One of the basic rules of company law is that if a wrong has been committed against a company, the proper claimant ought to be the company itself. However, if the directors are the perceived wrongdoers, it is unlikely that those directors will authorise such legal action to obtain a remedy for that wrong-doing. Accordingly, in certain circumstances and subject to permission from the courts, shareholders may step into the company's shoes to pursue that claim on the company's behalf – a 'derivative' action where the shareholders' right to claim derives from that cause of action instilled in the company.
This form of claim was originally derived from common law principles, but is now set out in legislation in sections 260 and 261 of the Companies Act 2006 (the Act) as an exception to the general rule that a shareholder cannot bring a claim. This legislative opportunity, however, is still subject to the court's oversight by way of the derivative claimant's requirement to seek permission from the court to continue the claim. The judgment delivered in Saatchi v Gajjar and Another  3472 EWHC Ch offers a very useful overview and update as to the factors that the court will take into consideration when deciding whether to grant permission for a shareholder to pursue such an action.
A company was formed by the derivative claimant shareholder (S) and defendant (G) as 50/50 shareholders, with G also acting as the sole director in the company. S began proceedings against G in relation to an alleged misappropriation of Company assets (via director loans, vehicle purchases and various other payments). S was seeking the court's permission to continue with a derivative claim brought in respect of causes of action vested in the Company pursuant to the Act.
Relevant provisions of the Act
To better understand the outcome of this court action, it is useful to briefly set out the key provisions of the Act. The starting point is that section 260 of the Act provides that a derivative claim may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, or breach of trust by a director of the company.
There are then two stages of the proceedings. The shareholder must first establish a prima facie case for being given permission to proceed (section 261 of the Act). If that stage is passed, the matter proceeds to a second stage and a full hearing. At this point, the court will consider whether to grant the shareholder permission to proceed, referring to a number of factors set out in section 263 of the Act.
Establishing a "prima facie" case
In this first stage, the member will issue a claim, and will make an application to the court, supported by witness statement evidence, setting out what the member considers to be the relevant details seeking permission from the court to continue with the derivative action. More than likely, this would include a description of the alleged breaches of duty by the directors. This is only the first step to advancing a claim. The purpose of this provision is to enable the court to dismiss unmeritorious claims at an early stage without having to involve the defendants or the company.
This step is undertaken by the court considering the application papers without a hearing. If the court is satisfied, it will give permission or leave to continue with the claim, and make an order on such terms as it considers fit. If the court is not satisfied, it must refuse permission and dismiss the claim. Thus, the decision will be made, usually without any submissions from, or involvement of, the company.
Hearing for permission
Upon the derivative claimant first establishing a prima facie case, the claim will proceed to a full permission application. The court will give directions for the service of the claim form and supporting documents to be served on the company and any other party, and may give directions about the evidence to be provided by the company.
Upon convening the substantive hearing for permission to continue the claim, for the most part, the court has a discretion and must balance a number of potentially competing factors. However, the court must refuse permission, if any of the following circumstances are applicable:
- A director acting in accordance with s.172 of the Act (duty to promote the success of the company) would not seek to continue the claim; or
- The proposed act or omission relating to the derivative action has been authorised by the company, or if the act or omission has already taken place, it was either authorised before it occurred or has been ratified since it occurred.
Where the above preconditions have been met, the court will have discretion to determine whether to permit the derivative claim to continue having regard to all relevant matters, including whether a member is acting in good faith in seeking to continue the claim, and/or whether the act or omission gives rise to a cause of action that the shareholder could pursue in their own right.
Each case, therefore, will turn on its particular facts.
Application of the test in Saatchi v Gajjar
The judge in Saatchi v Gajjar provided a thorough review of the preconditions and court discretionary powers. The court held that:
- The cumulative level of the payments made e.g. director loans, car finance arrangements, payments to family members etc. by the director, was sizeable, and there was no evidence that the company members had given informed consent to the transactions. The circumstances surrounding these payments was such, that the substance of the claim was something more than just a prima facie case for a director acting in accordance with s.172 of the Act to seek to continue with it; and
- There was no evidence that assent to the making of the payments had been sought or obtained from S, as a co-shareholder. It was argued by G that S had effectively provided 'carte blanche' for G to do as he wished and therefore had provided informal assent to the making of the payments. However the judge, (with particular attention upon the director loans and payroll payments), noted that a shareholder would need all the necessary information to make an informed decision when assenting to such payments. G had not provided sufficient evidence to show that this was the case.
- A director, having regard to their obligations to promote the success of the company, would attach importance to these allegations and claims;
- as a large number of the payments were potentially in breach of G's duty to promote the success of the Company, it was unlikely that any ratification post-dating the payments would be provided by S.
Court's Discretionary Powers
Section 263(3) of the Act lists certain factors which are to be taken into account by the court when exercising its discretion at the main permission hearing. This assumes that the court has not already decided that it must refuse permission based upon any of the factors mentioned above.
- S could not bring the claim in his own right, as it vested in the Company. The court considered that S was acting in good faith in bringing the claim;
- it was unlikely that there would be any disruptive impact on the Company's activities in pursuing the claim, as S was the main and/or only client to the Company;
- upon a review of the alternative remedies available (unfair prejudice petition under s.994 of the Act, or a petition to wind up a company under the Insolvency Act 1986), none precluded a derivative claim to be brought, which in fact was likely to be the best course in any event given the facts (action against a director during a time where he had complete control of the Company); and
- any potential concerns that the Company would be unable to cover the costs of pursuing a claim was ultimately not a factor, as it had been agreed with S that the Company would only pay costs should the claim be successful.
Based upon these factors, the court confirmed that S was granted permission to continue with the derivative action.
The provisions within the Act set out the process and foundation for a derivative claim. However, it is still important to refer to case law for guidance in relation to the factors the court will take into consideration when either (a) considering if a prima facie case exists and (b) granting permission for the claim to continue at the substantive hearing stage. Each derivative claim application is fact specific, but each provides a further understanding of the court's approach and interpretation of the applicable legislative provisions in this area of the law. Saatchi v Gajjar offers a very useful and comprehensive review of applicable case law and as such can be seen as a guide to others seeking to pursue or defend such claims. It demonstrates that whilst individual allegations may not carry the same weight, when considered as a collective, the cumulative value may be of sufficient substance to enable the court to conclude that a claim can be properly brought as a derivative action, and that permission should be granted for a derivative claimant to continue with a claim.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.