Derivative Claims - Exam questions and corrections from University of London on the detailed chapiter. PDF

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COMPANY – Q – DERIVATIVE CLAIMDerivative Claims 2016 A-Q7-pbm q (personal claim sh toward director)/B-Q2017 A-Q8-pbm q B-Q1-essay2018 A-Q3-essay B-Q1-essay2019 A-Q5-pbm q (focus on permission stage) B-Q8-pbm q (permission stage + reflective loss)2017 – B – Q ‘The reforms to derivative claims in Part...

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COMPANY – Q – DERIVATIVE CLAIM Derivative Claims

2016 A-Q7-pbm q (personal claim sh toward director)/B-Q7 2017 A-Q8-pbm q B-Q1-essay 2018 A-Q3-essay B-Q1-essay 2019 A-Q5-pbm q (focus on permission stage) B-Q8-pbm q (permission stage + reflective loss)

2017 – B – Q1 ‘The reforms to derivative claims in Part 11 of the Companies Act 2006 have done little to improve the effectiveness of such claims.’ Discuss 2018 – A – Q3 ‘Derivative claims are an ineffective means of enforcing directors’ duties. It would be better if the law allowed any shareholder to bring a personal action, for her own benefit, against a director who has breached her duties to the company.’ Discuss. 2018 – B – Q1 Do the rules governing derivative claims require reform and, if so, how? 2016 – A – Q7 In January 2016, the directors of Superbank Plc decided that Superbank¶should acquire Readyloans Ltd. Superbank’s directors called a meeting of¶Superbank’s shareholders to approve the proposed acquisition. ¶At the meeting, a number of shareholders, including Arthur, strongly opposed¶the acquisition, claiming the price being paid for Readyloans was too high.¶The directors reassured the shareholders that they had investigated¶Readyloans very carefully, and that it was worth far more than the price¶Superbank was paying to acquire it. A majority of shareholders then voted to¶approve the purchase, although a substantial number of shareholders,¶including Arthur, voted against.The directors, who together own 10% of¶Superbank’s shares, voted to approve the purchase.¶ By May 2016 it was clear that Readyloans was worth much less than the price¶Superbank paid to acquire it. Superbank’s shares have fallen massively in¶value. The directors of Superbank accept they were negligent in failing to¶appreciate the true value of Readyloans.¶ Advise Arthur whether:

¶a) he could bring a personal action against the directors for the fall in¶the value of his shares; and¶ b) if he began a derivative claim against the directors, he would be¶likely to be given permission to continue that claim.¶ 2017 – A – Q8 Fiona is a director of Lastlines Ltd. Fiona owns 40% of the shares in the company. Her mother, Evelyn, owns 10%. Two months ago, Fiona forgot to¶renew the insurance policy for the company’s offices. The offices burned¶down and the company lost £5 million. Fiona accepts that she breached her¶duty of care, skill and diligence. However, a board meeting of Lastlines was¶held, and it decided that Fiona’s mistake was a one-off and that, in view of¶section 1157 Companies Act 2006, there would be no point taking any action¶against her.¶ One month ago, David, who is Fiona’s former husband, and who still owns 5%¶of the shares in Lastlines, wrote to the board demanding that Fiona be sued¶for her incompetence. In response, Lastlines’ board called a shareholders’¶meeting, which voted to ratify any breach of duty by Fiona. Fiona and Evelyn¶both attended and voted at that shareholders’ meeting. When David tried to¶attend and vote at the meeting, the Chairperson of the meeting declared that¶David was not acting in the company’s best interests, and ejected him from¶the meeting.¶ David wants to bring a derivative claim against Fiona but wonders whether, if¶he did so, he would be given permission to continue that claim. He also¶wonders who would pay the legal costs in bringing such a claim. ¶Advise David.¶ 2019 – A- Q5¶ Mary is a director of Fastways Plc. In May 2018, she negligently forgot to renew the company’s insurance policies. Shortly thereafter, one of Fastways’ factories burned down. Fastways suffered a loss of £1 million as a result. John used to be married to Mary. In February 2019, he bought 2 per cent of the shares in Fastways. He then contacted Fastways board of directors and demanded that Fastways sue Mary for the loss Fastways suffered as a result of Mary’s negligence. Fastways’ board met and decided that it would not be in Fastways’ interests to sue Mary. The board noted that Fastways’ independent non-executive directors had already recommended that no action should be taken against her. The board also noted that Fastways’ main customer, Eggtops Ltd, is owned by Mary’s brother and would probably cease doing business with Fastways if Fastways sued Mary. Fastways board also called a shareholders’ meeting. The meeting passed a resolution to ‘excuse Mary for her mistake’. Mary’s mother, Sally, who owns 30% of Fastways’ shares, voted in favour of the resolution. John has now begun a derivative claim against Mary and Sally. Advise him whether he is likely to be given permission to continue that claim against each of them.

2019 – B – Q8 George owns 70 per cent of the shares of Beasties Ltd. Henry, Joan and Fiona each own 10 per cent of the shares of Beasties Ltd. The four shareholders are the company’s only

directors. Fiona has also lent Beasties £100,000. Under a personal guarantee, George personally promised Fiona to repay that loan to her if Beasties fails to do so. In 2018, George made a series of negligent decisions which caused substantial losses for Beasties. The company is now on the verge of insolvency, Fiona’s shares are almost worthless, and the company is unable to repay her loan. Fiona demands that Beasties sue George. However, the directors vote not to take any action. A shareholders’ meeting, attended by all the shareholders, passes a resolution to ratify George’s breaches of duty. Only Fiona votes against. Advise Fiona whether: a) if she started a derivative claim against George, she would be likely to be given permission to continue that claim; and b) could personally claim against George, both for the drop in the value of her shares and to enforce the personal guarantee in respect of the loan. [Do NOT discuss section 994 Companies Act 2006 or section 122(1)(g) Insolvency Act 1986 in your answer to part (b).]

2017 – B – Q1 ‘The reforms to derivative claims in Part 11 of the Companies Act 2006 have done little to improve the effectiveness of such claims.’ Discuss General remarks¶ This question required discussion of the new procedure for bringing derivative claims, found in¶Part 11 Companies Act 2006. It required students to explain what that procedure is and to explain¶how this ‘statutory claim’ differs from its common law predecessor. Finally, having explained the¶differences, the question requires a student to evaluate the impact of the changes that have been¶made. Have they improved the derivative claim? If so, how – in what ways? Have they failed to¶address outstanding problems that existed at common law? Law cases, reports and other references the examiners would expect you to use ¶Relevant cases here: Prudential Assurance v Newman; Franbar Holdings v Patel;¶Iesini v Westrip Holdings Ltd; Kleanthous v Paphitis; Mission Capital plc v Sinclair;¶Wishart v Castlecroft Securities Ltd; Wallersteiner v Moir (No.2); Smith v Croft;¶Bhullar v Bhullar; Re Fort Gilkicker Ltd and Abouraya v Sigmund.¶ Common errors¶ A common error was a failure to answer the question asked. Some students simply¶described, in very general terms, what derivative claims are, but failed to explain in¶just what ways, and to what extent, the rules under Part 11 differ from the¶corresponding common law rules governing derivative actions.¶Likewise, even where students did explain changes that were made in introducing¶the statutory claim under Part 11, many students failed to ask whether these¶changes improved matters or made them worse and whether or not we can now¶say, in light of the changes, that the derivative claim has become effective.¶ A good answer to this question would…¶ explain the introduction of the statutory derivative claim in Part 11 CA 2006 to¶replace the previous common law action. Note the intention behind this change –¶improving accessibility and clarity of the law; also arguably broadening the¶circumstances when such claims can be brought. Note the removal of the ‘fraud’¶requirement and, probably, of wrongdoer control. Note the clearer articulation of a¶‘permission to continue’ requirement, in ss.262 and 263.¶A good answer might analyse the criteria for determining if permission is to be¶granted and show whether these conditions are unduly restrictive of the claimant’s¶ability to proceed. A good answer would offer some analysis of relevant case law, to¶show how the courts are interpreting and applying these criteria – whether for¶example they are interpreting them strictly, or more favourably towards claimants. A¶good answer might also try to give a sense of what proportion of claims that are¶started are actually given permission to continue (around 40 per cent or less).¶A good answer might also note continuing uncertainty within the law, especially due¶to the failure to replace entirely the old case law, e.g. in respect of which breaches¶of duty can be authorised/ratified (s.239(7)), and in respect of so-called ‘multiple’¶derivative claims. ¶Poor answers to this question…¶ did not focus on the question asked. They spent too long talking generally around the rule in¶Foss, and all the supposed exceptions to Foss, before eventually turning to mention

derivative¶claims. Poorer answers would then often give a very superficial account of the statutory action,¶going into little depth about the rules found in Part 11 and, worse, saying nothing about how the¶new rules differ from the common law rules. Finally, poorer answers usually made little attempt to¶evaluate the new rules or to offer an opinion about whether the new statutory action is effective.¶ 2018 – A – Q3 ‘Derivative claims are an ineffective means of enforcing directors’ duties. It would be better if the law allowed any shareholder to bring a personal action, for her own benefit, against a director who has breached her duties to the company.’ Discuss. General remarks¶ This question relates to Chapter 11 of the module guide. It requires discussion of¶two ‘claims’ made by the question. First, is it true that derivative claims are¶ineffective? Second, would it be better to permit each shareholder to bring a¶personal action? It’s important to understand what the question means when it talks¶about shareholders bringing a personal action against the director – see below.¶ Law cases, reports and other references the examiners would expect you to use¶ Relevant cases on derivative claims include: Franbar Holdings v Patel; Iesini v¶Westrip Holdings Ltd; Kleanthous v Paphitis; Mission Capital Plc v Sinclair; Wishart¶v Castlecroft Securities Ltd; Wallersteiner v Moir (No.2); Smith v Croft; Bhullar v¶Bhullar. On a personal action against a director, relevant case law includes: Sharp v¶Blank; Peskin v Anderson; Giles v Rhind.¶ Common errors¶ Students tended to be much better at discussing derivative claims than discussing¶the personal action against a director. On the latter, many students discussed an¶action under s.994. That is not, strictly speaking, a personal action against a¶director. However, some credit was usually given for such discussion, since these¶are certainly ‘personal actions’. ¶A good answer to this question would…¶ explain the nature of a derivative claim, and the purpose behind it - permitting a¶shareholder to sue a director for breach where the company itself is unwilling to¶sue. It would describe the main rules governing the statutory derivative claim in Part¶11 CA 2006, showing the conditions which must be satisfied for a shareholder to¶bring such a claim. It might note that some of these conditions have been relaxed in¶the new statutory derivative claim, compared to the old common law action, such as¶the abandonment of the requirement to demonstrate ‘fraud’, and perhaps the¶requirement to show wrongdoer control. It would also note, however, how the¶claimant must still secure permission to continue the claim, and would analyse the¶criteria (in s.263(2) and (3)) that the courts apply in deciding whether or not to give¶such permission. Such analysis should include some discussion of the relevant¶case law, such as Iesini, Franbar, Kleanthous, Singh, Wishart etc. to show how the¶courts actually apply the statutory criteria – whether for example the courts are¶interpreting them strictly, or more favourably, towards claimants. A good answer¶might also try to give a sense of what proportion of claims that are started are¶actually given permission to continue (less than

half).A good answer might also note some of the more practical problems that undermine¶the effectiveness of derivative claims – especially the ‘collective action’ problem, the¶risk of ‘free riding’, the lack of an effective incentive for any individual shareholder to¶sue, and so on.¶That could provide a good link into the second part of the question, asking whether¶the derivative claim should be replaced with personal actions against directors for¶breach of their duties. A good answer might say something about how UK company¶law currently deals with such actions – that they are effectively precluded, both¶through the rule that the duties of directors are owed to the company alone¶(Percival v Wright; s.170(1)) and by the rule that precludes a personal action for¶‘reflective loss’.¶The reasons for UK law’s current restrictions on such personal actions might be¶considered and evaluated – such as avoiding the ‘floodgates’ problem of multiple¶actions from a single breach of duty; ensuring some sharing amongst all¶shareholders of whatever money a director has (where the director cannot afford to¶fully compensate for the harm she has caused, and multiple personal actions would¶result in those who sue first securing full compensation, but those who sue later¶receiving nothing); upholding ‘majority rule’; ensuring the normal priority of creditors¶is protected (and perhaps link this to the criticism of the decision in Giles v Rhind).¶ Poor answers to this question… ¶tended only to address derivative claims, with nothing to say about personal claims¶against directors. Those that did address personal claims tended just to describe¶s.994, and the case law on that. But an action under s.994 is not, strictly speaking,¶an action against a director. Moreover, note that the question is not asking ‘can a¶shareholder bring a personal action against a director?’ but rather ‘should a¶shareholder be able to bring a personal action against a director?’ It needs some¶discussion of the pros and cons of allowing such personal claims. ¶Student extract¶ Under s260, a member may bring a derivative claim in respect of any claim a¶member may have against a director in order to seek relief on behalf of the¶company.¶The general rules is that because a company has its own rights and liabilities¶in law, it alone should be the one to sue for wrongs done to it (Foss). . …¶The one notable exception to Foss is when there is wrongdoer control. This¶means that the very persons who are wrongdoers and who should be sued¶are in charge of deciding whether or not the company should litigate ( Burland¶v Earle). In such a case, the court will consider under sections 263 whether¶or not to allow a derivative claim by a member instead.¶One of the reasons a company may also not be able to sue is if the¶wrongdoers have deprived it of the funds to litigate (Giles v Rhind). In such a¶case, although a member may then claim, there will be little point in enforcing¶directors’ duties because the company is itself on the verge of being wound¶up.¶The lack of certainty over who pays for a derivative claim also deters altruistic¶litigation for the company – a successful claimant has no lien for costs on¶assets recovered in a claim. Directors may forestall a derivative claim by¶bring a company claim with no intention of genuinely pursuing it. S262 then¶helps a member to turn that claim into a derivative claim provided the¶section’s criteria are met.¶Examiners’ reports 2018¶7¶[There was then a very brief mention of the criteria the courts must apply in¶deciding whether to give permission.]¶Thus derivative claims cannot be said to be wholly ineffective.¶ Comments on extract

¶Interpretation of the question: very poor – the student chooses to answer only¶part of the question. They are interpreting the question as ‘are derivative claims¶effective?’ The question clearly has much more to it than that. ¶Relevance of the answer to the question: it started well, with a reasonable¶discussion of derivative claims. Even had the question been only about that,¶however, the answer was a little superficial, providing little real analysis of precisely¶how effective such claims are. But then it failed to deal at all with the second part of¶the question, regarding the merits of allowing a shareholder to sue personally. ¶Substantive knowledge: OK on derivative claims (but more needed on the way the¶permission rules are applied by the courts). No apparent knowledge at all about¶personal actions against directors.¶ Use of authorities: weak – no real discussion of case law. ¶Articulation of argument: in relation to the effectiveness of derivative claims, there¶was at least a basic argument. But no argument developed in respect of the second¶part of the question.¶ Accuracy of information: OK on derivative claims.¶ Clarity of expression: good. ¶Legibility: good.¶ Overall: a Fail. The failure to answer the second part of the question, and the¶superficial examination of derivative claims, meant the student had not met the¶assessment criteria for a pass.¶ 2018 – B – Q1 Do the rules governing derivative claims require reform and, if so, how? General remarks ¶This question relates to Chapter 11 of the module guide. It required discussion and¶analysis of the law surrounding derivative claims, found mainly in Part 11 CA 2006.¶It required students to explain what those rules are, to evaluate how successful they¶are, to identify any problems with those rules, and to suggest how they might be¶changed/improved.¶ Law cases, reports and other references the examiners would expect you to use¶ Relevant cases here: Prudential Assurance v Newman; Franbar Holdings v Patel;¶Iesini v Westrip Holdings Ltd; Kleanthous v Paphitis; Mission Capital Plc v Sinclair;¶Wishart v Castlecroft Securities Ltd; Wallersteiner v Moir (No.2); Smith v Croft;¶Bhullar v Bhullar; Re Fort Gilkicker Ltd and Abouraya v Sigmund. Mention might be¶made of the Law Commission Report ‘Shareholder Remedies’ which was influential¶in the process of reforming the earlier common law rules on derivative actions.¶ Common errors¶ This question was often well done. A common error in weaker scripts was a failure¶to answer the question asked. Sometimes, essays were produced on ‘majority rule’¶generally, or on the broad topic of ‘the rule in Foss v Harbottle’, instead of focusing¶on the derivative claim specifically. Others described the rules but made no attempt¶to evaluate them, or to suggest how they might be reformed and improved.¶ A good answer to this question would…

¶explain the nature of a derivative claim, and the purpose behind it - permitting a¶shareholder to sue a director for breach where, at least in some circumstances, the¶company itself is unwilling to sue.¶Explain the introduction of the statutory derivative claim in Part 11 CA 2006 to¶replace the previous common law action. Describe and explain the main elements¶of Part 11 and examine the conditions which must be satisfied for a shareholder to¶bring such a claim, including especially the claimant’s obligation to get permission¶to continue the claim, and the criteria (in s.263(2) and (3)) that the courts apply in¶deciding whether or not to give such permission. Such analysis should include¶some discussion of the relevant case law, such as Iesini, Franbar, Kleanthous,¶Singh, Wishart, etc. to show how the courts actually apply the statutory criteria –¶whether for example the courts are interpreting them strictly, or more favourably,¶towards claimants. A good answer might also try to give a sense of what proportion¶of claims that are started are actually given permission to continue (less than half).¶It might also note continuing uncertainty within the law, especially due to the failure¶to replace entirely the old case law, e.g. in respect of which breaches of duty can be¶authorised/ratified (s.239(7)), and in respect of so-called ‘multiple’ derivative claims.¶A good answer would ens...