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Derivative Action & Ratification Of Breaches Of Duty Notes

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Derivative Action & Ratification of Breaches of Duty
Contents
G&D Chapter 16: Directors' Duties (pp568-76)............................................................................. 164
Shareholder Approval / Whitewash of Specific Breaches of Duty.....................................164
What is being decided?................................................................................................................... 164
Who can take the decision for the company?........................................................................165
Disenfranchising particular voters............................................................................................ 165
Voting majorities............................................................................................................................... 166
Non-ratifiable breaches.................................................................................................................. 166
G&D Chapter 17: The Derivative Claims and Personal Actions against Directors...........166
The Nature of the problem and the Potential Solutions........................................................166
The board and litigation................................................................................................................. 167
The shareholders collectively and litigation.......................................................................... 167
Derivative claims............................................................................................................................... 167
Other possible solutions................................................................................................................. 167
The General Statutory Derivative Claim....................................................................................... 168
The scope of the statutory derivative claim........................................................................... 168
Deciding whether to give permission for the derivative claim......................................169
Varieties of derivative claim......................................................................................................... 170
Subsequent conduct of the derivative claim..........................................................................170
The Statutory Derivative Claim for Unauthorised Political Expenditure........................171
Shareholders' Personal Claims against Directors.....................................................................172
Conclusion................................................................................................................................................ 173
Personal Claims........................................................................................................................................... 173
When may such claims arise?........................................................................................................... 173
Peskin v Anderson [2001] 1 BCLC 372.................................................................................... 173
Priority as between the company and the member (no reflective loss).........................174
Prudential Assurance v Newman Industries (No 2) [1982] Ch 204.............................174
Johnson v Gore Wood and Co [2002] 2 AC 1 / HL...............................................................174
Giles v Rhind [2002] 4 All ER 977.............................................................................................. 175
Gardner v Parker [2004] 2 BCLC 554....................................................................................... 177
Perry v Day [2005] 2 BCLC 405................................................................................................... 177 1|Page Mitchell, Shareholders' Claims for Reflective Loss (2004) 120 LQR 457...................177
Statutory Derivative Action [contrast Foss v Harbottle].............................................................179
Bhullar v Bhullar [2015] EWHC 1943........................................................................................... 179
Cinematic Finance v Ryder [2010] All ER 283........................................................................... 179
Kleanthous v Theo Paphitis [2011] EWHC 2287 (Ch)............................................................179
Stainer v Lee [2010] EWHC 1539 (Ch).......................................................................................... 180
Mission Capital v Sinclair [2008] EWHC 1339........................................................................... 180
Franbar Holdings v Patel [2009] BCLC 1...................................................................................... 181
Iesni v Westrip Holdings [2010] BCC 420................................................................................... 181
Stimpson v Southern Private Landlords [2009] EWHC 2072..............................................183
Bridge v Daley [2015] EWHC 2121................................................................................................ 183
Cullen Investments v Brown [2015] EWHC 473.......................................................................185
Re Fort Gilkicker Ltd [2013] EWHC 348 (Ch)............................................................................ 185
Hirt, The Company's Decision to Litigate against its Directors [2005] JBL 159...........185
Introduction........................................................................................................................................ 185
Problem underlying enforcement of directors' duties......................................................186
Legal Strategies to deal with the underlying problem.......................................................186
Analysis and evaluation of present law and reform proposals wrt legal strategies
.................................................................................................................................................................. 188
Conclusion............................................................................................................................................ 188
Worthington, Corporate Governance: Remedying and Ratifying Directors Breaches
(2000) 116 LQR 638............................................................................................................................. 188
A Keay & J Loughrey, Derivative Proceedings in a Brave new World for Company
Management and Shareholders [2010] JBL 151.......................................................................189
Questions....................................................................................................................................................... 189

G&D Chapter 16: Directors' Duties (pp568-76)
Shareholder Approval / Whitewash of Specific Breaches of Duty
In line with the general law, those to whom duties are owed can release those who owe them duties from their legal obligations. Hence, the company too can release the directors from their general duties, within limits.
What is being decided?
Company will normally act by resolution of either the board or the general meeting:

What does their resolution seek to achieve?
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Decision to authorise / ratify a breach will have effect of either treating director having never committed a breach or are deemed to have not committed the breach. Prior approval is authorisation while post-facto approval is ratification.
These are different from affirmation, which is making an avoidable contract binding onto the company, and adoption, where the transaction is one which is beyond the powers of the directors but is one that can be entered into by the shareholders.
Affirmation / adoption does not by itself amount to implicit forgiveness and may still enforce personal remedies against directors.
However, a single resolution may be aimed at both affirmation and waiver.
Ex ante authorisation may either be given on a specific case-by-case basis or generally via the AoA, although this will be viewed with more suspicion -
Sharma v Sharma [2013]. This is because such an investor who has given a general waiver will necessarily be less well informed on the facts of any particular breach which goes to the issue of informed consent.
Authorisation and ratification are recognised in S180(4)(a), which aims to preserve the common law as it stands for authorisation.
S239 seeks to recognise and amend the common law rules on ratification.
There is therefore a difference in what is needed if approval is given on the day before the breach compared to the day after the breach.

Who can take the decision for the company?
Which corporate organ? Board or delegates - pursue legal claim against third parties,
affirm voidable contracts, waive breaches of duty committed by third parties dealing with the company. However, where the wrong was committed by a director, the common law rule is that the members must approve the breach in a general meeting.
This is parallel to the power which beneficiaries under a trust have to ratify the breaches of trustees.
The common law has been modified by the CA - SS177, 180(1)(b) - advance authorisation of self-dealing transactions - merely need board notification. SS176,
180(1)(a) - breaches to the conflict of interest rule - board authorisation is possible subject to AoA. In these cases, the potential mischief is not great enough to require the cumbersome general meeting approval procedure.
In contrast, the common law rules are not modified wrt advance authorisation of proposed breaches of other general duties per SS171-4 and 176.
The common law position of GM approval also applies wrt ratification. As a result, there is a divergence between the rules for ratification and authorisation.
Note however that this does not apply to companies in the vicinity of insolvency - in those cases, it would be more appropriate to wait for the insolvency practitioner to be appointed, who may or may not exercise that power on behalf of the creditors - West
Mercia Safteywear Ltd v Dodd [1988].

3|Page Disenfranchising particular voters
Where authorisation decision is given by board itself, the conflicted director should not be in a position to authorise his own breach. Per S175(6), no conflicted director may count towards quorum or vote.
With ratification, where the director is also a shareholder, his votes and those of connected persons are to be disregarded at the general meeting per S239(4).
However, with authorisation at the general meeting, the common law continues to apply per S180(4)(a). Similarly, Chs 4 and 4A of Pt 10 appear to permit interested directors to vote on resolutions required by those Chapters (subject to stricter requirements for public companies). This divergence is undesirable as a breaching director may seek to get the prospective breach authorised at a general meeting while wielding his own votes.
Allowing directors acting qua shareholder to vote at the general meeting as they saw fit was based on the notion that shareholders do not owe the company fiduciary duties,
and that votes are property rights attaching to shares per North-West Transportation v
Beatty (1887). However, perhaps the starting point of the law should be that members owe the company to exercise their powers in good faith and for proper purposes.
Members should not be allowed to procure forgiveness for themselves and avoiding liabilities for personal remedies for breach of a duty they owe to the company.
Voting majorities
What is the necessary majority for approval decisions? At common law, the normal rule is an ordinary majority subject to AoA. Wrt authorisation, CA preserves common law.
Wrt ratification, S239(2) says that the ratification decision 'must be taken by the members' and 'may' be taken by ordinary majority unless by some other rule a higher threshold is required eg AoA.
What if the majority, in approving a breach by the directors, act unfairly to the minority? Minority oppression is dealt with in Pt 4. Before that, it should be considered whether or not the decision taken is valid, and disenfranchising conflicted directors or members as required. Additionally, certain breaches are considered not to be ratifiable.
Non-ratifiable breaches
Are all breaches of law capable of being ratified? This is not expressly answered by CA.
At common law, some breaches can neither be authorised nor ratified but the breadth of the rule is uncertain.
The shareholders may not ratify a breach with expropriates company property to themselves - Re Halt George (1964) Ltd [1982]. Hence, directors were not allowed to authorise the diversion of company contracts to themselves in Cook v Deeks [1916].
However, how far does this principle extend? Why did HL in Regal (Hastings) Ltd v
Gulliver [1942] believe it possible for the directors to have ratified their breach had they acted qua shareholder to do so at a general meeting? Ultimately, almost every breach will at least involve the potential future misappropriation of corporate property in the form of opportunities meaning forgone potential profits.

4|Page However, the general trend is towards allowing ratification. Perhaps this category of non-ratifiable breaches will die a natural death as many of them can be effectively dealt with the rules on directors and shareholders being disqualified in the case of conflicts.

G&D Chapter 17: The Derivative Claims and Personal
Actions against Directors
The Nature of the problem and the Potential Solutions
Not every breach of directors' duties should result in resort to litigation - issue is what is in the best interests of the company - the action of suing, even if an effective remedy is obtained, may lead to reputational damage per Taylor v NUM (Derbyshire Area)
[1985] per Vinelott J.
However, a line must be drawn to stop self-dealing - ie directors deciding, conveniently,
that it is not in the interests of the company for the company to sue them for an alleged breach of their duties.
The board and litigation
Art 3 of model articles for both public and private companies says that normal management powers, including decision to litigate, lie with the board. Does this include the case of where the board decides whether or not to litigate against one of their number?
The board may be nevertheless able to act impartially eg where AoA delegates such decisions to sub-board consisting solely of non-conflicted directors per John Shaw &
Sons (Salford) Ltd v Shaw [1935] - members cannot countermand such a decision. Or the wrongdoing directors could have been fired or suspended. Similarly, per S212, the liquidator may sue in his own name but in substance on behalf of the company in the interests of creditors in the context of winding up.
The shareholders collectively and litigation
To correct for any potential conflict, the shareholders collectively may decide to sue at common law - this is something of an anomaly in comparison to the normal approach to the division of powers between members and board. Unless there are specific AoA
provisions, the shareholders will need to procure an ordinary resolution to launch litigation. However, it is uncertain if shareholders will enforce the interests of the company in making the decision to litigate. The directors may control the general meeting through their own shareholdings. Or the wrongdoing director may simply absent himself from the general meeting where the resolution is to be taken, preventing the shareholders from finding out enough information to make a decision.
Derivative claims
Provisions were thus eventually made to allow individual shareholders standing to pursue litigation on behalf of the company against the alleged wrongdoing director,
subject to appropriate safeguards per Foss v Harbottle (1843). Greater litigation may allow potential wrongdoing to be brought to light more readily but it is uncertain whether or not such derivative claims are really in the interests of the company. As

5|Page damages tend to be pro-rated according to shareholding, only those with relatively significant shareholdings will be incentivised to sue.
Foss - should individual shareholders be allowed to sue derivatively or must litigation be left to shareholders as a whole? Derivative action should not be allowed where the members as a whole have decided against it but there is no mechanism to compel a general meeting and interested directors would still be allowed to vote.
Law Comm (1997) therefore thought that individual shareholders should instead be given opportunity to petition to court for permission to sue. These were endorsed by
CLR and form part of CA 2006 - derivative claims cannot be brought at common law but only under the statute [though common law is still relevant to foreign-registered companies per Abouraya v Sigmund [2014]]. The rule in Foss is therefore much less relevant.
Other possible solutions
Aside from board, members as a whole, and individual members, some others may be given standing to sue on behalf of the company:

Sub-set of the board eg non-conflicted members or independent NEDs only - this is the approach taken to authorisation of conflicts of interest but not ratification of breaches of duty, which is left to members. Decision not to sue is analogous to ratification so using a sub-set of the board should not be allowed here either.
However, to ensure greater flexibility, S283(2)(a) requires a court granting leave for derivative action to consider how the non-conflicted directors would have acted in good faith on the litigation question and the actual or likely views of non-involved shareholders.
Entrusting litigation decision to some group of shareholders - this is used in
Germany but it is not well-received by the common law, except in the case of unauthorised political donations
Giving right to commence action to those outside of the company - this would not make sense in the majority of companies but note enforcement powers of
Regulator in Community Interest Companies per Companies (Audit, Investigation and Community Enterprise) Act 2004, s44. Analogy may also be made to powers of liquidator in insolvent companies.

The General Statutory Derivative Claim
The scope of the statutory derivative claim
The court's gatekeeper role
Pt 11, CA 2006 - general statutory derivative claim - gives court gatekeeper role. The action moves at initiative of member but court permission must be granted before any substantive steps of litigation beyond informing the company that the claim has been issued and that court permission is being sought per CPR 19.9(4), 19A(2). Under common law, Foss test merely required court to decide whether or not the member had standing to sue but now the court has a discretion to decide whether or not it is in the best interests of the company to have litigation brought.

6|Page The same policy considerations that featured in Foss are still part of the Act but they are considerations to take into account rather than absolute bars.
The types of claims covered by the statutory regime
Limitations on statutory jurisdiction - only applies to derivative claims or derivative proceedings ie claims brought in respect of cause of action vested in company and seeking relief on its behalf per S260(1). CPR 19.9(3) - the company must be added to claim as defendant although it is the rights of the company which are being enforced so case name is Shareholder v Director and Company. The company is only the nominal defendant - action is really against directors.
Majority of derivative claims can only be brought under the Act, either under Pt 11 or under unfair prejudice rules in Ch 20. The Foss rule is essentially irrelevant. However,
not all claims which a shareholder may wish to bring would be captured by Pt 11 - only wrt claims 'arising from an actual or proposed act or omission involving negligence,
default, breach of duty or breach of trust by a director of the company' per SS260(3) and 265(3). In all other cases eg claim again a non-directorial senior employee, the rules on derivative claims do not apply by analogy - the normal constitutional division of management powers (ie to board) should apply. The concern is simply to avoid a situation of directors (ie the board) becoming conflicted.
Pt 11 claims against directors may be brought against former and shadow directors per
SS260(5) and 265(7). However, this does not widen the scope of duties owed to the company by former or shadow directors. It simply creates an additional mechanism of enforcement.
Shareholder claimants
Shareholder may bring a claim for a cause of action which arose before he became a member of the company per S260(4) and S260(5). The shareholder has a property interest in the company while a member whether those assets were acquired beforehand or not. Those who have sold their shares would be deemed to have accepted the loss.
Statutory extension of notion of member - those who are owners of shares by operation of law but are not on members' register eg executor of an estate - will be allowed to sue in those circumstances too - S112. This is particularly useful in quasi-partnerships where directors have power to refuse new registration of members - this protects the rights of the transferee.
Deciding whether to give permission for the derivative claim
Central issue - nature of the discretion vested in the court to approve continuance of claim. This is broad but not unconstrained. SS263(1) and 268(1) - C needs to make out prima facie case, sets out three situations where leave will not be granted, and then lays down a list of factors to consider when given permission to proceed.
Prima facie case and judicial management of proceedings

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