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Summary Shareholder remedies

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Company Law

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Cambridge University (CAM)

A simply but detailed explanation of the various remedies available to shareholders including those contained in sections 275 and 994 of the Companies Act 2006.

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COMPANY LAW SUPERVISION VII
SHAREHOLDER REMEDIES
- When looking at which actions are applicable, look at the remedies which the claimant is seeking
e.g. if the claimant wants damages for the company then consideration of a s.994 action is
pointless.

1. INTRODUCTION

- Directors’ duties will not play a significant role in the governance of companies if they are rarely
enforced. However, this is not to say that in every case where it is arguable that a director has
infringed his duties to the company, the company should be contemplating litigation.

- The question is whether the best interests of the company require that litigation be instituted.
There are many reasons why litigation may not be in the best interests of the company e.g. if there
is only a small chance of success, or if the defendants are not solvent.

- Given that there is not clear answer as to whether or not to litigate in any given case, the role of
the law is to determine the persons who can safely be entrusts with taking the decision.

If the board decides to sue, all well and good, but it may result in less litigation than is optimal
(i.e. than the interests of the company would dictate) if the board has exclusive control over the
initiation of litigation in the company’s name. In recognition of this argument, the common law
takes the view that, even if the board does not wish to sue, it is open to the shareholders
collectively by ordinary resolution to decide to do so.

2. DERIVATIVE CLAIMS

- A derivative claim is one made by a member of the company in respect of a cause of action vested
in the company and in which relief is sought on behalf of the company.

On the one hand, such access to the courts for individual shareholders will increase levels of
litigation against wrongdoing directors. On the other hand, it is difficult to demonstrate that such
litigation will invariably be brought in the interests of the company e.g. it may be brought to
promote the personal interests of the shareholder.

- The prima facie position at common law was as follows:

Foss v Harbottle (1843)
In effect the court established two rules. Firstly, the “proper plaintiff rule” is that a wrong
done to the company may be vindicated by the company alone. Secondly, the “majority
rule principle” states that if the alleged wrong can be confirmed or ratified by a simple
majority of members in a general meeting, then the court will not interfere.

- The rule is based on two fundamental principles of company law, namely respect for the separate
legal personality of the company and the principle of majority rule. In addition to reflecting those
fundamental principles, the rule has certain practical advantages. It is convenient and efficient that
the company should sue in respect of a wrong done to it rather than have a multiplicity of
shareholder suits.

- However, rule was subject to an important exception.

Pavlides v Jansen
A minority shareholder could bring an action on behalf of the company where he could
show that: (1) The wrong constitutes a fraud (i.e. a breach of duty) against the minority;

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, (2) The wrongdoers are in control of the company and will not allow the company to
sue; and (3) A majority of disinterested shareholders would wish to pursue the litigation.
- While in theory the scope of this exception is broader that the section 260 provision (below) in
that it could in theory be used to pursue claims against third parties, the requirement that the
wrongdoers be in control of the company (by reason of their votes as shareholders) is a significant
limitation in practice.

- The effect of the requirement of “wrongdoer control” meant that in the vast majority of publicly
listed companies, where the shareholdings of directors would not amount to de jure or de facto
control, the exception was not available.

3. THE SECTION 260 DERIVATIVE ACTION

- A report on shareholders' remedies by the Law Commission in 1997 recommended that the
common law action be replaced with a statutory derivative procedure. This proposal was adopted
by the Company Law Review: the statutory derivative claim is set out in CA 2006 Pt 11.

- Section 260(1): A derivative claim is brought in respect of a cause of action vested in the
company, and seeking relief on behalf of the company. NB The claimant must still be a member of
the company: it is not sufficient that the cause of action arose while they were a member.

- Section 260(2) abolishes the old system of common law derivative actions. But to what extent are
existing principles still applicable?

- Section 260(3) limits the scope of the statutory derivative claims to causes of actions which arise
out of negligence, breach of duty or breach of trust by a director of the company. The claim may
be against the director or another person.

Iesini v Westrip
A claim may be brought against a person who has dishonesty assisted in a breach of
fiduciary duty or who has knowingly received trust property.

- Where the company has a cause of action not associated with a director of the company (e.g. a
claim against an employee), it would appear that the litigation decision should be taken according
to the division of powers contained in the company’s articles of association.

3.1. Procedure

- Stage one: According to section 261 the claimant must issue a claim form and notify the company
of the claim. The court will consider whether there is a prima facie case for permission to continue
to be granted.

- Sage two: According to section 263(2) the court must refuse permission to continue if any of the
three conditions there are met.

Cinematic Finance v Ryder
The claimant was a majority shareholder in the company. It was held by Roth J that the
new statutory code of the Act preserves the existing law as to the need to show
‘wrongdoers control’. The new statutory rules did not formulate a substantive rule to
replace the rule in Foss v Harbottle but had provided a new procedure with more modern
criteria for determining whether a shareholder should pursue an action.

Although s.263(2) of the Act did not mention that permission was to be refused where the
applicant had control of the company, it would only be in exception circumstances that
such an application would be allowed to continue.

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, The evidence indicated that one of the principal reasons for the use by the claimant of a
derivative action procedure was to save the cost of pursuing the remedy through the
insolvency procedure. This was not a sufficient reason to allow a derivative action to
proceed.

Kleanthous v Theo Paphitis
Newey J: The court can potentially grant permission for a derivative claim to be
continued without being satisfied that there is a strong case. The merits of the claim will
be relevant to whether permission should be given, but there is no set threshold.

Section 263(2)(a): The test is whether any director acting in accordance with the section
172 duty would continue the claim. This sets a comparatively low bar. Even so, this
threshold will not be met when the claim against a defendant is particularly weak.

- Further, under section 263(3), the court must take into account several factors in making their
decision.

Iesini v Westrip
Section 263(3)(b): This provision requires the court to consider those criteria which a
hypothetical director acting in accordance with section 172 would consider.

These criteria include the amount at stake, the apparent strength of the case, the prospects
of securing a satisfactory outcome without litigation, the prospects of successful
execution of any judgment, the likely cost of the proceedings, the disruption caused to the
company's business, and potential risks to reputation and business relationships.

Stainer v Lee
Section 263(3)(f): The availability of an alternative remedy falls within the discretion of
the court, and so is not an absolute bar.

Roth J emphasises the fundamentally different nature of a claim under s.260 and a claim
under s.994. Although the same fact may form the basis of either claim, the appropriate
relief is different in to two cases: the former provides a remedy for misconduct in the
form of restitution to the company, while the latter provides relief from mismanagement
the remedy for which is being bought out.

Given that the applicant is not seeking to be brought out, and is instead seeing
restitutionary payment to the company, the theoretical availability of proceedings under
s.994 is not a reason to refuse permission.

Nurcombe v Nurcombe (before CA 2006)
The court was entitled to examine the conduct of a plaintiff in order to satisfy that he was
a proper person to bring an action on behalf of the company. If a plaintiff’s conduct was
tainted in some way relief might be barred under the rules of equity.

In commencing the present action, the plaintiff was effectively stating that she now
wished to exploit her status as a shareholder to obtain more money than she had
previously gained as the ex-wife of the director in breach. The court would not entertain
such a course of conduct.

Franbar v Patel
There was no aspect of the derivative claim for which the claimants could not be
compensated by relief granted in the s.94 petition. Section 263(3)(f) did not require exact
identity of defendants, all that was required was for the act or omission of which
complaint was made to give rise to a cause of action available to a member in its own

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