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A Guide to Derivative Claims

If you’re a member of a company, it can be tough to know which course of action to take in the midst of a dispute when, quite often, there are multiple options to consider. In this guide, our business disputes solicitors will take a look at a particular type of claim known as a derivative claim and provide an in-depth analysis of how derivative claims work in practice.

What’s a derivative claim?

A derivative claim is a type of claim that can be brought against the director of a company for something that they did or proposed to do (or did not do/proposed not to do) which was:

  • Negligent
  • In default
  • In breach of their duties, or
  • In breach of trust in respect of their actions and responsibilities towards the company

In addition to existing directors, a derivative claim can also be brought against a former director of a company or a shadow director. A shadow director is a person whom the law considers as a director because of the influence and control they have over a company, but they aren’t officially appointed to the board of directors. A claim can also be made against third parties involved in the same wrong doing.

Lastly, the reason why the claim is described as ‘derivative’ is because the shareholder’s right to sue is not personal to them; rather it derives from the right of the company – but which the company has failed to exercise.

Who can bring a derivative claim?

A derivative claim can be brought by members of a company, trustees or personal representatives holding shares in the company. Additionally, it’s sometimes the case that a shareholder takes over a derivative claim that was commenced by the company itself.

What’s the difference between a derivative claim and an unfair prejudice claim?

Essentially, the fundamental difference between the two types of claim is that in bringing an unfair prejudice petition, a shareholder is seeking to protect their own rights as a shareholder of the company, whereas in a derivative claim, a minority shareholder is seeking to protect the rights and interests of the company as a whole as opposed to their own personal interests as a shareholder.

Further, a derivative claim can generally only be brought by minority shareholders, whereas any person who is a member of a company – including majority shareholders – can bring an unfair prejudice claim.

Grounds for bringing a derivative claim

A company director has specific duties in law and they are set out in a piece of legislation called the Companies Act 2006 (the ‘Companies Act’). The main duties that our business disputes solicitors typically see at the centre of litigation are:

  • The duty to act in the company’s best interests
  • The duty to exercise reasonable care, skill and diligence
  • The duty to promote the success of the company
  • The duty to declare an interest in a proposed transaction or arrangement

Breaches of any of the above duties are examples of when it might be appropriate for a derivative claim to be considered as a prudent course of action and amount to grounds for bringing a derivative claim.

What criteria do you have to meet to successfully bring a derivative claim?

The criteria that have to be met is split into two different stages, as below:

The first stage

Once proceedings for a derivative claim have been issued, the court’s permission must be obtained before the claim can potentially continue. Simultaneously, the claimant shareholder has to notify the company of the claim at this point.

The court will scrutinise the circumstances in which permission is sought to decide whether there’s a prima facie case for permission to continue the proceedings, exercising their discretion as they deliberate this. This means that any evidence the claimant shareholder puts forward at this stage is very important, because this is what the court will base its decision on along with any representations from the company/directors opposing the claim.

If the court dismisses the application on paper, the claimant shareholder has 7 days within which it can request an oral hearing, at which point they will invite the court to reconsider their application for permission.

The second stage

At this stage, the court will decide in a dedicated permission hearing whether to grant permission for the claim to be continued. The judge will hear evidence from the applicant(s) (the claimant shareholder) and the respondent(s) before they reach a decision.

The court must refuse permission to continue the claim if it’s satisfied that an individual acting in accordance with the duty to promote the success of the company wouldn’t bring a claim, or if the act/omission complained of has been independently authorised or ratified by the company.

Other factors the court must consider in determining whether to give permission and as set out in section 263 of the Companies Act are as follows:

  • Whether the shareholder is acting in good faith in seeking to continue the claim
  • Whether the company has decided not to pursue the claim
  • Whether the act or omission is likely to be authorised or ratified
  • Whether the act or omission gives right to a cause of action which the member could pursue in his own right rather than on behalf of the company
  • The importance which a member acting in accordance with the duty to promote the company’s success would attach to the claim

There’s also a noteworthy point in section 263(4) which states that in considering whether to give permission, the court shall have ‘particular regard to any evidence before it as to the views of members of the company who have no personal interests, direct or indirect, in the matter.’

How to bring a derivative claim

Going through the above process of obtaining the court’s permission is the first step in how to bring a derivative claim, regardless of whether it’s via the statutory route or the common law route.

The statutory derivative claims process

From 1 October 2007, the new statutory claim replaced the previous common law action for claims pursued by members of the wronged company in question, with the exception discussed under ‘common law derivative claims process’ below.

If permission is successfully obtained, the process to be followed is set out in the Civil Procedure Rules, specifically CPR 19.9 and Practice Direction 19C (which is moving to become 19A from 6 April 2023) for how continuing the claim should happen.

Common law derivative claim process

Making a common law derivative claim is still appropriate for ‘double’ or ‘multiple’ derivative claims. These are claims that are commenced by a member of a company against a director/directors for breach of duty in respect of the company’s subsidiary. As mentioned above, a claimant must demonstrate a prima facie case and be granted permission from the court to pursue a common law derivative claim and further, the court will apply the same factors in exercising its discretion as for statutory derivative claims.

The difficulty in being successful with a derivative claim

It’s clear from the processes outlined above that there are high hurdles to get over in order to be successful with a derivative claim. The permissions and pre-conditions to satisfy in the first instance means that it’s not necessarily an attractive action to take and furthermore, if permission is refused, the claimant shareholder(s) is/are at risk of being liable for the costs of bringing the action in the first place.

Derivative claim remedies

As with all proceedings in the civil and commercial courts, there are a range of potential remedies available for derivative claims. The crucial point to highlight here is that, in cases where the court orders the payment or repayment of money by the directors held liable, the money won’t go to the shareholder(s) who instigated the claim – rather, it will be paid or repaid to the company for the benefit of the company as a whole.

The main remedies for successful derivative claims are as follows:

  • Damages payable to the company from the director(s) held to be at fault
  • An injunction to prevent the director(s) at fault against taking any further unlawful action/committing any further breaches
  • The setting aside of transactions which have personally benefitted the director(s) at fault
  • The removal of a director/directors from their position as an employee/employees
  • Restoration of any company property held by the director(s)
  • An order for restitution or requiring the director(s) to account for any profits they have made.

Alternatives to derivative claims

For smaller and medium-sized businesses, it might be worth a shareholder seeking redress to think about bringing an unfair prejudice petition instead with a view to recovering damages on their own behalf instead of for the company (or a sale of their shares).

Pursuing a breach of contact claim might be another potential alternative course of action if there’s a shareholder agreement in place and if the director(s) at fault has/have done something in contravention to what’s set out in that document. Additionally, it might, as a last resort, be the best plan to apply for an order winding up the company, depending on the circumstances.

Summary

It’s clear from this article that bringing a derivative claim is not a straightforward course of action if you’re embroiled in conflict with a director(s) the company you’re involved with. It’s absolutely essential to seek advice from an business disputes lawyer about your options, particularly with a view to minimising costs and ensuring you get the most effective result.


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