Recent cases on derivative actions under the Companies Act 2006 – are fears of “activist shareholders” unfounded?

Background

A derivative action is an action brought by a shareholder on behalf of the company. Owing to the complexity of the previous law, very few derivative actions succeeded. When the Companies Act 2006 (“the 2006 Act”) came into force, it introduced a wider range of circumstances in which such actions could be brought. A derivative action is now expressly available for a breach of duty by a director, even if the director has not benefited personally from the breach. Furthermore, it is no longer necessary for the shareholder to show that the director(s) who carried out the wrongdoing control the majority of the company’s shares. 

Initially, some legal commentators were concerned that activist shareholders would bring such actions simply to disrupt the affairs of the company or make life difficult for its directors. This was despite the 2006 Act containing some procedural hurdles which must be overcome before a shareholder can bring a claim for a derivative action. Recently there have been some cases which consider such hurdles.

Recent cases

In Franbar Holdings Ltd v Patel and ors [2008] EWHC 1534 (Ch) the judge refused an application for permission to continue a derivative action partly on the basis of one hurdle, which requires the court to be satisfied that a director acting in accordance with his duty to promote the success of the company would seek to continue the claim. The judge identified several factors which the hypothetical director would take into account which included: the prospects of success of the claim; any damage to the company’s reputation and business in the event of the action failing; and the cost of the proceedings. The judge considered that in the circumstances it was not possible to conclude that such a director would continue the claim. The failure to overcome just one hurdle was sufficient for the judge to refuse permission. Another key reason for the refusal was the ability for the shareholder to seek a different remedy under the 2006 Act on the basis of what is known as “unfair prejudice”.

In Stimpson & Ors v Southern Landlords Association [2009] EWHC 2072 (Ch) permission to continue a derivative action was again refused. The judge gave a long list of reasons to support his view that a hypothetical director would not seek to continue the action. The judge also stated that if even he was wrong on that specific point, his refusal could be justified on other grounds.

In Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch) the judge emphasised the importance for the derivative action to be based on an act or omission involving negligence, default or breach of duty by a director. As the directors had followed the advice of eminent professionals, the judge considered that they had not been negligent or breached their duties.

Summary

It appears that the courts will interpret the 2006 Act strictly when determining whether the new derivative action can be used. Therefore, for the moment at least, any concerns that activist shareholders will be allowed to use the action frivolously seem to be unfounded.