The Companies Act 2006 introduced new legislation governing the rights of shareholders to sue in respect of a wrong done to a company. Prior to the introduction of the Companies Act 2006, there was a general principle that a minority shareholder who has no other remedy may sue where directors use their powers, intentionally or unintentionally, fraudulently or negligently in a manner which benefits themselves at the expense of the company. This principle had been developed through a number of Court decisions, but the extent of the power was unclear, particularly in Scotland. The Companies Act 2006 now provides detailed provisions regulating the bringing of such proceedings, known as derivative proceedings.
The Act provides that, in order to pursue a derivative action, an applicant must seek the leave of the Court. The reason for this provision is to prevent spurious actions being pursued by shareholders with potentially significant expense implications for the company concerned. No Rules of Court have been made in Scotland directed specifically to the question of how applications for leave under the Act should be made. However, the recent decision of Alexander Martin Wishart Petitioner (Lord Glennie, 12 February 2009) from the Commercial Court sets out some useful guidance.
In Scotland, the application for leave proceeds as a separate Court action and involves a two stage process. At the first stage, the Court will consider whether a prima facie case has been made out, i.e. that there has been a relevant act or omission by one or more directors of the company and those responsible for that act or omission are and remain in majority control of the company, thus preventing institution of proceedings at the instance of the company.
The application is then served upon the company and a full hearing, at which the company may be represented, takes place. At this hearing, the Court is required to consider:
- Whether a person acting in accordance with his duty to promote the success of the company
would seek to raise the proceedings; and
- Whether the act or omission complained of was or has been authorised by the company or has subsequently been ratified by it.
If the Court is satisfied that (i) a person acting in accordance with his duty to promote the success of the company would not seek to raise the proceedings; and / or (ii) that the act or omission in question has been authorised or ratified by the company then the Court requires to refuse leave.
If the Court does not require to refuse leave as a result of the issues raised above then the Court will require to take account of certain other matters in considering whether or not to grant leave, in particular:
- Whether the member is acting in good faith in seeking to raise the proceedings;
- The importance that a person acting in accordance with his duty to promote the success of
the company would attach to raising them;
- Whether the act or omission complained of could be and is likely to be authorised or ratified by the company as the case may be;
- Whether the company has decided not to raise proceedings in respect of the same cause of
- Whether the cause of action is one that the shareholder could pursue in his own right rather
than on behalf of the company.
In considering these issues, the Court has made it clear that, whilst every case must be dealt with on its own merits, the hearing on leave should not be a lengthy or drawn out hearing and it should not be used as an opportunity to try the merits of the derivative action itself. Extensive evidence should not normally be necessary at this stage.
The issue of expenses was also considered by the Court. The Court held that it was competent to order a company to pay the shareholder's legal expenses in respect of or connected with the derivative action. However, the Court recognised the importance of such an order being subject to review. Thus, in this particular case, the Court ordered the company to meet the shareholder's legal expenses up until the stage of a procedural hearing in the derivative action. The shareholder's right to apply for an order for costs in relation to later stages of the derivative action was reserved. This is a rather "creative" ruling on expenses.
The Court noted that there may be some merit in Rules of Court being made to deal specifically with derivative proceedings, so watch this space for developments!