Proving companies as per their different standards.

Proving fraud and control is a difficult process, hence the question of standing had to be considered as a preliminary issue as in Prudential Assurance Co Ltd v Newman Industries Ltd where it was held that the question of standing be made a preliminary issue.1 Unfortunately, preliminary hearings are in most instances long, cumbersome, and expensive thus discouraging the possible plaintiff.

1.     Ratification

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The existing derivative remedy under the common law was faced with the challenge of the law relating to ratification because it required that a derivative action could only be brought by a shareholder against a director in the case of a director’s breach of duty only if the breach was unable to be ratified by the company.2 This rule was used by a number of directors and companies to deprive a shareholder his/her ability to bring derivation action because of the divergent authorities that classifies acts and omissions of directors as ratifiable by the companies as per their different standards. Therefore, the lack of clarity in this aspect offers the foundation for controversies that may result in injustices for the shareholders seeking derivative remedies.

2.     The uncertainty of rule of exceptions

The rule of exceptions derived from Foss v Harbottle appears simple but is marred with serious uncertainties that result in confusions and misconceptions. The complexity and obscurity of the law makes it very difficult to accurately state the law; this posts numerous hurdled in front of a shareholder who may wish to seek derivative action.  

3.     The inadequacy of the alternative remedies

A number of remedies have been suggested to derivative action; one such remedy is the oppression remedy that was intended to protect the rights of the minority shareholders. The oppression remedy has had numerous diverse interpretations in court, which has led to its failure to furnish the minority shareholders with adequate protection.  In addition, it has been reported that the oppression remedy has been widely used in the recent past to circumvent possible derivative actions.3

(Statutory Derivative Action)The shortfalls of the common law discussed above prompted discussions which led to the introduction of the Statutory derivative action which was aimed at overcoming the existing problems by increasing the effective remedies available to shareholders. The statutory derivative action was introduced by the Law Commission in order to simplify and modernize the law with the aim of improving its accessibility. Likewise, the statutory scheme was enforced to ensure that companies receive appropriate remedies for actions that prejudice its interests.4 The Statutory derivative regime is included in Part 11 of the Act and it began to operate in 2007. One important characteristic of the statutory derivative action scheme is that it allows the courts to perform a gate-keeping role so as to exclude frivolous and unmerited cases where the costs to be paid by the companies exceed the benefits it intends to receive.5 Generally, the purpose of the introduction of the statutory derivative action was to enhance managerial accountability by empowering the shareholders and others to have the capacity to deter managerial misconduct. It should thus provide strong encouragement for company managers to uphold accountability to the shareholders. Likewise, the statutory derivative action was aimed at deterring managerial abuses while providing an avenue where shareholder activism can help recover the damages and property belonging to a company; it is thus important in enhancing compensation since it offers avenues through which shareholders can enforce their rights and recover money owed to the company.

The statutory scheme requires the permission or leave of the court to be secured by a shareholder before being allowed to continue with a derivative action against a company’s director or any other person who may have harmed the interests of the company. The permission/leave is secured if the shareholder passes through two stages successfully; as in the Foss v Harbottle, the court first considers whether prima facie case has been satisfied before ascertaining if the court may require that evidence be provided by the company. The second part of the admission of the case involves the consideration of factors under CA 2006 s. 263(2) and (3). However, the open-ended nature of the factors in s. 263(3) which were considered inexhaustible renders such factors uncertain. Therefore, practitioners tend to struggle with the understanding of factors in s. 263(2) and 263(3). Specifically, s 263(2) states that proceedings brought on behalf of a company must be brought in the company’s name; this implies that the right to bring a derivative action at general law is abolished as in s 263(3). Additionally, permission/leave of the court is only obtained pursuant to s 237(2) where the court only grants the application if it is satisfied that;

a)      it is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; and

b)    the applicant is acting in good faith; and

c)      it is in the best interests of the company that the applicant be granted leave; and

d)     if the applicant is applying for leave to bring proceedings – there is a serious question to be tried; and

e)     either:

i)               at least 14 days before making the application, the applicant gave written notice to the company of the intention to apply for leave and of the reasons for applying; or

ii)              It is appropriate to grant leave even though subparagraph (i) is not satisfied.

All the requirements of s 237(2) given above must be satisfied for permission/leave to be granted. Section 237(3) explains how a reputable presumption that granting permission is or is not in the best interest of the company.  In Airey v Cordell, it was held that the appropriate test for leave to bring a derivative claim was the view of a hypothetical and independent board of directors of the company.6 This means that the discretion of the board of directors of a company was important before permission is granted.7

  Generally, there existed an array of ambiguity in the non-exhaustive list of factors to be considered by courts. In addition, the court has the responsibility to dismiss an application if the evidence availed by the applicant does not disclose the prima facie case for giving permission.8

The statutory regime has also had its share of challenges, which may have contributed to a fewer cases in the UK under the statutory regime. Among many other challenges are the costs associated with the actions which seem to dissuade the institution of proceedings; for instance, if permission action is not successful, then an applicant shareholder is liable only for both his/her costs as well as the costs of other parties. Secondly, there is lack of financial incentives for any shareholder to take time and incur the possible costs of prosecuting a derivative action. This is because any relief ordered will be in favor of the company; hence the shareholder does not receive any direct benefit from an action. Thirdly, experience shows that judges have been invoking a more strict approach to leave applications which may discourage shareholders from taking action.9

Despite having a share of its challenges, the statutory derivative claim increases certainly on when and how a derivative action can be initiated if compared to the common law. However, it has not provided much encouragement to the shareholders and neither has it made derivative action more accessible for shareholders. Generally, if the statutory scheme has to be effective in offering protection of minority shareholders, a number of changes can be instigated. First, it should allow a wider range of applicants to bring derivative actions rather than only the members of the said company. As it stands, the Act defines a derivative claim as a claim brought by a member of the company in respect of a course of action vested in the company and seeking relief on behalf of the company.10 Therefore, a claim can only be brought within the Act or in pursuance of an order under s 994, otherwise no provisions for an enlarged access to interested parties to bring a claim.11 

The legislation should be broadened to allow multiple derivative action which is brought by a minority shareholder of a parent company for a breach owed to a subsidiary company. Secondly, the scheme would be better if shareholders were allowed to bring derivative proceedings against anybody with or without initial cause of action by the company board on such individuals. This would prevent the abuse of the boards by attempts to protect wrongdoers due to varied understandings of negligence in bad faith as prescribed in Pavlides v Jensen.12 Likewise, increased incentives to shareholders would enhance the success of the statutory claims; therefore, as suggested by the Law Commission, inclusion of the power to provide indemnity would act as important incentives to shareholders to initiate proceedings. Fourth, the concept of ratification still remains more controversial into the statutory regime as it was in the common law. Therefore, to avoid the controversies and uncertainties, the concept of ratification should be removed altogether in the regime. Still with the statutory regime, the court still relies on the assessment of a company’s commercial interest as in Kleanthous v Paphitis.13

The courts have also been too cautious when granting costs due to outcomes of derivative actions; for instance, only in two out of eight cases in England have the shareholders been successfully granted costs. For instance, in Stainer v Lee, Roth J ordered an indemnity to a limit of £40,000;14 in all the cases where costs have been granted, no cost limits have been issued. Courts can decide in favour of the applicant but it can go without costs being awarded. This is a serious drawback on the scheme as most shareholders would see no value in engaging in the derivative actions.

(Unfair Prejudice) A shareholder can obtain redress from the court by making an unfair prejudice petition under The Companies Act 2006.15 An unfair prejudice petition is a remedy for the minority oppression in companies and is brought when the company affairs are being conducted in a manner that is unfairly prejudicial to the interests of member(s).16 Some of the unfair prejudice that have been found by the court include instances where;

1.     A shareholder has been excluded from the management of a quasi-partnership,

2.     Failing t proper dividends by the companies,

3.     The majority shareholders awarding themselves excessive remuneration or musing the company for their personal gains,

4.     Diverting businesses to other issues of the company,

5.     Serious accounting failures, and

6.     Failing to obtain shareholder approval for the sale of company property to its directors among others.

The unfair prejudice law cannot be brought by a member unless his interests have been adversely affected by some conduct. The unfair prejudice petition can only be brought by a member; a ‘member’ is defined by the Companies act as a subscriber to the memorandum or any other person who agrees to become a member of a company and whose name is entered in the register of members.17 A ‘member’ also includes nominee shareholder; therefore, a person with beneficial interest but is not a registered member cannot thus bring a petition. In addition, a petition on unfair prejudice grounds can only be successful if the mentioned conduct is unfairly prejudicial. The grounds on which an act can be termed unfairly prejudicial are still controversial and should be objective rather than subjective. In Bovey Hotel Ventures Ltd, Re, it was ruled that it was not necessary to show that majority acted in the knowledge that the conduct would be prejudicial to the petitioner, what is important is whether a reasonable man would regard the cat as an unfair prejudice on the minority’s  interest.18 An unfair prejudice petition can only succeed if unfairness as well as prejudice can be proven; in Jesner v Jarrard Properties, it was held that an act that prejudices the petitioner may not be unfair.19 The use of this law still remains controversial and with numerous uncertainties in the statutory derivative action as it was in the common law derivative action.

 

 

With these drawbacks on the statutory derivative claim, a more robust and workable derivative claim ought to be developed. Likewise, the court should be more apt to avoid appearing as obstacles in the quest for justice by minority shareholders through statutory claims. Therefore, more clarity is required on what cases to be brought under section 994 and those to be initiated as derivative proceedings. However, if the courts could adopt a different approach in the statutory scheme, the scheme would be much better than the initial common law derivative action because it allows action to be taken in relation to a wider range of wrongdoing and against a large range of respondents. As it stands, the statutory derivative claim has only introduced minor changes that may not have sufficiently changed derivative action as was expected.