What is a derivative action?

Derivative actions allow shareholders to initiate proceedings on behalf of the company against directors or third parties. These actions address wrongs done to the company that the company itself fails to redress. 

Derivative actions are distinct from personal actions brought by shareholders. In a derivative action, the cause of action belongs to the company, not the individual shareholder. This mechanism is designed to address situations where those in control of the company, typically the directors, refuse to take action against themselves or others for misconduct that harms the company.

Reasons for bringing a derivative claim

Shareholders can bring a claim against the directors of the company for a number of reasons including:

Breach of fiduciary duty

Fiduciary duties are legal obligations that require directors to act in the best interests of the company and its shareholders. Examples of this type of breach include:

Self-dealing and conflict of interest:

A director enters into a contract with the company in which they have a personal interest without disclosure. For instance, awarding a contract to a company they own.

Misuse of company property:

A director uses company assets for personal gain, like using company funds to renovate their own home.

Negligence

Failure to exercise due care:

Directors make decisions without proper consideration, leading to financial losses. For example, investing in a speculative venture without adequate risk assessment.

Ignoring professional advice:

A director disregards expert advice, resulting in detrimental consequences for the company.

Breach of trust

Diversion of business opportunities:

Directors exploit business opportunities meant for the company for personal benefit.

Unapproved Transactions:

Directors engage in significant transactions without proper authorisation or shareholder approval.

Fraudulent Conduct

Falsification of accounts:

A director falsifies company accounts to conceal poor performance or embezzlement.

Fraudulent concealment of information:

Directors withhold critical information from the board or shareholders that impacts decision-making.

Breach of statutory duty

Failure to comply with legal obligations:

Directors neglect duties like filing annual returns, resulting in penalties or reputational damage.

Environmental and health violations:

Directors fail to adhere to environmental or health and safety laws, causing legal actions against the company.

Bringing a derivative action

The Companies Act 2006 codifies the process for bringing derivative actions under Sections 260 to 264. The Act outlines the conditions under which a derivative claim may be brought, the procedure to be followed, and the factors the court must consider when granting permission to proceed with the claim.

Before the enactment of the Companies Act 2006, derivative actions were governed by common law principles. The Foss v Harbottle rule established that only the company itself could sue for wrongs done to it, with limited exceptions. 

Under Section 260, a derivative claim can only be brought by a member of the company. This includes shareholders and, in certain circumstances, those with a beneficial interest in shares.

The Act specifies that a derivative claim can be brought for an actual or proposed act or omission involving negligence, default, breach of duty, or breach of trust by a director of the company.

A crucial aspect of bringing a derivative action is the court granting permission to do so. The application for permission involves a two-stage process:

• Prima Facie Case: Initially, the court will assess whether there is a prima facie case for the derivative claim. If the shareholder fails to establish this, the claim is dismissed without further hearing.
• Full Hearing: If a prima facie case is established, a full hearing is conducted where the court considers various factors, including the good faith of the shareholder, the views of independent shareholders, and whether the act or omission in question could be ratified by the company.

How can ARC Cost assist?

ARC Costs maintains an extensive legal network of expert commercial litigation solicitors with a track record of success on these types of cases. We would be happy to pass on your details to assist in your case. 

In addition to introducing you to a solicitor, we can also assist in the recovery and negotiation of legal costs in shareholder dispute cases, whether you are the paying or receiving party.

ARC Costs are highly experienced in advising and assisting with costs issues and disputes in different areas of law. As Costs Draftsman and Costs Lawyers, we can assist you with your commercial litigation costs issues.

Should you wish to discuss your costs query with us, please contact us on 01204 397302 or via email at info@arccosts.co.uk. Alternatively, you can complete our online query form, and we will contact you to discuss your query further. We can provide expert legal advice on costs in our free, no obligation initial consultation.

We may receive payments from third party solicitors on our panel to whom we may refer your claim. We will never charge you for any referrals made to our panel of third parties.