Derivative claim

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What is a derivative claim?

Derivative claims are statutory claims under section 260 of the Companies Act and are made against directors for breach of common law or statutory director duties.

Who can bring a derivative claim?

A derivative claim is brought by the company itself, not the individual shareholders

Grounds for a derivative claim

There are a number of ways a derivative claim can arise, but usually they are based on breach of trust, a conflict of interest, negligence or where the director has personally benefitted in some way whilst not acting in the company’s best interests.

Specific examples of director conduct giving rise to a derivative claim include:

• where a director has transferred company funds to their own personal bank account.
• where a director has stripped company’s assets.
• misappropriation of company assets.
• taking reckless decisions which cause financial harm to the company.
• participating in fraudulent schemes, such as financial statement manipulation or embezzlement, which harm the company and its shareholders.
• Acting in a conflict of interest situation and failing to disclose the conflicts of interest that adversely affect the company’s interests.
• Acting in a way which unfairly prejudices minority shareholders or unfairly prejudice any class of shareholders, such as diluting their rights.
• dividend mismanagement such as declaring or paying dividends when it is not legally or financially prudent to do so, causing harm to the company.
• breach of statutory duties and violations of statutory duties under the Companies Act 2006, such as failing to keep proper accounting records or file required documents.

However, it is worth noting that a director that is subject to a derivative claim does not necessarily have to have gained a personal benefit from the breach of duty. Equally, the director doesn’t have to be the majority shareholder of the company, although in reality this is a fairly common occurrence as it allows them to exercise a fair degree of overall control over the company.

How to start a derivative claim

Court permission is required to commence a derivative claim. The court will look if the claim is in the best interests of the company and whether it is made in good faith. If neither of these are satisfied, the court will not allow it to proceed.

It can be difficult to get these types of claims off the ground because of the issues between the directors and the fallout with the shareholders. However, our expert team can help you get a derivative claim up and running if there are sufficient grounds to proceed.

The proceedings themselves are complicated. The court requires that there be an initial stage to the proceedings for these claims, where they will assess at an early stage whether there is a strong case. If the court assesses that there is a strong case, then the proceedings may continue and a trial will take place. If not, the claim will be dismissed before a trial takes place.

Overlap with other shareholder remedies

A derivative claim can sometimes overlap with other remedies such as an unfair prejudice petition or an application for winding up on just and equitable grounds. It may be bought alongside these claims, as all of them are based on breach of directors’ duties.

Legal costs

A successful party will usually be awarded costs, and the unsuccessful party will have to pay such costs. The minority shareholder might seek an indemnity from the company when applying for permission to bring an application, on the basis that it is a company claim and the company should have bought the case. However, this is not necessarily going to be agreed by the company.

Our expert team can guide you through the likely costs of a derivative claim, how to lessen the risk of any adverse costs order and maximise your chances of getting all your legal costs paid.

What orders can a court make?

If a claim proceeds to trial and is successful, the court has wide discretion in terms of what it can order. These remedies or orders include

• removing a director from his role.
• ordering a director to pay damages.
• Injunctions against directors to stop them undertaking specific actions.
• Recovery of legal costs from the director.

Other practical points to consider

It is also worth considering the following points when considering a derivative claim

• A derivative claim can often be resolved by way of alternative disputes resolution, settlement negotiations or by mediation. This can help keep costs down, and it may also possibly allow for the continuation of a relationship between the parties.
• Companies should check to see if their directors and officers insurance (D&O) covers derivative action as well as company claims. If it doesn’t, this is something worth considering.
• Prevention is always better than cure. It is likely that if a shareholders agreement is in place that sets out clear boundaries between the parties and allows for the expectations of all parties to be met, then a minority shareholder may not feel so aggrieved that they need to bring a derivative claim, and the matter may be resolved internally without the costs and stress that a claim may bring.

At Francis Wilks & Jones we frequently act for shareholders in derivative claims and advise on shareholder rights. Please don’t hesitate to contact one of our senior team who will respond to you immediately.

I have found FWJ to be perceptive, to the point and realistic. They have been able to assimilate and forcefully defend a very aggressive claim with very limited historic information.

A client we advised on a complicated property and partnership dispute