If it is alleged that a wrong has been committed against a company then, in the usual course of events, the correct claimant is the company itself, with the decision as to whether or not to sue being made by the company’s board of directors. Provided the majority agree with the directors’ course of action, it is not usually open to shareholders to complain about the decision made. However, there are certain situations in which the court has the discretion to allow shareholders to bring a personal claim, on behalf of the company, to pursue allegations of wrongs committed by the directors. Such claims are known as “derivative actions”.
In Cullen Investments Ltd v Brown (2015), the High Court considered the statutory basis for bringing a derivative action in a dispute between joint venture partners, even though it was possible that the claimant shareholder had its own rights of action which might mean there was no need for a derivative action. The question of whether an alternative remedy exists is a key question for the court when considering whether to grant permission for the shareholder to continue the derivative claim under the Companies Act 2006 (the “Act”).
Cullen Investments Ltd (“Cullen”), an investment company, applied for permission to continue a derivative action (the “Action”) under s.261(1) of the Act. Cullen brought the Action, on behalf of Kauri Investments Ltd (“Kauri”), against Mr Brown, Kauri’s CEO.
In 2005, Mr Brown and Cullen entered into a joint venture, investing in the EU and UK property markets (the “Venture”). Kauri was incorporated by Cullen as a vehicle through which the Venture could be pursued. The parties signed Heads of Agreement and the Venture was pursued successfully for a number of years. The Heads of Agreement contained a term which allowed Mr Brown to invest in property on his own behalf, provided that: he had given Kauri the first right of refusal on any such investment and Kauri had declined; the investment did not materially affect Mr Brown’s duties as CEO of Kauri; and the investment did not place Mr Brown in a position of conflict in relation to Kauri.
In 2008, an opportunity arose to enter into a new joint venture agreement with a partner in Germany, investing in German residential property (the “German Option”). Mr Brown raised this with Cullen and a new corporate structure was set, the costs of which were born by Kauri as it was anticipated that the German Option would be pursued for the benefit of the Venture. However, Cullen and Mr Brown could not agree on how to fund the Venture’s participation in the German Option, and Mr Brown subsequently contended that, in January 2009, Cullen informed him that it would not advance the capital required to pursue the German Option, and that Mr Brown was free to pursue the German Option in his personal capacity. Mr Brown emailed Cullen, confirming that this was his intended course of action. Cullen did not reply. Mr Brown then secured third party funding for the German Option and signed the deal on 7 April 2009. Consequently, Cullen commenced a claim directly against Mr Brown as well as bringing the Action.
Cullen argued that it had not turned the German Option down and that, alternatively, even if it had done so, Mr Brown’s position as CEO required him to offer the German Option to Kauri on such terms as he had negotiated after 22 January 2009. In practice this would have meant asking Cullen’s permission to use the money borrowed from the third party funder. Mr Brown argued that he was entitled to invest personally in the German Option because Cullen had turned down the opportunity to do so.
The Court had to decide whether Cullen could continue to bring the Action on Kauri’s behalf. There were two issues for consideration:
- whether permission had to be refused under s.263(2)
- of the Act which provides that permission may be approved if a hypothetical person acting in accordance with the duty to promote the success of the company would not seek to continue the claim, or under s.263(2)(c) of the Act (whether the act or omission was authorised by the company before it occurred, or has been ratified by the company since it occurred) on the basis that the JVA entitled Mr Brown to take up the German Option personally
- whether any of the considerations listed in s.263(3) (which include whether the member is acting in good faith in seeking to continue the claim, the importance that a person acting in accordance with the duty to promote the success of the company would attach to continuing it, whether a proposed or past act or omission would be likely to be authorised or ratified, whether the company has decided not to pursue the claim or whether the member has a cause of action that he may pursue in his own right rather than on behalf of the company) of the Act meant permission should be refused
In granting Cullen’s application, the Court found that permission should not be refused under s.263(2) of the Act. Although some evidence supported Mr Brown’s assertion that taking advantage of the German Option was within the terms of his agreement with Cullen, the hypothetical director contemplated by the Act would conclude that:
- there were good prospects of establishing that Cullen had not refused to take up the German Option and, consequently, that Mr Brown had not been released from his duties. In particular, Mr Brown had not expressly confirmed to Cullen that he was pursuing the German Option in a personal capacity and had therefore failed to make the necessary full and frank disclosure
- consequently, there was good evidence that Mr Brown had concealed his personal investment in the German Option deliberately and that this conduct did not hold with his contention that his actions were authorised by Cullen
- the case would turn entirely on the existence of a grant of express authority allowing Mr Brown to take the German Option for himself, with the most likely conclusion being that there was no such grant of authority
- it was worth taking the risk that the litigation might result in an empty judgment. Had the relevant amount truly not been worth suing for, or had Mr Brown not been able to satisfy any judgment, Mr Brown would surely have raised this in his defence
Further, of the considerations listed in s.263(3) of the Act, only s.263(3)(a), (b) and (f) of the Act were relevant and none of them were adequate to support a refusal of Cullen’s application. In particular:
- there was no basis for concluding that Cullen was lacking in good faith by bringing the claim (s.263(3)(a))
- the hypothetical director would attach considerable importance to the fact that the claim was being funded by Cullen and there was no financial risk to Kauri. Further, there was a possibility that the litigation could significantly enhance Kauri’s funds (s.263(3)(b))
- although Cullen was also pursuing a remedy in its own right, it was not clear whether Cullen had a direct claim, and the Action was therefore being brought in the alternative so as to mitigate the risk that Kauri, and not Cullen, was entitled to all or part of the relief sought. Although there was a possibility that the Action would prove to be unnecessary, taking such proceedings was worthwhile in order to avoid a potential injustice (s.263(3)(f))
Clearly, this decision, as with so many, turns on its specific facts, but it is nevertheless beneficial to see the Court’s approach to the relevant factors in granting Cullen permission to continue the Action. In particular, the weight given to the fact that Kauri had none of the risk (as Cullen was funding the proceedings), but stood to gain all of the benefit, such that, for the company, there was no downside to the Action continuing, is to be noted. It will be interesting to see how this case develops as it moves forward through the Courts.