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Minority Protection

Minority Protection

Derivative Action

A new simplified derivative action procedure came into force on 1 October 2007. This procedure enables members of a company to take action on behalf of the company in relation to breaches of duty by its directors.

The statutory derivative action allows any member of a company (even if they joined after the act complained of) to launch an action on behalf of the company against any of its directors in relation to the negligence, breach of duty or breach of trust by that director. This gives shareholders the direct power to stop directors breaching their duties instead of relying upon the board of directors themselves to bring an action on behalf of the company.

There is a two stage process for getting permission to continue a derivative action. At the first stage the shareholder must show a prima facie case. The court will review this without hearing evidence from the defendant. If a prima facie case is established then it moves to the second stage. The court will direct the company itself to give evidence and after hearing this will decide whether to give permission for the action to continue.

The purpose of this process is to weed out frivolous or "vexatious" claims. The court must refuse permission where:

a person acting under a general duty to promote the success of the company would not seek to continue the claim; or

the act or omission complained of has been authorised or ratified by the company.

In deciding whether to give permission the court must also have regard to:

whether the member is acting in good faith;

the importance that a person acting in accordance with the duty to promote the success of the company would attach to continuing the claim;

whether the act or omission could be or is likely to be authorised or ratified by the company;

whether the company has already decided not to pursue the claim;

whether the act or omission gives rise to a cause of action that a member could pursue against the director in his or her own right;

any evidence as to the views of other shareholders with no personal interest in the matter.

Unfair prejudice

A statutory remedy for wronged minority shareholders is available under s.994 of the Companies Act 2006.

A shareholder may petition the court where the affairs of the company are being conducted in a manner that is unfairly prejudicial to all or part of its members.

There is no simple definition of what constitutes “the affairs of the company” or “unfair prejudice”. The courts have interpreted their meaning over many years and each case will depend on the facts. The terms are considered by the court to be “general words” and the court has a wide discretion in their application.

Situations where unfair prejudice has been found include:

a minority shareholder was wrongly excluded from management;

the majority shareholders have consistently ignored the rights of the minority;

the directors have awarded themselves excessive remuneration whilst refusing to pay dividends to shareholders;

there is deadlock within the company and no decisions are capable of being made;

a failure to consult the complainant or to provide information;

misappropriation of company business or assets;

mismanagement of internal company affairs;

the failure to pay reasonable dividends;

improper allotments of shares and rights issues.

It is important to note that a successful claim must prove that the actions complained of were both "unfair" and "prejudicial".

The court has a very wide discretion to make an appropriate order “if the court is satisfied that a petition … is well founded, it may make such order as it thinks fit for giving relief in respect of the matters complained of”.

The section goes on to list various possible orders including an order for the shares of any party to be purchased by another party or the company itself. The purchase of the complainant’s shares by the wrongdoers is the most commonly sought and granted remedy.

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