A derivative claim is a claim brought by a shareholder, or a group of shareholders, on behalf of the company to challenge the conduct of the director(s) of the company.
They might be started if the shareholders consider that the company has been mismanaged in a serious way.
For example, if a director acted in a way that was negligent, or in breach of their duties, harm may be caused to the company itself. The company is the legal entity with the right to make the claim, and the shareholders run the claim for the company’s benefit.
Reasons to start a derivative claim
If a director breaches their duties, which are contained in the Companies Act 2006, there may be grounds for a derivative claim. Some common examples are that a director has breached his / her duty to:
- Act in the best interests of the company
- Exercise reasonable care, skill and diligence
- Promote the success of the company
- Declare an interest in a proposed transaction.
Practically, this could look like a director receiving excessive or unauthorised remuneration, or diverting business opportunities for their own personal gain.
How to begin a derivative claim
Usually, it is the minority shareholder(s) who bring a derivative claim. However, these claims can also arise in joint ventures, if certain partners think that they have been excluded from decision making.
The claimants prepare the claim, setting out the grounds for the claim, providing relevant evidence, and explaining the harm caused to the company. The shareholder(s) will also notify the company of the claim.
The evidence in support can include company documents like board minutes, financial records, emails, and advice given to the company by accountants.
Court permission is required
The shareholders first issue the claim at court, and then the court must give its permission for the claim to continue. The directors have a chance to make representations to oppose the claim and argue that it should be denied permission to continue.
The court will look at the evidence it has been given and use its discretion to decide if the claim should proceed.
This stage is done ‘on paper’ to begin with, which means that there is no hearing. If the court considers that there is sufficient merit in the claim on paper, there will be a full permission hearing.
The process of obtaining court permission is a fairly high bar, so the evidence will need to be robust and cogent at this stage to persuade a court that the claim has merit.
What you need to prove to be successful
The court must be satisfied that the shareholders are acting in good faith in bringing the claim. The shareholders must also prove that the company has suffered harm as a result of the director’s wrongdoing.
What remedies are available?
There are a range of remedies available, and the shareholders can explain in their pleadings which remedy they are seeking. However, the remedy that is applied to a successful derivative claim is down to the discretion of the court.
Available remedies include:
- The repayment of money by the director(s) who have been held liable. If this remedy is ordered, shareholders must be aware that the repayment goes to the company as a whole, and not to the shareholders who brought the claim on the company’s behalf.
- An injunction preventing the directors from taking certain action, or mandating the directors to take an action.
- Set aside of a transaction which has been found to have benefitted the director at fault personally.
- Removing a director.
Protection for costs
The court can order the company to indemnify the shareholder for their legal costs. This protects the shareholders from incurring high legal fees personally, and instead the company foots the bill.
The court has a wide discretion for these orders and it can adapt them throughout the claim. For example, the court could make a ‘staged order’ which changes as the claim progresses. As new facts emerge through the case, the court could reduce to make future orders, and the shareholder could incur personal liability for the legal costs.
Alternatives to derivative claims
In some instances, a shareholder can bring an unfair prejudice claim instead of a derivative claim. They are not the same claim, but the facts may give rise to both circumstances. In an unfair prejudice claim, a shareholder is looking to protect their own rights, rather than the interests of the company. It is their personal claim. For more information on unfair prejudice claims, please see our guide.
There may also be a breach of contract claim if there has been a breach of the shareholder agreement.
In particular serious circumstances, it may be appropriate to apply for a winding up petition. This is the most draconian option though, and should be seen as a last resort.
As solicitors who specialise in this area, we can help you decide which claims to pursue, and how to prepare the claims for the best chance of success.
