Shareholders bringing derivative claims against directors face significant challenges

Published 4 mayo 2021

The case of Hughes v Burley and others [2021] EWHC 104 (Ch) provides a useful illustration of the challenges facing shareholders in obtaining permission to pursue derivative claims against directors, particularly where the claim may be of limited interest to the company (as opposed to the shareholders). From a D&O insurance perspective, the decision highlights the need for directors and D&O insurers to give careful consideration to the capacity in which the director was acting when carrying out the actions which are subject to the derivative claim. 

In Hughes, the High Court refused permission to a shareholder to pursue a derivative claim against a company director. The Court considered some of the proposed claims were not unarguable but declined to grant permission for the claim to proceed on the grounds that the Claimant had not shown that he was able to fund the litigation or meet an adverse costs order.

Derivative claims

A derivative claim is an action brought by a shareholder against the company’s director(s) seeking redress on behalf of the company for a wrong committed by the director(s). If successful, the relief is granted and any damages are awarded in favour of the company as opposed to the shareholder.

Section 260(3) of the Companies Act 2006 provides that a 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 a company. Permission of the court is required in order to pursue a derivative action. 

Facts

A property development company (the “Company”) was established by Mr Hughes and Mr Burley, who were directors and equal shareholders. Mr Burley provided a loan to the Company that was secured over properties acquired by the Company. The relationship between Mr Hughes and Mr Burley broke down. Mr Burley appointed an independent receiver over the properties. The receiver sold the properties to a separate company owned by Mr Burley without obtaining formal valuations. 

Mr Hughes sought permission to pursue several derivative claims on behalf of the Company. His arguments included that:

• Mr Burley owed a duty of good faith to Mr Hughes as a result of a joint venture agreement between them. Mr Hughes argued that the Company could rely on these contractual terms and enforce them directly against Mr Burley, in turn enabling Mr Hughes to bring a derivative claim.
• As director, Mr Burley owed fiduciary and statutory duties to the Company and had breached those duties.
• The receiver breached a duty to act equitably when marketing and selling the properties without obtaining valuations.

Decision

The Court had to consider whether to grant permission to Mr Hughes to bring the derivative claim against Mr Burley on behalf of the Company. The Judge considered that Mr Hughes’ claims were speculative but not unarguable but refused permission to allow the claim to proceed. Mr Hughes had not indemnified the Company in respect of costs and had not shown that he was able to fund the litigation or meet an adverse costs order. Further, the objective of advancing the claim was primarily for the benefit of Mr Hughes and not the Company. On this basis, the Judge exercised his discretion not to permit the claim to advance.

Analysis

There was concern that the derivative action procedure, provided for in the Companies Act 2006, would prompt a large number of claims (including unmeritorious claims) for breach of directors’ duties. That concern has not transpired and there have been few reported cases of derivative actions. The requirement to obtain the court's permission to proceed with a derivative action provides a procedural filter that protects against spurious derivative claims. The courts will be cautious before allowing a shareholder to commit the company to potentially expensive litigation, particularly if the member is really trying to advance their own interests.

A reminder to D&O Insurers to consider the capacity in which the director was acting

The judgment in Hughes v Burley contains comments from Mr Justice Pearce of interest to directors and D&O insurers. 

1. The Judge suggested that a derivative claim may be available in relation to acts which a director commits outside of their role as director. The Judge noted that if the Claimant’s case was made out both in fact and in law, it was strongly arguable that the duties in respect of which the derivative claim was pursued arose from Mr Burley’s role as co-venturer with Mr Hughes and not as director. From a D&O insurance standpoint, this would have raised the question as to whether the alleged wrongful acts of Mr Burley were in his capacity as director. As D&O insurance policies typically restrict cover to a person acting in their capacity as a director, this case serves as a useful reminder to directors and D&O insurers to carefully consider the capacity in which the director was acting when conducting the activity which forms the basis of the claim. 
2. The Judge rejected the defendants’ submission that a breach of contract was not a ‘breach of duty’ as provided for in section 260(3) of the Companies Act 2006. In his view, a breach of contract is a breach of duty, the duty being one that arises under contract. On this basis, the Judge considered that, in principle, it is possible to base a derivative claim on a director’s breach of contract. Although this helpfully clarifies this area of law, it does not create any unusual issues under civil liability based D&O policies.