knowledge 14 June 2019 |

High Court Calls a Halt to Derivative Action

There are two significant rules of company law deriving from the seminal case of Foss v Harbottle.¹ 

• Where a company has been wronged, the company not the shareholders is the proper person to institute proceedings. 

• An individual shareholder may not bring proceedings to overturn a decision of the company where that decision is one which the majority of the members may confirm.

However, under an exception to the rule in Foss v Harbottle, a shareholder may bring an action where that shareholder’s personal rights have been infringed.  It can also bring a derivative action on behalf of the company where:

• an act is illegal or ultra vires the company; 

• more than a bare majority is required to ratify the "wrong" complained of;

• a fraud has been perpetrated by a majority of those in control; or 

• the justice of the case requires a minority to be permitted to institute proceedings (a less settled exception).

However, the bringing of a derivative action is tightly controlled by the court rules. Leave of the court is required. The member in question must provide the court with a detailed affidavit setting out the basis of the claim and why it is appropriate that it should be brought. A high bar is set here including the necessity of an opinion from counsel stating whether the member has a reasonable prospect of success.

The recent case of Saggart Motors Ltd v NG Motors Ltd² shows that the High Court will take a dim view of failure to comply with these procedural requirements.

In that case, a minority shareholder had commenced unauthorised proceedings on behalf of the company and obtained interim without notice orders against a defendant offering a potentially onerous undertaking as to damages on behalf of the company as a requirement of the grant of the orders. That shareholder now sought to remedy the position and continue the proceedings as a derivative action. He also sought to continue the interim relief against the defendant.

The majority shareholder objected saying that the proceedings had not been authorised by the plaintiff’s board of directors and were barred in law. Leave to commence proceedings had not been obtained and so a derivative action could not be maintained.

For his part, the minority shareholder argued that the late application to proceed by way of derivative action was really issued in aid of the defendants who had raised the matter in correspondence. It was simply a matter that had only now arisen and the application was one which it had elected to make. He pointed to Order 15 rule 39(4) RSC which permits a belated application to proceed by way of a derivative action.

Pilkington J rejected this argument. She said that the provision clearly envisaged a belated application for a derivative action where matters arose in the conduct of litigation which made it necessary for such an application to be heard. However, in this case the relevant facts were always known and an application to issue proceedings as a derivative action should have been made at the outset, particularly when the initial court application sought interim ex parte interlocutory relief. It was plain to the shareholder in question that he was a minority shareholder and he had not stated on affidavit that he had the company’s consent to commence the proceedings.

Pilkington J was also satisfied that none of the threshold criteria necessary to establish an entitlement to proceed by way of a derivative action had been met; specifically that none of the exceptions to the rule in Foss v Harbottle applied.

She queried why these matters had not been canvassed before the court when the interim relief was obtained. She pointed out that in any ex parte application, the duty of full disclosure is paramount. Here, possibly unbeknownst to the earlier court, the plaintiff company was granted relief in an action that it did not sanction and that was opposed by the majority shareholder. She struck out both applications.

Comment

This case illustrates that the court will be critical of failures to comply with its mandated procedures in and around derivative actions. It also re-emphasises the need for litigants to be fully aware of and to comply with their duty of full and frank disclosure when seeking onerous ex parte relief.