Beware Shareholder Litigation

Directors need to be prepared for the changes coming in from October 2007 explains Nigel Hanson.

IT WAS one of those dusty old principles that every law student had to know – the rule in Foss v Harbottle (1843).

Broadly it said that courts would not intervene in the internal management of a company if majority shareholders approved the company’s actions and disgruntled minority shareholders could not bring a claim on behalf of the company for a wrong done to the company.

Really wish you’d studied law now, right?

But the boffins’ favourite case is about to be jettisoned, sidelined by new rules in the Companies Act 2006. For the first time minority shareholders will be able to sue company directors on behalf of the company: so-called “derivative” claims.

Unfortunately the new law, which comes into force in October, could create new worries for hardworking boardroom executives. Minority shareholders will be able to sue directors for wrongdoing against the company, including for breach of duty.

Directors’ new statutory duties, as listed in the Act, are extensive. They include the duty to promote the success of the company for the benefit of the shareholders, to exercise reasonable care, skill and diligence, and to declare an interest in any proposed transaction.

In promoting the success of the company, directors will also be under a duty to have regard to such things as “the impact of the company’s operations on the community and the environment” and “the interests of the company’s employees”.

Former, and shadow directors are also potentially liable.

A shareholder who is concerned, for example, about a company’s controversial record on pollution could bring an action against directors for pursuing a damaging environmental strategy.
Such a claim would be brought by a shareholder on behalf of the company, with damages payable to the company for the benefit of shareholders as a whole.

A further concern is that a claimant does not need to have been a shareholder at the time when alleged wrongdoing occurred. Conceivably, people might buy shares with the sole aim of suing directors.

But directors will find comfort in a number of procedural safeguards in the Act aimed at deterring gung-ho litigation by vexatious claimants or unreasonably militant shareholders.

Any shareholder bringing a claim risks being ordered to pay substantial costs if unsuccessful, and must first obtain the court’s permission to bring an action, by providing evidence of an answerable case.

When deciding whether to give permission, the court will need to consider factors such as whether the shareholder is acting in good faith, whether the director’s conduct could be ratified by the company, and any evidence as to the views of other shareholders who have no personal interest in the matter.

Claims where there’s been no commercial harm to the company, or without merit, will be dismissed without any company involvement.

Nevertheless, wise directors should ensure their insurance covers them against shareholders’ “derivative” claims, and cover their backs by recording reasons for their decisions to show they have properly discharged their duties.


































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