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Double derivative actions after enactment of the Companies Act 2006

03 April 2013

The continuing availability of common law "double derivative" actions – where the members of the allegedly wronged company's holding entity bring a derivative action on behalf of the company − has been confirmed by the High Court, despite codification of the law governing derivative actions by Part 11 of the Companies Act 2006.

The case of Universal Project Management Services Ltd v Fort Gilkicker Ltd & ors [2013] All Er (D) 313, emphasises a judicial desire to satisfy the law's search for a suitably interested "champion" of the wronged company, with precise legal relationships being of no legal relevance, provided the holding entity is in "wrongdoer control".

Background

Briggs J had to determine two interrelated issues: whether the English common law recognised double derivative actions prior to the introduction of the Companies Act 2006 (the Act) and, if it did, whether those common law actions were abolished upon the coming into force of the Act.

The applicant, Universal Project Management Services Ltd (UPMS) (embodied by a Dr Frischmann), was one of two equally participating members of the limited liability partnership (LLP) that owned all of the shares in Fort Gilkicker Ltd (FGL). The other member of the LLP was the second defendant, Mr Pearce. Mr Pearce and Dr Frischmann were the only two directors of FGL, which was a single purpose vehicle set up to develop a former Victorian coastal battery, Fort Gilkicker. Disagreement as to the specifics of that development ultimately led to UPMS alleging that Mr Pearce had misappropriated a valuable business opportunity of FGL for his personal benefit and in breach of his fiduciary duty as a director of FGL. That being a claim vested solely in FGL, which was highly unlikely to bring an action given that the jointly owned LLP was FGL's sole shareholder, with Dr Frischmann and Mr Pearce its sole directors, UPMS sought to litigate the cause of action on behalf of FGL.

Did the common law recognise a "double derivative" action?

Derivative actions were developed by the common law as an exception to the rule in Foss v Harbottle (1843) 2 Hare 461 that the only person with locus standi to pursue a claim on behalf of a company is the company itself. Under the pre-Companies Act 2006 common law, where an action against a company amounted to fraud (which for these purposes encompassed numerous equitable wrongs, including breach of fiduciary duty), the rule in Foss was relaxed in favour of the aggrieved minority, who were permitted to bring a minority shareholders' action. Denying them that right would mean the grievance could never reach the court as the wrongdoers, being in control, would not allow the company to sue (Prudential Assurance Co Ltd v Newman Industries (No 2) [1982] Ch 204). "Wrongdoer control" applies not only to minority situations but also where the aggrieved members are in 50/50 control, such that either may prevent the company from suing.

Common law derivative actions typically involved conferral of locus standi upon members of the wronged company. However, there were reported examples where locus standi was conferred upon a member of its holding company, when the holding company was itself subject to the same wrongdoer control as the company. Briggs J did not find this surprising as the derivative action is merely a procedural device designed to prevent a wrong going without a remedy. An applicant is not seeking to exercise some right inherent in membership, rather, he is availing himself of the court's readiness to permit someone with a sufficient interest to sue as the company's representative, for the benefit of all its stakeholders. Briggs J's view was that, rather than representing a distinct form of derivative action, the double derivative action was simply one part of this "single piece of procedural ingenuity designed to service the interests of justice in appropriate cases".

Did enactment of the Companies Act 2006 extinguish the common law double derivative claim?

Chapter 1 of Part 11 of the Act introduced a comprehensive code prescribing the conditions for bringing a derivative claim. Section 260 provides that the Chapter applies to proceedings "by a member of a company" seeking relief on behalf of the company in respect of a cause of action vested in the company. In a clear expression of intent to oust the common law, the section states that derivative claims may only be brought under Chapter 1 or in pursuance of an order of the court in proceedings for protection of members against unfair prejudice. The question for Briggs J was whether this statutory curtailing of derivative claims extended to abolition of double derivative actions at common law.

The primary purpose of codification of derivative claims was to remove what many saw as "complicated, unwieldy and obscure" common law provisions. As Briggs J observed, it challenges commonsense to conclude that in doing so Parliament intended to abolish such a regime in relation to derivative claims by members, but to retain an equally complicated, unwieldy and obscure regime for others seeking to litigate an action on behalf of a company. It was similarly unpalatable to conclude that Parliament would have intended to narrowly define the ambit of a derivative claim in such a way as to abolish "a convenient procedural device for doing justice in cases of wrongdoer control" in a modern context where multi-layered corporate structures are ever more common. On the face of the legislation, the Judge saw no persuasive reason why Parliament would have chosen to enact a statutory scheme for doing justice where a company is in wrongdoer control, but not where its holding company is in the same wrongdoer control.

Having found little assistance in an analysis of the Law Commission Report or related academic commentary, the Judge ultimately concluded that the Act did not abolish common law double derivative actions. He did so largely as a matter of statutory construction. The plain meaning of s260 restricts the ambit of "derivative claim" to proceedings by a member of a company. By implication, claims by persons other than members, such as members of the holding company, are excluded. As is well established, statute will only be construed as taking away common law rights if it does so expressly or by necessary implication (Islington Borough Council v Uckac [2006] 1 WLR 1303) and in this case, while the Act did so in relation to derivative claims by members, the abolition was neither express nor a necessary implication in relation to the remainder of the common law. As the Judge observed, Parliament could easily have phrased s260 so as to have that result, or it could have taken the approach adopted in the Australian Corporations Act 2001 and expressly abolished the whole of the common law derivative action in relation to companies.

The common law double derivative action therefore survived the Act, and its availability is wide. The extension of locus standi beyond the members of the wronged company reflects the need for a suitably interested claimant to pursue the company's claim when it is disabled from doing so. The precise nature of the corporate body which owned the wronged company's shares is of no legal relevance, provided that it is itself in wrongdoer control and has some members at least who are interested in seeing the wrong done to the company put right.

Comment

Writing in an extra-judicial capacity, Lord Millett has observed that abolition of double derivative claims would give potential fraudsters a simple moral, "choose an English company and be careful to defraud its subsidiary and not the company itself" (Millet, "Multiple Derivative Actions", July 2010). The approach to statutory construction taken by Briggs J in this case avoids that undesirable situation and means that, for the time being at least, common law double derivative actions survive enactment of the Companies Act. Just as notable, however, is the overt display of judicial pragmatism. The ultimate goal was provision of a "champion" of the wronged company and neither statutory ambiguity nor the complexities of legal structure were permitted to stand in its way.

Further information

This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.