UK: England and Wales: the Companies Act (2006): the statutory derivative action

In Franbar Holdings Ltd v Patel and others [2008] EWHC 1534 (Ch), the High Court considered the operation of the statutory derivative action introduced by Part 11 of the Companies Act (2006). This is one of the first reported cases concerning the operation of the statutory derivative action. Although not a full trial of the various claims, Franbar is nevertheless important because it provides (a) clarification regarding ratification and (b) insights concerning the relationship between the new statutory derivative action and the unfair prejudice remedy in Section 994.

In Franbar the trial judge (Mr William Trower QC, sitting as a Deputy Judge of the High Court) had before him several applications including a petition under Section 994 of the Companies Act (2006) and an application to continue a derivative action.  Section 261(1) of the 2006 Act requires a member bringing a derivative action to seek the court's permission to continue the action. Section 263 sets out the circumstances in which permission should be given and, in subsection 2, provides that permission must be refused if the court is satisfied:

(a) that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim, or
(b) where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or
(c) where the cause of action arises from an act or omission that has already occurred, that the act or omission— (i) was authorised by the company before it occurred, or (ii) has been ratified by the company since it occurred.

The judge did not consider head (b) because the allegations concerned past conduct.  With regard to head (a) - referring to the duty imposed on company directors - the trial judge identified several factors  which the hypothetical director would take into account including:

• The prospects of success
  
• The disruption which would result if the proceedings continued
  
• The cost of the proceedings
  
• Any damage to the company's reputation and business if the action failed

With regard to head (c) - authorisation or ratification - the trial judge considered Section 239 which governs ratification by the shareholders of a director's acts. Section 239 provides that a resolution proposed at a meeting will only be passed if the necessary majority is obtained excluding the votes of the director (if a shareholder) and any shareholder connected with him (on the latter, see Section 252). It was argued that Section 239 had replaced the principle that directors' acts cannot be ratified where they constitute a fraud on the minority and the wrongdoers are in control of the company. 

The trial judge rejected this argument, relying upon Section 239(7) which provides that the framework for ratification in Section 239 "does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to acts that are incapable of being ratified by the company". In the judge's opinion (at para. [45]):

...the [following] words of Sir Richard Baggalay ... in North-West Transportation v Beatty (1887) 12 App Cas 589, 594, describing the circumstances in which a company cannot ratify breaches of duty by its directors, remain good law:

"... provided such affirmance or adoption is not brought about by unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who oppose it"

It follows that, where the question of ratification arises in the context of an application to continue a derivative claim, the question which the court must still ask itself is whether the ratification has the effect that the claimant is being improperly prevented from bringing the claim on behalf of the company ... That may still be the case where the new connected person provisions are not satisfied, but there is still actual wrongdoer control pursuant to which there has been a diversion of assets to persons associated with the wrongdoer, albeit not connected in the sense for which provision is made by section 239(4)". 

The judge also considered Section 263(3), which specifies several factors to be considered when determining whether permission should be given, including factor (f): "whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company". The trial judge observed that where an act or omission gives rise to a claim for unfair prejudice (under Section 994) against a member and a claim for breach of duty against a director, Section 263(3)(f) is engaged. He also held that the adequacy of the remedy in (f) was a relevant consideration.  

The trial judge's decision was that permission should not be given for the derivative action to proceed. Although he found that there was substance in some of the complaints made, further work was needed to establish a clear claim of breach of duty.  For this reason it was open to a hypothetical director to decline to proceed with the derivative action. The judge also attached significant weight to the fact that the shareholder bringing the derivative action would be able to gain what it wanted through its separate Section 994 petition and shareholder action. 

Notes:

[a] The Franbar judgment has not yet appeared on BAILII although it is available on Lawtel (for subscribers only). A summary has, however, been provided here by the ICLR as part of its free WLR(D) service. This summary - which focuses on the issues surrounding ratification - will be removed if, as is likely, Franbar is reported in one of the ICLR series of law reports. Update (22 September 2008): the judgment is now available on BAILII - click here.

[b] Separate sections of the 2006 Act deal with derivative proceedings in Scotland: see Part 11, Chapter 2.