Shareholder Protection: Derivative Proceedings

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Questions and Answers

What is the primary purpose of derivative proceedings?

  • To bring legal action on behalf of the company (correct)
  • To secure personal financial gain for shareholders
  • To facilitate the exclusion of certain members from management
  • To allow shareholders to vote on management decisions

What is a common ground for initiating derivative proceedings?

  • A successful business merger
  • A minor disagreement within management
  • A justifiable loss of confidence in the company’s management (correct)
  • An increase in dividend payouts

Which legal case established the rule in Foss v Harbottle?

  • Salomon v Salomon & Co Ltd
  • Daborn v Bath Tramways Motor Co
  • Foss v Harbottle (correct)
  • Westmeston v Wellcome

What does the proper claimant principle state?

<p>The company is the primary entity entitled to make claims for wrongs against it (C)</p> Signup and view all the answers

Under what condition can individuals pursue claims despite the majority rule principle?

<p>In the case of transactions requiring a special majority (C)</p> Signup and view all the answers

What is NOT a ground that would typically warrant derivative proceedings?

<p>A minor internal disagreement about policy (B)</p> Signup and view all the answers

In which scenario might a company NOT take action against its directors?

<p>When directors are insiders controlling company affairs (B)</p> Signup and view all the answers

Which of the following best describes the term 'ultra vires'?

<p>Transactions conducted beyond the company's authorized powers (B)</p> Signup and view all the answers

What happens to any sums recovered as a result of derivative proceedings?

<p>They belong to the company, not the individual shareholders (A)</p> Signup and view all the answers

Which principle states that a corporation cannot take action against a majority-approved transaction?

<p>The Majority Rule Principle (A)</p> Signup and view all the answers

What must a person have in order to bring a derivative claim under the Companies Act 2006?

<p>Membership in the company at the time of the incident (B)</p> Signup and view all the answers

Which of the following is NOT a condition under the mandatory test for derivative proceedings?

<p>Permission granted by the company’s board of directors (C)</p> Signup and view all the answers

What is a key element the discretionary test considers when evaluating a derivative proceeding?

<p>Whether the claim would benefit the company as a whole (B)</p> Signup and view all the answers

If a derivative proceeding does not proceed due to court discretion, which of the following is a valid reason?

<p>The court believes the claim could be pursued individually by the member (D)</p> Signup and view all the answers

Under which section of the Companies Act 2006 can one find procedures related to derivative claims in Scotland?

<p>ss265-269 (A)</p> Signup and view all the answers

In the case that ratification occurs regarding a director's conduct amounting to negligence, which section governs this?

<p>s239(1) (A)</p> Signup and view all the answers

What is required from a member before a derivative proceeding can be initiated, according to the prima facie test?

<p>A clear prima facie case (A)</p> Signup and view all the answers

Which of the following individuals may NOT bring a derivative claim against a director?

<p>A former director of the company (A)</p> Signup and view all the answers

What does a Wallensteiner order allow a company to do in response to derivative proceedings?

<p>Indemnify the shareholder for their legal costs (D)</p> Signup and view all the answers

Which of the following scenarios would prevent a derivative proceeding from being permitted?

<p>The claim could have been pursued individually by the member (D)</p> Signup and view all the answers

The sole purpose of derivative proceedings is to benefit individual shareholders financially.

<p>False (B)</p> Signup and view all the answers

A shareholder can initiate derivative proceedings even if the company’s management is fully in agreement.

<p>False (B)</p> Signup and view all the answers

A common ground for petitioning derivative proceedings is justifiable loss of confidence in the company’s management.

<p>True (A)</p> Signup and view all the answers

The majority rule principle allows individual shareholders to challenge majority-approved transactions regularly.

<p>False (B)</p> Signup and view all the answers

Derivative proceedings can lead to recovery sums being awarded directly to individual shareholders.

<p>False (B)</p> Signup and view all the answers

The rule in Foss v Harbottle allows shareholders to act independently against the company’s management.

<p>False (B)</p> Signup and view all the answers

Fraud is a valid ground for initiating derivative proceedings.

<p>True (A)</p> Signup and view all the answers

The exceptions to the rule in Foss v Harbottle include ultra vires transactions.

<p>True (A)</p> Signup and view all the answers

Shareholders can bring derivative claims for personal infringements of their rights when those infringements do not affect the company’s welfare.

<p>False (B)</p> Signup and view all the answers

Derivative proceedings originated from equitable principles.

<p>False (B)</p> Signup and view all the answers

A derivative claim can be brought against any former member of the company regardless of when the cause of action arose.

<p>False (B)</p> Signup and view all the answers

Permission from the court is required in Scotland to raise derivative proceedings after the claim has been initiated.

<p>False (B)</p> Signup and view all the answers

If the court is satisfied that the claim is likely to be continued by a person acting in accordance with s172, permission for the derivative claim must be granted.

<p>True (A)</p> Signup and view all the answers

Derivative proceedings must be brought by at least two shareholders of the company for them to be valid.

<p>False (B)</p> Signup and view all the answers

A derivative claim can arise from an act or omission that is still to occur, provided it has been authorized by the company.

<p>True (A)</p> Signup and view all the answers

Compensation awarded from derivative proceedings goes directly to the pursuing member who initiated the claim.

<p>False (B)</p> Signup and view all the answers

The discretionary test for derivative proceedings assesses whether the member is acting in bad faith.

<p>False (B)</p> Signup and view all the answers

In England, a shareholder must seek leave from the court to continue a derivative claim after it has been initiated.

<p>True (A)</p> Signup and view all the answers

The prima facie test ensures there is a valid claim before proceeding with derivative actions.

<p>True (A)</p> Signup and view all the answers

If a director's actions have been ratified by the company, derivative proceedings are still permissible.

<p>False (B)</p> Signup and view all the answers

Flashcards

Derivative Proceedings

A shareholder can sue on behalf of the company in court, seeking remedies for the company's wrongdoings.

Proper Claimant Principle

Usually, a company itself should sue for its own wrongs.

Foss v Harbottle

A legal case establishing the 'proper claimant principle' for company lawsuits.

Unfair Prejudice Remedy

A legal recourse available to shareholders if their interests are harmed by company decisions.

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Majority Rule

Ordinary company decisions made by a simple majority are not subject to derivative proceedings.

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Special Majority

Certain company decisions require a higher level of agreement.

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Ultra Vires

Actions exceeding a company's legal authority.

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Personal Claims

Shareholders can sue regarding personal rights violations.

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Fraud

Intentional deception or dishonesty carried out by one or more people.

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Deadlock

A situation where a company cannot act due to disagreement among stakeholders.

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Derivative Claim

A legal action brought by a shareholder on behalf of a company against a third party (often a director) when the company itself fails to act.

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Companies Act 2006, Part 11

The UK law that establishes the procedure for derivative claims, specifically in England and Wales & Scotland (s.260-269).

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Prima Facie Case

A preliminary showing that there's a credible basis for a legal claim.

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Mandatory Test (s263(2)/268(1))

Specific conditions that must be met for a court to allow a derivative claim; If met, court must REFUSE permission.

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Discretionary Test

The test that a court must use if the mandatory conditions aren't met; the court considers factors like good faith and company's decision to handle the claim.

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Ratification (s239(1))

Formal approval of a past company act/omission that was previously not ratified.

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Wallensteiner Order

A legal principle allowing a company to indemnify (reimburse) a shareholder for costs if the derivative claim was reasonable.

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Shareholder Qualification

Only current (not former) company members can bring derivative actions.

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Director Negligence

The basis for a derivative claim; arises when directors act negligently, breach a duty, or breach a trust related to the company.

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Derivative claim grounds

Negligence, default, breach of duty or breach of trust by directors (including former, shadow, and de facto directors).

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What is a derivative proceeding?

A lawsuit brought by a shareholder on behalf of the company against wrongdoers, usually directors, when the company itself fails to take action.

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Why are derivative proceedings necessary?

To protect the company's interests when directors breach their duties or act improperly, and the company itself is unwilling or unable to sue.

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Who can bring a derivative proceeding?

Only current members of the company, regardless of when the wrongdoing occurred.

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What are the grounds for bringing a derivative proceeding?

A cause of action must arise from director negligence, default, breach of duty, or breach of trust.

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Foss v Harbottle Rule

A legal precedent establishing that companies, not individual shareholders, are the proper claimants in legal actions, unless specific exceptions apply.

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What is the 'no director test'?

A mandatory test for derivative proceedings: permission is refused if a director acting in the company's best interests wouldn't pursue the claim.

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What is ratification?

The company officially approves a director's past actions, even if they were negligent or breached a duty.

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Exceptions to Foss v Harbottle

Certain situations allow shareholders to bring derivative proceedings, such as transactions requiring a special majority, ultra vires acts, or infringement of shareholder rights.

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What is the discretionary test?

If mandatory tests fail, the court considers factors like good faith and the company's willingness to act.

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What is a Wallensteiner order?

A court order that allows the company to reimburse the shareholder for their costs in bringing a derivative proceeding.

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What is the 'prima facie' test?

The initial step where the court determines if the shareholder has a credible case.

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Grounds for Derivative Proceedings

Reasons why a shareholder might initiate derivative proceedings, including fraud, deadlock, mismanagement, or exclusion from management.

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What is the 'ultimate purpose' of a derivative proceeding?

To recover losses for the company, not benefit the shareholder personally.

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Study Notes

Shareholder Protection: Derivative Proceedings

  • Derivative proceedings allow shareholders to sue on behalf of the company, seeking remedies for corporate wrongs. Any recovery goes to the company, not the shareholder.

Common Grounds for Derivative Proceedings

  • Failed commercial purpose of the company
  • Fraudulent activities
  • Deadlock within the company
  • Loss of confidence in management
  • Exclusion from management

Historical Basis (Common Law)

  • Foss v Harbottle: The company itself is the proper claimant in most cases of corporate wrongs.
  • Proper claimant principle: The company should take action against wrongdoers. However, if insiders control the company's actions, there may be difficulty in the company taking action.
  • Majority rule principle: No individual shareholder can bring an action for a corporate issue that could be decided by a simple majority vote.

Exceptions to Foss v Harbottle

  • Transactions requiring special majorities
  • Ultra vires (beyond the company's powers) or illegal transactions
  • Personal claims of shareholders (e.g., infringements of voting rights)
  • Fraud on minority shareholders (requires fraud, wrongdoers controlling, a majority of non-controlled shareholders agreeing, clean hands, and proper corporate purpose)
  • Common law derivative actions are complex.

Statutory Derivative Proceedings (Companies Act 2006)

  • Statutory procedure: Companies Act 2006, Part 11, sections 260-269 provide a streamlined process for England and Wales / Scotland.
  • England: Shareholders can initiate claims but need court permission to continue.
  • Scotland: Court permission is needed to initiate and continue a claim.
  • Eligibility: Claims must involve director negligence, default, breach of duty, or breach of trust. Applies to former and shadow directors as well.
    • Only current shareholders can bring the action. Former members are excluded.

Example Scenarios

  • Jane, Bob, and Carol: Alex, a shareholder, can bring a derivative action against Jane and Bob if they breached duty and caused company loss.
  • Alex joining after the scheme: Alex can still pursue the derivative action if he joined after discovery but before the full financial loss is realized.
  • Sam joining: Since Sam is a former shareholder, they cannot join Alex's action.

Stages of Derivative Proceedings

  • Stage 1 (Prima Facie Test): Does the applicant have a valid claim? If not, the action ends. A passing score lets the court demand evidence from the company.
  • Stage 2 (Mandatory Test): Are any of the conditions in s263(2)/268(1) met?

    • If 'no director test', or action authorized or ratified by the company, the action ends.

    • If not met, go to stage 3.

  • Stage 3 (Discretionary Test): Consider factors like shareholder good faith, company's decision not to pursue, the possibility of separate recourse, etc.
    • Permission to continue or refusal to continue.

Mandatory Test (s263(2)/268(1))

  • The shareholder's action wouldn't be pursued by a director in accordance with their duty.
  • The cause of action is (or was) authorized or ratified by the company.

Discretionary Test (s263(4)/268(3))

  • Consider the shareholder's good faith.
  • Company's likely stance.
  • If the claim is for a future act, would the company authorize (or ratify) it.
  • If the act has occurred, has it likely been authorized or ratified by the company?
  • Has the company decided not to pursue the claim?
  • Could the member pursue the same cause of action in their own right without derivate claim?
  • Shareholder seeking court approval will need to provide evidence of the view of non-interested members of the company

Costs & Financial Considerations

  • Compensation: Awards go to the company, but shareholders can recover legal costs.
  • Indemnity (Wallensteiner Order): The company may have to indemnify shareholder's costs if they have a reasonable claim.
  • Scotland (Wishart v Castlecroft): Similar principles for costs.

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