Introduction
This essay examines the concept of derivative actions under the UK Companies Act 2006, focusing on whether and under what circumstances an individual shareholder can bring such an action on behalf of a company. A derivative action allows a shareholder to seek redress for a wrong done to the company, typically when the company itself fails to act due to control by wrongdoers. This legal mechanism is crucial in corporate governance, ensuring accountability and protecting minority shareholders. The essay will explore the historical context and statutory framework of derivative actions, primarily under Part 11 of the Companies Act 2006, and analyse the procedural requirements and judicial considerations involved. Additionally, it will evaluate the challenges and limitations shareholders face in pursuing such claims, supported by relevant case law and academic commentary. By addressing these aspects, the essay aims to provide a sound understanding of derivative actions, their applicability, and the implications for corporate law.
Historical Context and Statutory Evolution
The concept of derivative actions has its roots in common law, notably established in the landmark case of *Foss v Harbottle* (1843), which set out the principle that only the company, as a separate legal entity, could sue for wrongs done to it (Sealy and Worthington, 2013). This rule initially restricted shareholders from initiating actions, except in limited circumstances such as fraud on the minority. However, the rigid application of this rule often left minority shareholders vulnerable, unable to seek redress when company directors acted against the company’s interests.
Recognising these limitations, the UK legislature reformed the framework through the Companies Act 2006. Part 11, specifically Sections 260 to 264, introduced a statutory derivative action, replacing the common law regime. This reform aimed to provide clearer guidelines and enhance accessibility for shareholders seeking to protect company interests. According to Hannigan (2018), the statutory derivative claim was a significant step toward balancing the rights of minority shareholders with the need to prevent frivolous litigation. Despite these advancements, the statutory regime imposes strict procedural hurdles, which will be discussed in subsequent sections.
Statutory Framework for Derivative Actions
Under Section 260 of the Companies Act 2006, a derivative action may be brought by a member of a company in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty, or breach of trust by a director. This provision broadens the scope of actionable wrongs beyond the common law requirement of fraud, encompassing a wider range of director misconduct (Davies and Worthington, 2016). Importantly, the action must be brought in the company’s name, as the claim seeks to recover losses suffered by the company rather than the individual shareholder.
Section 261 further stipulates that a shareholder must obtain court permission to continue a derivative claim. This involves a two-stage test: first, establishing a prima facie case, and second, demonstrating that the court should grant permission based on factors outlined in Section 263. These factors include whether the member is acting in good faith, whether the company itself would likely pursue the claim, and the importance a hypothetical director acting in accordance with their duties would attach to continuing the action. This rigorous process aims to filter out vexatious claims while ensuring genuine grievances can proceed (Hannigan, 2018).
Judicial Considerations and Case Law
The judiciary plays a critical role in interpreting and applying the statutory provisions on derivative actions. In *Franbar Holdings Ltd v Patel* (2008), the court emphasised that permission would not be granted lightly; shareholders must provide concrete evidence of wrongdoing and demonstrate why the company itself cannot or will not pursue the claim. Similarly, in *Iesini v Westrip Holdings Ltd* (2009), the court clarified that the good faith requirement under Section 263 is not merely procedural but involves assessing the claimant’s motives (Sealy and Worthington, 2013). These cases illustrate the courts’ cautious approach, arguably prioritising the prevention of abuse over facilitating shareholder actions.
Moreover, the case of Wishart v Castlecroft Securities Ltd (2009) highlighted the importance of considering alternative remedies. The court noted that if a shareholder could achieve redress through other means, such as a personal action or winding-up petition, a derivative claim might be deemed unnecessary. This judicial stance suggests a pragmatic approach, though it may limit the utility of derivative actions for some shareholders (Davies and Worthington, 2016). Indeed, while the statutory framework offers a structured process, the judiciary’s stringent application often poses a barrier to success.
Challenges and Limitations of Derivative Actions
Despite the reforms introduced by the Companies Act 2006, several challenges persist for shareholders seeking to bring derivative actions. First, the procedural requirements, particularly the need for court permission, can be both time-consuming and costly. As Hannigan (2018) argues, these hurdles may deter minority shareholders, especially those with limited resources, from pursuing legitimate claims. Furthermore, the burden of proving bad faith or director misconduct can be onerous, particularly when internal company documents are inaccessible to the claimant.
Another limitation lies in the risk of costs. Under the general rule, a shareholder initiating a derivative action is not indemnified by the company for legal expenses unless the court orders otherwise, which is rare. This financial risk, coupled with the uncertainty of success, often discourages potential claimants (Sealy and Worthington, 2013). Additionally, there is a broader concern that derivative actions may be misused for personal gain rather than in the company’s interest, a tension the courts continuously grapple with when assessing good faith.
Implications for Corporate Governance
The availability of derivative actions under the Companies Act 2006 has significant implications for corporate governance. On one hand, it serves as a deterrent to director misconduct, reinforcing accountability and protecting minority shareholders from oppression. On the other hand, the restrictive nature of the statutory regime may undermine its effectiveness as a governance tool. As Davies and Worthington (2016) suggest, while the mechanism theoretically empowers shareholders, in practice, it often fails to address systemic imbalances of power within companies.
Moreover, the reliance on judicial discretion introduces an element of unpredictability. Although the criteria under Section 263 provide guidance, their subjective interpretation can lead to inconsistent outcomes, as seen in varying court decisions. Therefore, while derivative actions remain a vital mechanism, their practical utility is arguably limited by procedural and financial constraints.
Conclusion
In conclusion, a shareholder can indeed take a derivative action under the Companies Act 2006, as provided for under Part 11, to address wrongs committed against a company. The statutory framework marks a progressive shift from the restrictive common law principles, broadening the scope of actionable claims and offering a structured process for redress. However, the requirement for court permission, stringent judicial scrutiny, and financial risks pose significant challenges to shareholders. Case law such as *Franbar Holdings Ltd v Patel* and *Iesini v Westrip Holdings Ltd* highlights the courts’ cautious approach, prioritising the prevention of abuse over ease of access. Consequently, while derivative actions play a critical role in corporate governance by promoting accountability, their practical impact is curtailed by procedural and systemic barriers. Future reforms might consider easing these restrictions to better balance the interests of minority shareholders with the need to safeguard companies from vexatious claims.
References
- Davies, P. L. and Worthington, S. (2016) Gower and Davies’ Principles of Modern Company Law. 10th ed. London: Sweet & Maxwell.
- Hannigan, B. (2018) Company Law. 5th ed. Oxford: Oxford University Press.
- Sealy, L. and Worthington, S. (2013) Sealy & Worthington’s Cases and Materials in Company Law. 10th ed. Oxford: Oxford University Press.
