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Franbar Holdings Limited –v- Patel and Others

Directors’ duties are owed to the Company and only the Company is able to enforce them, although in certain circumstances shareholders may be able to bring a Derivative Action to enforce a course of action vested in the Company on the Company’s behalf.

The Companies Act 2006 introduced a new Derivative Procedure to replace the common law action in respect of claims on or after the 1 October 2007.

However an action may only be brought in respect of an act or proposed act or omission involving negligence, default, breach of duty or breach of trust by a Director of the Company as well as in respect of an alleged breach of the general duties of Directors including the duty to exercise reasonable care, skill and diligence.  There is no requirement for a Director to have benefited personally from the breach, as was previously the case.

However the court must refuse permission for a claimant to bring a derivative claim where it is satisfied that either:

A person acting in accordance with the general duty to promote the success of the Company would not seek to continue the claim.

In this recent High Court case M Limited was wholly owned by F Limited.  At the end of July 2005 F Limited sold 75% of the shares in M Limited to C Limited.  At the same time F Limited and C Limited entered into a shareholders’ agreement which, among other matters, granted F Limited an option to sell the remaining shares in M Limited to C Limited and granted C Limited to call for those shares, in each case at the price of 9 times M Limited’s adjusted earnings.

Disputes arose between the parties.  F Limited issued proceedings and the complaints related to the diversion of business opportunities from M Limited to C Limited, a suspension of an appointed person as a Director of F Limited and a failure to provide adequate financial information including the audited Management Accounts.  F Limited made a number of applications to the court, one of which was an application for permission to continue a derivative claim by the members.

The High Court refused the application under Section 261 of the Companies Act for permission to continue with a derivative claim. 

Whilst there was substance in the complaints which had been made by F Limited and that some of those complaints would, if established, give rise to breaches of duty which were incapable of ratification.  There was work still to be done in formulating a clear claim for breaches which had caused actionable loss to M Limited, and it would be open to a hypothetical Director to decline to proceed with the derivative claim at this stage.  While he might attach importance to its continuation in the future, it was not possible to be satisfied that he would do so now.  Considerable weight was given to the fact that F Limited should be able to achieve all that it could properly want through a petition under Section 994 of the Companies Act 2006 and a shareholders action rather than a derivative action.

This is one of the first reported decisions in which the statutory derivative action provisions have been considered. The court has made it clear that derivative actions cannot be a panacea. Perspective litigants must therefore consider other options first.

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Notes to Editors

Pearson Hinchliffe Commercial Law is a commercial law practice providing a range of legal services to business and commercial clients in Oldham and across the North West. The firm's specialities include Company & Commercial, Employment Law, Commercial Litigation and Commercial Property matters.

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