Chapter 11 and 12 answers
Derivative claim
2019/ZB
Question 8
George owns 70 per cent of the shares of Beasties Ltd. Henry, Joan and Fiona each own 10 per cent
of the shares of Beasties Ltd. The four shareholders are the company’s only directors. Fiona has also
lent Beasties £100,000. Under a personal guarantee, George personally promised Fiona to repay that
loan to her if Beasties fails to do so.
In 2018, George made a series of negligent decisions which caused substantial losses for Beasties.
The company is now on the verge of insolvency, Fiona’s shares are almost worthless, and the
company is unable to repay her loan.
Fiona demands that Beasties sue George. However, the directors vote not to take any action. A
shareholders’ meeting, attended by all the shareholders, passes a resolution to ratify George’s
breaches of duty. Only Fiona votes against.
Advise Fiona whether:
a) if she started a derivative claim against George, she would be likely to be given permission to
continue that claim; and
b) could personally claim against George, both for the drop in the value of her shares and to enforce
the personal guarantee in respect of the loan.
(Do NOT discuss section 994 Companies Act 2006 or section 122(1)(g) Insolvency Act 1986 in your
answer to part (b).)
Answer:)
a.) The rule in Foss v Harbottolle imposes a restriction on individuals to bring a claim on behalf of the
company. The derivative processing are seen as an exception to the general rule which allows a
shareholder to bring a claim for loss that the company has suffered.
Coming to the procedure of bringing a derivative claim, S.261 will require Fiona ( the member) to
apply to the court for permission continue her claim. The procedure could be seen as two part
process. In the first stage a paper hearing takes place where the Fiona will be required to establish
that she has a prima facie case (Iesini v Westrip 2009). In case the application is rejected at this
stage, she can apply again through a oral hearing to proceed her application however no further
evidence from any side will be permitted at this stage (Practice Direction 19C). Whereas, she is
successful in the first stage, the case will than enter the second stage where a full permission hearing
will take place and further evidence from the company will be permitted (Franbar v Patel 2008).
The criteria for this stage is set out in S.260(2) and (3). The ‘mandatory bars’ of S.260(2) state three
instances which lead to direct refusal of continuing the application. The first is where the person
acting in accordance with S.172, duty to promote the success of the company, would not seek to
continue the claim (Trevor & Anor 2011). No evidence in the question shows a members intention
regarding the company and therefore judging someone with reference to s.172 will not be possible.
The second bar is where the act or omission in question is yet to take place or has been authorised
by the company. George’s negligence acts have already taken place and not where they authorised
by the company thus this bar won’t apply here. Lastly, in case the act or omission has already taken
place but was authorised by the company or ratified since it occurred this will also lead to failure of
the application process.
The process of ratification under S.239(4) did take place and it requires the resolution for ratification
to be passed without the votes of the wrongdoer/those connected with the wrongdoer. This means
that George’s votes must be disregarded. However, we are not aware whether any of the other
, shareholders are connected to George, within the definition in s.252(4)(Franbar v Patel). Therefore,
Fiona being the only against George, means that his negligence would be ratified as Henry and Joan
will have the majority. Thus, the ratification is valid , which means that the application should be
refused. However, what can be argued here is that the concept of ratifiable wrongs has been
debatable as according to certain decisions and text-writers, certain breaches of the law are non-
ratifiable. Whereas, others have held the view that any breach can be ratified if the ratification is
carried out by means of the votes of disinterested members(Re Singh Brothers Contractors 2013).
In case its argued that the ratification is invalid and Fiona is able to pass her claim through these
mandatory bars, it doesn’t make it necessary for the courts to give permission for the derivative
claim to proceed as than it will be the courts discretion on what to do. A list of ‘discretionary factors’
was set out in S.263(3) under which the courts see different factors to reach their decisions such
motives of the claimant (Stimpson v SLA 2010) which in this case also seems o
include Fiona’s personal motive of getting her loan back rather than compensation for company’s
loss. Additionally, even though ‘fraud’ is no more a requirement for derivative actions it can be still
argued that George had committed negligence and not a fraud. Other factors such as
consequence for the company (Jafari-Fini v Skillglass 2005), cost of proceedings (Stainer v Lee 2010),
and objective belief of a reasonable directors (Cullen Investments v Brown 2015) could also be
included in reason for which Fiona’s case fails.
b.) Fiona can bring a personal claim against George for the wrong he has done (MacDougall v
Gardiner) however, the infringement of Fiona’s right is only possible if George owed a duty to her,
that he had neglected. Generally, the directors only owe a duty to the company (171-177 CA 2006)
however, a contractual duty under the companies constitution or an agreement between them
could exist. The fact that George had given a guaranty to Fiona that he will make sure that the
company pays her loan back or else he would personally compensate for it. Here a contractual duty
could arise but what must be noted is that the loss Fiona is suffering is reflective rather than direct.
This is because George’s negligence to the company is what brought the company to insolvency,
making it unable to pay Fiona’s loan. Thus, Fiona claiming a reflective loss (discussed earlier in the
question), cannot sue George in personal action (Johnson v Gore Wood).
The claim for the drop in the value of her shares will be a potential reflective loss claim. The general
rule states that in case the loss suffered by the shareholder is reflection of the loss suffered by the
company the courts will not allow a personal claim (Prudential v Newman 1982). This is because the
courts believe that when a director’s action cause some sort of loss to the company, such as in form
of diminution of shareholding value, its the company which is the proper claimant (Foss v Harbottle)
and not the individual shareholders (Stein v Blake 1998). Thus, applying the general rule Fiona will be
unable to recover her loss under the reflective loss principle.
However, there could be some exceptional cases where the shareholders could establish that beside
the duties that the director owe to the company, they also owe duties to the shareholder.
Such as a director may owe a duty of care to the shareholders in tort. However, such a claim would
not be successful if the duty of care could be established through ‘assumption of responsibility’
principle (Williams v NLHF 1998), and in this case no such duty could be be establish, therefore the
claim would fail (Sharp v Blank 2019).
Another exception could in case the Fiona can establish a fiduciary duty owed to her by George due
to sufficient proximity of their relationship (Allen v Hyatt). The last possible exception is existence of
a separate contract between the Fiona and the George which imposes an obligation on the him and
thus could hold him liable (Platt v Platt 199). However, the facts do not state any existence of such a
