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Company Law

Analysis - guidance - compliance

25 JUN 2013

Derivative actions – the common law rears its ugly head

Hopes that the statutory derivative claim had consigned the case law on the common law exception to the rule in Foss v Harbottle to the realms of legal history have been dashed by the High Court.  In the recent case of Universal Project Management Services Ltd v Fort Gilkicker Ltd [2013] EWHC 348 (Ch), Briggs J held that whilst so-called multiple derivative actions are not provided for under the statutory scheme, they continue to be available at common law.

What is a multiple derivative action?

The expression ‘multiple derivative action' refers to an action brought on behalf of a company against its directors not by a shareholder of the company itself, but by a shareholder of a company further up the corporate chain.  Thus, where A owns a minority stake in B Ltd, which has a wholly owned subsidiary, C Ltd, a claim by A on behalf of C Ltd against the directors of C Ltd for breach of duty is described as a multiple derivative action.


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Fort Gilkicker - the facts

The scenario with which the High Court was faced in FortGilkicker was not dissimilar to that described above.  The key facts were as follows:

  • A Dr Frischmann and a Mr Pearce were engaged in a joint venture encompassing a series of property development projects
  • one of those projects concerned the development of Fort Gilkicker, a site in Hampshire 
  • the Fort Gilkicker development project was carried out through a company by the name of Fort Gilkicker Ltd (‘FGL') 
  • the board of FGL consisted of Dr Frischmann and Mr Pearce, and pursuant to the terms of the joint venture major decisions required the agreement of both men 
  • the shares in FGL were owned by Askett Hawk Properties LLP (‘the LLP'), in which Mr Pearce and Universal Project Management Services Ltd (‘UPMS') - a corporate vehicle for Dr Frischmann - were equal participants 
  • before FGL could acquire the Fort Gilkicker site, Dr Frischmann and Mr Pearce had a disagreement about the plans for its development, and shortly thereafter a company owned by Mr Pearce purchased the site from its then owner 
  • the case centred around UPMS's claim that Mr Pearce had breached his fiduciary duty as a director of FGL by appropriating the site for his own benefit.

In the normal course of events, any claim against a director should, of course, be brought directly by the company itself, acting through its board.  Alternatively, as an exception to the rule in Foss v Harbottle, a shareholder of the company might seek permission under Part 11 of the Companies Act 2006 to continue a derivative claim against the director on the company's behalf.

Given the facts, however, FGL was unlikely to act directly against Mr Pearce, and the LLP was unlikely to take any remedial action in its capacity as FGL's sole shareholder.  The solution adopted by UPMS was to apply to the court for permission to continue a derivative action itself.

Fort Gilkicker - the decision

The first question to which Briggs J turned his mind was whether multiple derivative actions existed at common law prior to the introduction of the statutory derivative claim under the Companies Act 2006.  In concluding that they did, he cited a number of cases, including Wallersteiner v Moir (No. 2) [1975] 1 QB 373, in which the court seemed to have accepted, albeit without discussion of the point, that where the wrongdoers were in control of both the subsidiary and its parent, a shareholder of the parent had standing to bring a derivative action on behalf of the subsidiary.  In Briggs J's view, this flexible approach was not surprising, for the "would-be claimant is not exercising some right inherent in its membership, but availing itself of the court's readiness to permit someone with a sufficient interest to sue as the company's representative claimant, for the benefit of all its stakeholders".

The next question was whether the multiple derivative action had survived the introduction of the statutory derivative claim under Part 11 of the Companies Act 2006.  The judge approached this question as a matter of straightforward statutory construction.  Section 260(1) defines a ‘derivative claim' as proceedings "by a member of a company - (a) in respect of a cause of action vested in the company, and (b) seeking relief on behalf of the company" (emphasis added), and section 260(2) specifies that a ‘derivative claim' may only be brought under Part 11 or pursuant to a court order in unfair prejudice proceedings.  The effect of these provisions, the judge held, was that the statutory regime deals only with derivative actions by shareholders of the company in question, and not with multiple derivative actions.  Given the comprehensiveness of the statutory rules governing derivative actions of the former variety, the common law in that specific area was by implication abolished; however, the Act did not expressly or by implication abolish the common law multiple derivative action.

Having concluded that the multiple derivative action at common law still existed, Briggs J granted UPMS permission to continue the action.  He took the view that it was irrelevant that FGL's parent was a limited liability partnership rather than a company and, in deciding whether to grant permission, applied the traditional test based on the existence of ‘fraud' and wrongdoer control.

Comment

It is difficult to argue with Briggs J's conclusion that multiple derivative actions continue to be available at common law.  Although relevant cases are certainly thin on the ground, the courts historically did not seem to object to the notion of such actions, and the judge's analysis of the impact of Part 11 of the Act on the common law is persuasive.

That is not necessarily to say, however, that the current state of affairs is satisfactory.  In the course of his judgment, Briggs J noted that the aim of the codification process was to produce a clear set of rules to govern derivative actions, and observed as follows:  "A conclusion that what Parliament in fact achieved in 2006 was to place a statutory code for derivative claims by members of the wronged company alongside a continued obscure, complicated and unwieldy common law regime for derivative claims by others does not commend itself as an exercise in commonsense."

The case raises two questions.  First, should such a device as the multiple derivative action exist?  Secondly, if the answer is in the affirmative, should it be incorporated within the statutory regime?

  • Should the multiple derivative action exist?

That the ordinary derivative action owes its existence to the courts' desire to do justice is beyond doubt.  In Foss v Harbottle itself, Sir James Wigram suggested that where a claim on behalf of the company by individual shareholders was the only appropriate response to a wrong done to the company, "the claims of justice would be found superior to any difficulties arising out of technical rules respecting the mode in which corporations are required to sue" ((1843) 2 Hare 461, at 492), and in Smith v Croft (No.2), Knox J noted that "the whole doctrine whereby a minority shareholder is permitted to assert claims on behalf of the company is rooted in a procedural expedient and adopted to prevent a wrong going without redress" ([1988] 1 Ch 114, at 170).  (To say that the interests of justice underpin the notion of a derivative action is not quite the same thing, of course, as to say that a derivative action should be permitted whenever justice so requires.  The Court of Appeal in Prudential Assurance Co Ltd v Newman Industries Ltd (No.2) [1982] 1 Ch 204 was certainly not persuaded that there was an ‘interests of justice' exception to the rule in Foss v Harbottle.)

In Fort Gilkicker, Briggs J's conclusion that multiple derivative actions existed at common law prior to the introduction of Part 11 was founded on authority, but he clearly felt that the extension of the ordinary derivative action was a reflection of the need to do justice.  As he put it, the different forms of derivative action were merely "a single piece of procedural ingenuity designed to serve the interests of justice in appropriate cases calling for the identification of an exception to the rule in Foss v Harbottle".

A purist might argue that to extend the derivative action to shareholders further up the corporate chain is to ignore the separate identity of the parent, in the sense that conceptually it is not appropriate to regard a shareholder of the parent as having the same interest in the subsidiary as the parent itself does.  If, therefore, standing is to be granted to a party which is technically an outsider to the subsidiary, why should it not also be granted to other outsiders, such as creditors, employees or even, in these times of increased scrutiny of directors' behaviour, regulatory bodies?

Briggs J commented in Fort Gilkicker that "the locus standi given to the member of the intermediate entity is not an aspect of that person's rights as a member, but simply the consequence of the law's search for a suitably interested representative, or champion, of the wronged company".  Taken in isolation, these words suggest that the judge might not, in fact, have objected to making the derivative action available to complete outsiders, but taken as a whole, the judgment indicates that he was holding only that parties in a position corresponding to that of UPMS should have standing, and on balance it would seem that he drew the line in the right place.

 This would appear to be one of those instances in which the law has struck a sensible balance between adhering rigidly to principle and providing a pragmatic solution to a problem.  Whilst it would be going too far to confer standing on complete outsiders, there would be a certain artificiality about refusing to extend the scope of the derivative action to shareholders further up the corporate chain, and if such an extension requires the court to peer behind the corporate veil, so be it.

  • Should multiple derivative actions be incorporated within the statutory regime?

This is a much easier question to answer, for it cannot make sense to have one strand of the old common law regime, with all its complexities and uncertainties, running alongside the statutory regime.

One option for reforming the current framework would be to insert into section 260 an exhaustive list of those parties who, in addition to shareholders of the company in question, have standing to bring a claim on the company's behalf.  The easier option, perhaps, would be to leave the question of standing to the courts to decide; this could be achieved simply by removing the reference to "a member of a company" from section 260(1), so that a ‘derivative claim' under Part 11 would be defined simply as proceedings "(a) in respect of a cause of action vested in the company, and (b) seeking relief on behalf of the company".

 In either case, the result would be a regime under which any party seeking to bring a derivative action, whether an ordinary derivative action or a multiple derivative action, would be subject to the statutory permission procedure.  The traditional exception to the rule in Foss v Harbottle involving ‘fraud' and wrongdoer control would have been dispensed with, once and for all.

And, finally, a word about the name ...

When the Law Commission consulted on reform of the common law derivative action in 1996 (Law Commission Consultation Paper No. 142 - ‘Shareholder Remedies'), it commented that it was logical to describe an action by a shareholder of a parent company on behalf of the parent's subsidiary as a ‘double derivative action', and an action by a shareholder of a parent company on behalf of a subsidiary of the parent's subsidiary as a ‘triple derivative action', and that such actions could be described as ‘multiple derivative actions'.

The logic which underpins these expressions is, however, not entirely clear, and in fact they may be positively misleading.  In Fort Gilkicker, Briggs J did not concern himself unduly with the labels attached to the different forms of derivative action, but at one point he referred to a multiple derivative action as an "extended form of derivative claim".  This language seems to convey more accurately the reality of the situation, and perhaps the next time a court is faced with a so-called ‘multiple derivative action' it will take the opportunity to consider whether it might be more aptly described as an ‘extended derivative action'.

For further information, see Gore-Browne on Companies, Chapter 18, paragraph 39. Click here to log-in. If you are not a subscriber, click here for a free trial.

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