, pointed out that this would be a likely consequence of the reform, although we are yet to see a claim last as long as a month as we did pre-2006. He followed on from his criticism that the first stage had not been observed stating that it would have saved a lot of time and money if it had been.  

Thus, it still appears that the courts approach derivative claims with scepticism and reluctance, although Stainer offers hope to shareholders that there may be a departing from former ways.