AIMS AND OBJECTIVES
After reading this chapter you should be able to:
Understand the proper claimant principle, its origins and shortcomings
Advise on the circumstances in which a shareholder may commence and will be permitted to continue a statutory derivative claim (s 260)
Recognise when a shareholder has a personal right he may sue to enforce in a personal capacity
Explain why a shareholder is not able to recover reflective losses except in one circumstance and why that exception exists
Advise whether or not a shareholder is likely to succeed in a petition based on a company’s affairs having been conducted in a manner unfairly prejudicial to the interests of the shareholder (s 994)
Advise on the basis of the just and equitable winding-up jurisdiction of the court
Understand the relationship between s 994 and just and equitable winding-up petitions
The introduction to this chapter highlights how the rights and claims considered in this chapter relate to one another and places those rights and claims in context.
In the following sections of the chapter, first, we examine the rule that the company is the proper claimant in proceedings in which a wrong is alleged to have been done to a company (the ‘proper claimant rule’), and limits of that rule. Second, we look at the circumstances in which shareholders may commence, and will be permitted to continue, a derivative claim. Third, we consider the personal rights of a shareholder to sue in his own name for legal wrongs done to him in a personal capacity, to make good losses he has suffered, including, potentially, reflective losses. We then examine petitions based on a company’s affairs having been conducted in a manner that is unfairly prejudicial to the interests of the shareholders (s 994 petitions) and their relationship to just and equitable winding-up petitions, the final type of petition covered in this chapter.
The law uses a number of legal mechanisms to protect companies from poor management and self-interested action by those in control, including imposition of the general and specific directors’ duties examined in Chapters 11 and 12. If the inadequate behaviour of directors causes losses to the company, the company can sue to recover losses caused by breaches of duty (see Chapter 13). The company and the company alone has the right to sue for breach of directors’ duties because, as we have learned, directors’ duties are owed to the company.
Where the wrongdoers are directors, the potential exists for wrongs to be overlooked and no remedies pursued by the company because it is the wrongdoers who are managing the company. This difficulty may be overcome by the shareholders becoming the decision-making organ of the company for the purposes of ensuring legal action is brought against the directors. The problem is more difficult to overcome, however, when wrongdoer directors also own a majority of a company’s shares.
We know from Chapter 9 that shareholder decisions are largely based on majority rule. Without more, then, the potential would exist for the holders of a minority of the shares in a company to have no procedure by which to assert the rights of the company when directors who were also majority shareholders acted in breach of duty to the detriment of the company. The derivative claim procedure has been developed to assist minority shareholders who find themselves in such a position to protect the company.
Rather than being concerned to protect the company, a minority shareholder in such a position is usually more concerned to protect himself personally from the adverse consequences of being a shareholder in a company with a majority shareholder managing the company in his (the majority shareholder’s) own best interests rather than for the benefit of all shareholders. The main procedure available to a shareholder to protect himself personally is to petition the court for a remedy pursuant to the Companies Act 2006, s 994 based on the company’s affairs having been conducted in a manner that is unfairly prejudicial to the interests of the minority shareholder.
If a company suffers loss caused by a breach of duty owed to the company its shareholders also usually suffer loss because the value of their shares is not as great as it would otherwise be. The shareholders’ loss of share value merely reflects the loss suffered by the company, and, for this reason, is called ‘reflective loss’. We know that shareholders are unable to sue wrongdoers who breach duties owed to the company, because those duties are not also owed to the shareholders.
Even where a wrongdoer owes a separate and additional duty to the shareholder, the shareholder may be unable to sue for breach of that duty and recover losses they have suffered. This is because insofar as the shareholders’ losses are reflective losses, to allow recovery could result in the wrongdoer being ordered to compensate more than one person for the same loss: the company (for the loss to the company) and individual shareholders (for the reduction in share value they suffer which is a reflection of the loss to the company). As a matter of public policy, the law has set its face against allowing shareholders to recover reflective losses except in one very limited circumstance.
Traditionally, analysis of shareholder remedies has been concerned with the extent to which the law can be used by minority shareholders to secure a remedy for losses arising out of self-interested action by directors who are also majority shareholders. The remedy could be either for the company, by way of a derivative claim, or for the shareholder personally, either by asserting personal rights (subject to the limits on recovery of reflective loss), or by bringing a claim based on a company’s affairs having been conducted in a manner that is unfairly prejudicial to the interests of the shareholders. This focus is, however, changing.
Increased emphasis on good corporate governance in the interests of all stakeholders in companies, the enshrinement of ‘enlightened shareholder value’ in s 172 of the 2006 Act and the placing of the derivative claim on a statutory footing, have come together to raise the question of to what extent shareholder remedies may be used to enforce better management of companies in the interests of all stakeholders. Minority shareholders may challenge, or threaten to challenge, management decisions as having been taken in breach of duty by commencing a derivative claim. This has raised the spectre in some commentators’ minds of minority shareholders who support public interest groups using the law to influence board decision-making in favour of public interest groups. Detailed consideration of the role of derivative claims in influencing board decision-making is outside the scope of this book but may be pursued by reading relevant literature listed under further reading at the end of this chapter.
We know already that the company is a separate legal entity from its shareholders and consequently has legal rights and liabilities. If its rights are infringed, by a person failing to perform a contract they have entered into with the company, for example, the company may sue to enforce its rights under the contract. We also know that the decision to litigate rests with the board of directors as part of the general powers of management of the company (see Chapter 9). From this perspective, it makes perfect sense to have a basic rule, known as the rule in Foss v Harbottle, that in any legal proceedings in which a wrong is alleged to have been done to a company, the proper claimant is the company.
Foss v Harbottle  2 Hare 461
The claimants, Foss and Turton, were shareholders in a company formed to buy land for use as a pleasure park. The defendants were directors and shareholders of the company. The claimant shareholders alleged that the defendants had defrauded the company in a number of ways including some of the defendants selling land belonging to them to the company at an exorbitant price. The claimants sought an order that the defendants make good the losses to the company. Held, dismissing the action: In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company and as the company was still in existence, it was possible to call a general meeting and therefore there was nothing to prevent the company from dealing with the matter.
Although logical on its face, the rule has presented enormous difficulty to courts over the years.
‘The rules governing shareholder remedies in English company law are notoriously convoluted. Towering over this area, like Frankenstein’s monster, stands the legacy of Foss v Harbottle. While not a Gothic novel, it has none the less generated its own horror stories of unfulfilled rights and ruinous litigation.’
Quite apart from reflecting the separate personality doctrine, the proper claimant principle also reflects a couple of sentiments nineteenth-century courts felt towards companies. It is perhaps an over-zealous commitment to these sentiments that resulted over the years in the unfulfilled rights and ruinous litigation to which Sugarman refers. First, is the reluctance of the courts to become involved in business decisions. Second, is the fear felt by the courts of multiplicity of legal actions arising from differences between shareholders:
‘The court is not to be required on every occasion to take the management of every playhouse and brewhouse in the Kingdom.’
Carlen v Drury (1812) 1 Ves & B 149 per Lord Eldon
Courts have held strong to the principle that disputes amongst members of a company should be resolved by the members themselves according to the internal decision-making process provided by the company constitution and the Companies Acts (Mac-Dougall v Gardiner (1875–76) LR 1 (CA)). Internal rules usually provided for majority rule, and the rule in Foss v Harbottle (1843) deliberately subjected minority shareholders to the rule of the majority shareholder.
The courts were compelled to recognise limits to the rule in Foss v Harbottle (1843). The rule was not applied, for example, if a minority shareholder complained to the court about action by the company for which more than a simple majority was needed, as in Edwards v Halliwell  2 All ER 1064, which is a trade union case, but the principle is applicable to companies.
Edwards v Halliwell  2 All ER 1064
The constitution of a trade union provided that contributions were not to be altered until a ballot vote of members had been taken and a two-thirds majority in favour obtained. Contributions were increased following a resolution supported by a simple majority. Two members sued seeking a declaration that the resolution was invalid. Held: Where a matter cannot be sanctioned by a simple majority of the members of the company but only by some special majority, an individual member is not prevented from suing by the rule in Foss v Harbottle.
The principal area where the rule presented difficulties was where those who control the company and, in particular, the decision to sue or not sue a person who has legally wronged the company, are themselves the wrongdoers. The most important limit to the rule, which is the only true exception to the rule, came to be referred to as ‘fraud on the minority’. Where directors who were also majority shareholders had perpetrated a fraud on the company, a minority shareholder was permitted to commence an action based on a wrong done to the company to secure a remedy for the company. The action was called a ‘derivative action’.
Cook v Deeks  1 AC 554 (PC)
Three directors obtained a contract in their own name to the exclusion of the company in breach of fiduciary duty (now s 175). As holders of 75 per cent of the shares, they secured a resolution declaring the company had no interest in the contract. Held: The contract belonged in equity to the company and the directors could not use their shares to vest it in themselves. In these circumstances, where the board and majority shareholders were not willing to commence an action, minority shareholders could bring an action on behalf of the company.
With the exception of multiple derivative actions, the Companies Act 2006 has replaced the common law derivative action with a statutory derivative claim in ss 260–264 (considered below in section 14.3). All circumstances in which permission to continue a derivative action is granted may now be seen as exceptions to the proper claimant principle.
It is helpful to illustrate how the proper claimant principle, and the exception to it, works by analysing a hypothetical scenario.
Directors as wrongdoers
Consider a company with two directors. They find out informally that planning permission will be granted for a piece of land owned by the company. They keep this information to themselves and buy the land from the company for £250,000, a price representing its value without planning permission which is far lower than its value with planning permission.
In these circumstances, the directors cannot act as a decision-making organ of the company and decide to sell the land to themselves because they are conflicted-out. Articles normally provide that they cannot vote on the decision of the company to sell the land to them, and, even if the articles did not say this, and the directors cause the company to sell the land to them, they are in breach of ss 172, 175 and 190, as they have not acted to promote the success of the company (s 172), have used information obtained as directors to personal advantage (s 175) and they have failed to obtain the approval of the shareholders (s 190). Consequently, the transaction will be voidable by the company, the directors will be liable to account for any profits they have made and must indemnify the company against any losses caused by the breach of duty.
Although the directors, as the board, ordinarily have the power to decide whether or not to commence any legal action, in these circumstances control of the decision to litigate transfers to the shareholders and the shareholders, as a decision-making organ of the company, decide whether or not the company will sue the directors. The legal proceedings are still brought by the company, in the name of the company, seeking a remedy for the company.
Majority shareholders as wrongdoers
Staying with the hypothetical situation, the company has three shareholders each owning one-third of the shares. Two of the shareholders are the directors. The wrongdoer directors are not going to decide to sue themselves therefore the decision to litigate or not reverts to the shareholders. Does this help the company if the wrongdoers are also shareholders?
Shareholders take most decisions by ordinary resolution, which encompasses majority rule (see Chapter 9). In our hypothetical situation, the wrongdoers own a majority of the shares and, as majority shareholders, they are able to pass or defeat ordinary resolutions. Are they, therefore, permitted to:
pass an ordinary resolution approving the sale of the land pursuant to s 190?
pass an ordinary resolution ratifying the breach pursuant to s 239?
defeat a proposed resolution to sue the directors to recover the land?
have any legal action commenced by the minority shareholder stopped because he is not the proper claimant?
A claim brought by a member under the Companies Act 2006, ss 260–269 against a director for an actual or proposed act or omission involving negligence, breach of duty or breach of trust by a director of a company. The claim is brought by the member for and on behalf of the company itself
The answer to the second question is no. On a resolution to ratify his breach of directors’ duty, the votes of both the director/shareholder and any person connected with him are disregarded (s 239(4)). Curiously, there is no similar provision in s 190 requiring the votes of the director to be discounted on a resolution to approve a substantial asset transaction which leaves the matter moot and the answer to question 1 dependent upon the approach the court takes to statutory interpretation. A literal approach would suggest that all shareholders can vote, as the section does not state otherwise, whereas s 239 does state otherwise. A purposive approach may suggest otherwise. Turning to the third question, a resolution to sue the directors, if defeated, could be characterised as an indirect decision of the company to ratify a breach of duty, thereby bringing it within s 239 which requires the directors’ votes to be disregarded. It is surprising that the answers to these questions are not clear cut.
The answer to the fourth question is that, provided the minority shareholder brings the legal action as a claim under s 260, a statutory derivative claim, the action will not be stopped based on him not being the proper claimant. He will, however, need to secure the permission of the court to continue the claim. We turn now to consider the statutory derivative claim.
The statutory derivative claim is the only proceeding by which a minority shareholder, notwithstanding his lack of control over company decision-making, can commence legal action in respect of a cause of action vested in the company, seeking relief on behalf of the company, to remedy a wrong done to the company. The 2006 Act has expanded the grounds on which a derivative claim may be brought but requires court permission for the continuation of claims. The consequences of introduction of the new statutory procedure were not easy to predict. Although a number of claims have been commenced, the number for which permission to continue has been granted by the court to date has been very small.
‘The statutory derivative action is designed to make the law more flexible, efficient and cost effective. But there were concerns that reform would open the floodgate and lead to vexatious claims with the effect of discouraging individuals to accept appointments as directors. In response, the Law Commission cautioned that members “should be able to maintain proceedings about wrongs done to the company only in exceptional circumstances” and that without good cause shareholders should not be encouraged to involve the company in litigation. As a result, the 2006 Act introduced a strict leave procedure and gave the courts new case management powers with the objective of protecting companies from disruptive litigations which are inimical to their interests. On the one hand, the law is concerned to uphold the majority rule principle in Foss. On the other hand, it recognises the need to protect the minority shareholders from abuse by the majority. The law aims to strike a balance between these two competing interests. The statutory derivative action is a recognition of the weaknesses inherent in the attempt of the common law derivative action to protect the minority shareholder and is an attempt to remedy the weaknesses.’
Mujih 2012 at p. 78
A statutory derivative claim may be brought only in respect of a cause of action 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. The cause of action may be against the director or another person or both (s 260(3)). Note that the exposure of third parties to a s 260 claim will depend upon dishonest assistance and knowing receipt as the courts have developed these concepts in the context of breaches of duty by directors (these concepts are usually addressed in trusts courses when examining the liability of strangers to the trust in the event of a breach of duty by one or more trustees and you may find cases you study there relevant here). Claims cannot be brought under s 260 against third parties based on causes of action arising independently from the directors’ legal shortcomings (Iesini Westrip Holdings Ltd  BCC 420).
The claimant in a s 260 derivative claim is the shareholder. Note that because the shareholder is bringing the action to secure relief for the company, the company must be made a defendant to the claim along with the directors and any third parties against whom relief is sought. An application to continue a derivative claim by a majority shareholder was rejected in Cinematic Finance Ltd v Ryder  EWHC 3387. The court accepted that a derivative action could be brought by a majority shareholder but stated that permission to continue would be given to a majority shareholder only in very exceptional circumstances and it was difficult to envisage what such circumstances might be. In Stimpson v Southern Private Landlords Association  BCC 387 (Ch D), the question of the importance of wrongdoer control of the members arose, although the comments in the case on this issue were obiter. In the absence of such control, the fact that it was open to the claimant to requisition an extraordinary general meeting and try to obtain a replacement board that could, if it considered it appropriate, authorise the litigation, was stated to be a powerful and perhaps overwhelming factor against granting permission to continue.
Application for permission to continue claim
Once the claim form has been drafted and either before or after it has been issued, an application must be made to the court for permission to continue the claim (s 261(1)). The shareholder is precluded from taking any further step in the proceedings until the court has given permission for the claim to continue. A two-stage process exists by which the court decides whether or not to permit the claim to continue.
Stage 1: a prima facie case
The court must be satisfied that the particulars of claim and the evidence submitted to support it disclose a prima facie case for giving permission to continue. If no prima facie case is disclosed, the court must dismiss the application and make any consequential order it considers appropriate (s 261(2)). If the court does not dismiss the application, the application moves to stage 2. At this stage, the claimant will submit written evidence with his application for permission to continue, supporting his statement of claim, and there is no requirement to involve the defendant.
Confusion has emerged from recent cases as to precisely what a claimant has to establish at this first stage. The burden of proof imposed on a claimant and the range of issues necessarily considered at this stage define the process within which the courts balance protection of the company from the cost and distraction of bogus actions on the one hand, and minority shareholders from unacceptable excesses of majority shareholder rule on the other. If a heavy burden is imposed, many claimants will have to be denied permission to continue at this stage.
In Scotland, the Court of Session in Wishart v Castlecroft Securities Ltd  BCC 161 has been described as adopting a ‘low threshold’, stating that, ‘no onus is placed on the applicant to satisfy the court that there is a prima facie case; rather the court is to refuse the application if it is satisfied that there is no prima facie case’. This approach has been contrasted with two English cases in which the approach taken has been that the court has to decide based on the evidence before it that there is a prima facie case both that the company has a good cause of action and that the cause of action arises out of a director’s default, breach of duty (etc.) (Iesini Westrip Holdings Ltd  BCC 420, Franbar Holdings Ltd v Patel  BCC 885 (Ch D)). Presumably, these two cases imply that the claimant must present evidence rather than simply asserting the relevant breach of duty (etc.) in the statement of claim. Stimpson (above) highlights the question of the extent to which this stage should involve consideration of the factors the court is required to consider at a later stage in determining whether or not it should give permission to continue (see s 263(3) and (4)). The confusion is assisted by the practice of stages 1 and 2 (below) sometimes being combined. Clearly, appellate court guidance is needed. Guidance should separate out (i) which issues are under consideration at stage 1 from (ii) where the burden of proof lies, and how the burden can be satisfied, in relation to those issues. If, for example, a breach of duty by a director is clearly established, is this the stage at which the court should look at whether the circumstances for granting permission to continue a claim have been established?
Stage 2 involves a hearing of the application for permission to continue the claim and the defendant and, if it wishes, the company take part. At this stage the court must refuse permission to continue if:
a person acting in accordance with the s 172 duty to promote the success of the company would not seek to continue the claim (s 263(2)(a)); or
the act or omission has been authorised (ahead of time) or ratified (after the event) by the company (s 263(2)(b) and (c)).
The court does not have to decide that a hypothetical or nominal director would consider the claim worth pursuing. Rather, permission to continue must be refused if, on the balance of probabilities, such a director would decide not to pursue the claim. Only if no director acting in accordance with s 172 would seek to continue the claim will the courts consider themselves bound to refuse permission under s 263(2)(a) (Airey v Cordell  EWHC 2728 and Iesini). The courts have identified a number of factors that directors would take into account in deciding whether or not to continue to pursue a claim, including: its prospect of success, the enforceability of any judgment obtained, disruption of the litigation to the company’s business, costs of proceeding and the impact on the company’s reputation (see Franbar).
The second ground for obligatory refusal preserves the difficult issue of which acts and omissions of directors the shareholders can authorise or ratify and which they cannot. This is a controversial area which s 239 of the Companies Act 2006 has gone some way to clarifying. Uncertainty remains, however, because, even in relation to ratification, s 239(7) preserves, ‘any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to acts that are incapable of being ratified by the company’. Cook v Deeks  1 AC 554 (PC) (see above) is authority for the proposition that ratification will be invalid where it amounts to expropriation of the company’s property by the majority shareholder.
In relation to authorisation, as noted in the context of directors’ duties, the Companies Act 2006 does not make clear how far an interested shareholder may vote to authorise a transaction for which the Act requires shareholder approval. The principle in Cook v Deeks should, arguably, be extended to any case in which the transaction for which authorisation is sought would amount to an expropriation of company property. In such a case, the court would surely be permitted to find that, as a matter of law, the transaction had not been authorised so that the court must refuse permission for a minority shareholder to continue a statutory derivative claim.
If the court is not compelled to refuse permission, it must take into account the following when deciding whether or not to grant permission to continue (s 263(3)):
whether or not the claimant is acting in good faith in seeking to continue the claim (see Nurcombe v Nurcombe  1 WLR 370 (below));
the importance that a person acting in accordance with s 172 would attach to continuing the claim;
whether or not the act or omission could be, and in the circumstances would be likely to be, authorised or ratified by the company;
whether the company has decided not to pursue the claim;
whether the act or omission in question is one in respect of which the shareholder could pursue an action in his own right (this would most likely be under s 994) rather than on behalf of the company (see Barrett v Duckett  1 BCLC 243);
any evidence before it of the views of shareholders who have no personal interest in the matter (see Smith v Croft (No 2)  Ch 114).
In relation to the first point above, Nurcombe v Nurcombe  1 WLR 370 is an example of the courts being alert to attempts by claimants to use the derivative claim where they have already received a remedy for the wrong done. Such a claimant will be regarded as not acting in good faith in bringing the derivative claim.
Nurcombe v Nurcombe  1 WLR 370
The first defendant (D1) in the derivative action was a director and the major shareholder of the company which was the second defendant (D2). The remaining shares were held by the claimant who was the former wife of D1. In earlier matrimonial proceedings by the claimant for financial provision it had become clear that D1 had diverted the considerable benefit of a contract for the purchase of certain land from the company to a company owned by his second wife. The judge in the matrimonial proceedings took into account that D1 had made a substantial profit out of his dealings in respect of the land and the lump sum awarded to his first wife, the claimant, in the matrimonial proceedings had reflected this. The claimant brought the derivative action, as a minority shareholder, on behalf of the company seeking payment by D1 to the company of the profit on the property transaction which she alleged he had diverted from the company in breach of his fiduciary duty as a director. Held: Dismissing the action, that P had abandoned her right to bring a minority shareholder’s action by obtaining, in the matrimonial proceedings, the benefit of a lump sum award based on the inclusion of the profit from the property transaction in the first defendant’s assets.
Note that the last but one point in the list above is narrower than the common law principle, established in Barrett v Duckett  1 BCLC 243, that a derivative action would not be permitted to proceed where an alternative adequate remedy was available. The availability of a s 994 petition has been considered in a number of applications for permission to continue. The approach taken to date was reviewed by Justice Newey in Kleanthous v Paphitis  EWHC 2287:
In Parry v Bartlett and another  EWHC 3146, the judge held that the existence of an alternative remedy under s 994 of the Companies Act for unfair prejudice was only a factor to be taken into account, not an absolute bar to the grant of permission to continue a s 260 claim.
In relation to the final point in the list above, a derivative action was struck out in Smith v Croft (No 2) (1988) because a majority of the independent shareholders’ votes would have been cast against allowing the action to proceed and there was no evidence to suggest that they would be cast for other than reasons genuinely thought to be for the company’s advantage.
It is noteworthy that in the first two cases in which permission to continue was granted, Stainer v Lee and others  EWHC 1539 and Kiani v Cooper  BCC 463, the court merely granted permission to proceed until after disclosure, not permission to proceed to trial. This enables the court to revisit the question of permission at a time when the strength of the case is much clearer.
If the court gives permission for a derivative claim to continue, the claim continues much like any other action with remedies available that would be available in a case brought by the company against its directors (see Chapter 13). In its report on ‘Shareholder Remedies’ (No 246), the Law Commission recommended that the consent of the court should be a pre-requisite to any subsequent discontinuance of a derivative action. This recommendation reflected concern that the claimant and the directors could collude, with the claimant being bought off by the directors which, even at a premium in the eyes of the shareholder, would in many cases cost the directors far less than their liability were the claim to proceed to judgment. Such arrangements would be unlikely to be in the interests of the company. This recommendation has not been adopted. It may be, however, that when judges grant permission to continue, they use the power given to the court in s 261(4)(a), ‘to continue the claim on such terms as it think fit’, to order that the claim cannot be discontinued without the court’s permission.
A derivative claim is brought by a shareholder for the benefit of the company. The shareholder is an agent acting on behalf of the company (per Lord Denning MR in Wallersteiner, below, and see also Re Sherborne Park Residents Co Ltd  2 BCC 99528 considered at section 14.4). For this reason, the court is usually prepared to grant a costs order, typically applied for early on in proceedings, that the claimant shall be indemnified by the company against his liability for costs of both the derivative claim and the application for permission to continue, whether the claim is successful or not.
The authority for such an order, now reflected in the Civil Procedure Rules (CPR 19.9E), is Wallersteiner v Moir (No 2)  QB 373. Note that it is only as valuable as the creditworthiness of the company, as it does not provide the shareholder with any form of property interest to secure the sum payable by the company (Qayoumi v Oakhouse Property Holdings plc  1 BCLC 352).
Aware of the danger of imposing a potentially large financial obligation on companies, the courts in both Stainer v Lee and Kiani v Cooper made costs indemnity orders subject to restrictions. In Stainer v Lee, for example, it was capped at £40,000 (with liberty to apply for its extension).
Shareholders may bring legal actions asserting their personal rights as shareholders. The rule in Foss v Harbottle is not relevant to these actions. The proper claimant is not the company, rather, the proper claimant for a wrong done to a shareholder is the shareholder in his personal capacity. In fact, the company in such cases is usually one, if not the only, defendant. Wood v Odessa Waterworks Co (1889) LR 42 Ch D 636 is an example of a shareholder bringing an action on behalf of himself and other shareholders, all in their personal capacity. This is known as a representative action. Representative actions are common when shareholder rights are asserted because there are often a number of shareholders with the same right.
Wood v Odessa Waterworks Co (1889) LR 42 Ch D 636
The rights of the shareholders in respect of a division of the profits of the company were governed by provisions in the articles of association. A shareholder, on behalf of himself and all other shareholders, brought an action for an injunction to restrain the company from acting on a resolution on the ground that it contravened the articles of association of the company. Held: ‘What I have to determine is, whether that which is proposed to be done is in accordance with the articles of association as they stand, and, in my judgment, it is not, and therefore the Plaintiff is entitled to an injunction so far as relates to the payment of dividends’, per Stirling J.
The precise scope of the personal rights of shareholders is not completely clear. When we examined the rights of shareholders to sue to enforce provisions of the articles of association we saw that there is disagreement as to precisely which rights set out in the articles of association may be enforced as personal rights by shareholders (see Chapter 6). The importance of defining the strict legal rights of shareholders has been eclipsed by the availability of the very popular unfairly prejudicial conduct petition under s 994 of the Companies Act 2006, for which a very wide range of remedies may be granted by the court (see s 996). Section 994 petitions can be brought to protect the ‘interests’ of one or more shareholders. This concept of ‘interests’ is broader than ‘rights’ and therefore s 994 petitions can be successfully brought in fact situations in which no strict legal rights of a shareholder have been infringed. Section 994 petitions are examined in the next section of this chapter.
Confusion often arises where a given fact situation gives rise to both a right of the company to sue its directors and a right of the shareholder to sue the company. Examples are when directors abuse the power to allot shares, or allot shares without first respecting the pre-emption rights of existing shareholders. An improper exercise of powers is a breach of duty by the directors (s 171). It is a wrong done to the company for which the company can sue the directors for a remedy against the directors. It is also a breach of the articles of association and an individual shareholder can sue the company for acting inconsistently with the articles (through the agency of its directors). Re Sherborne Park Residents Co Ltd  2 BCC 99528 is just such a case. The report is of a hearing of a motion (a preliminary hearing for a specific order, here, an order for costs) in what would today be a s 994 case brought by an individual shareholder.
Re Sherborne Park Residents Co Ltd  2 BCC 99528
A shareholder in a residential leaseholders’ management company objected to a planned allotment of shares by the directors and commenced what would now be a s 994 unfairly prejudicial conduct petition. By notice of motion, the shareholder sought an indemnity for costs order against the company arguing that the action was a ‘derivative’ action because the facts complained of involved a breach of fiduciary duty by the directors. Held: The court declined to make the costs order. Hoffmann J stated that the allotment was alleged to be an improper and unlawful exercise of the powers granted to the board by the articles of association and that whilst this was a breach of directors’ duty owed to the company, the true basis of the action was that the alleged abuse of fiduciary powers was an infringement of the petitioner’s rights as a member under the articles. A shareholder in such an action might sue as representative of himself and other shareholders who had identical interests but he did not in substance assert a right which belonged to the company alone. In a derivative action, the only true claimant is the company. The availability in derivative claims of costs orders indemnifying a claimant against the costs of the action whether the action is won or lost, is based on the shareholder being in a relationship with the company analogous to agent and principal for the purpose of bringing the action. That was not the case here.
As explained in the introduction to this chapter, when a company suffers a loss which significantly diminishes its assets, shareholders are likely to experience a reduction in the value of their shares. If these losses are caused by a breach of duty owed to the company, the position is clear: the company is the proper claimant and can sue for the breach. The shareholder cannot sue because the duty is not owed to him. Where, however, in addition to the company being owed a duty, the shareholder is also owed a duty by the wrongdoer, the principle that the shareholder has no right to sue to recover purely ‘reflective loss’ comes into play and is referred to as the ‘no reflective loss principle’ (Day v Cook  1 BCLC 1).
Where there is a breach of a duty owed to both the company and the shareholder, if the shareholder’s loss is reflective loss, the shareholder cannot recover it because the company’s claim ‘will always trump that of the shareholder’ (per Arde, LJ in Day v Cook  1 BCLC 1). This is because otherwise double recovery (by the company and the shareholder) will occur, or, if the action were to be allowed on a first come first served basis, a shareholder could recover at the expense of the company. Lord Millett stated the justification for the principle succinctly in Johnson v Gore Wood & Co  2 AC 1 (HL), the leading case on reflective loss.
‘Justice to the defendant requires the exclusion of one claim or the other; protection of the interests of the company’s creditors requires that it is the company which is allowed to recover to the exclusion of the shareholder.’
In Johnson v Gore Wood (2001), Lord Bingham summarised the law in three principles:
Only one true exception appears to exists to the no reflective loss principle. Where the company is unable to pursue its claim against the defendant because of the defendant’s wrongdoing, a shareholder will be permitted to bring an action to recover reflective loss (Giles v Rhind  1 BCLC 1 (CA)).
Giles v Rhind  1 BCLC 1 (CA)
Giles and Rhind were the principal shareholders and directors of Surrey Hills Foods Ltd (SHF). Rhind, having sold his shares and left the company, in breach of an obligation of confidence owed both to the company and to Giles, set up a business in competition with SHF, caused the company’s major customer to move its business to his new company and thereby brought about the insolvency of SHF. SHF commenced proceedings against Rhind which it was unable to continue when it went into administrative receivership because it could not afford to provide security for the costs of the defendant as ordered by the court. The action was discontinued on the basis of a consent order by which SHF was precluded from bringing any further action against Rhind. Giles therefore commenced an action against Rhind seeking damages for breach of the obligation of confidence owed personally to him. He claimed, amongst other heads of damage, the diminution in the value of his shares in SHF. Rhind argued that this was reflective loss which was not recoverable based on the no reflective loss principle. Rhind won at first instance. Giles appealed. Held: The appeal was allowed. Giles could continue his action. Per Waller LJ, ‘Even in relation to that part of the claim for diminution which could be said to be reflective of the company’s loss, since, if the company had no cause of action to recover that loss the shareholder could bring a claim, the same should be true of a situation in which the wrongdoer has disabled the company from pursuing that cause of action’.
Although Giles v Rhind has been followed (see Perry v Day  2 BCLC 405), the Court of Appeal in Gardner v Parker  2 BCLC 554 has made it clear that the case is authority for a very narrow exception to the no reflective loss principle. Only if the company is unable to sue the wrongdoer ‘because of the very wrongdoing of which complaint was being made’, will a shareholder not be barred from recovering reflective loss.
The unfair prejudice petition in s 994 has existed since 1980 when it replaced an ‘oppressive behaviour’-based remedy introduced in 1948. Between 1948 and 1980 only a couple of cases were reported in which oppressive behaviour had been successfully established. The unfair prejudice petition allows petitions to be made based on a much wider range of fact situations and remedies are awarded in a far higher proportion of cases than under the predecessor section.
Consequently, s 994 petitions are extremely popular. Many petitioners now choose to seek relief pursuant to ss 994–996 who, prior to 1980, would have:
brought an action asserting a particular personal right, based on breach of contract, breach of duty or a statutory provision providing him with a cause of action;
commenced a common law derivative action to assert the rights of the company and thereby benefit personally indirectly from a remedy in favour of the company.
Lord Hoffmann has played a significant judicial role in the development of this statutory remedy. Three cases in particular stand out:
Re a Company (No 00477 of 1986)  BCLC 376, which makes it clear that in companies with certain characteristics the interests of shareholders protected by s 994 are not limited to their strict legal rights (see below);
Re Saul D Harrison & Sons plc  1 BCLC 14 (CA), which is an attempt to stem the tide of unfairly prejudicial conduct petitions;
O’Neill v Phillips  1 WLR 1092 (HL), which is the leading case settling the approach to be taken to determine whether or not conduct of the affairs of the company is or has been unfairly prejudicial to the petitioning shareholder(s) (see below).
The right to petition is set out in s 994(1).
‘994 (1) A member of a company may apply to the court by petition for an order under this Part on the ground –
that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or
that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.’