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Companies Bill [Lords]

For the first time today, we have a decent amount of time for Opposition amendments—I suppose that I should be grateful. Despite amendments in the other place, which have improved clause 260, part 11 dealing with derivative claims is a complex area that still gives many much concern. Currently, a shareholder can only bring a claim on behalf of a company against directors in limited circumstances. Part 11 sets out a new procedure of derivative actions that enable shareholders to bring a claim on behalf of the company for directors’ breach of duty, if that breach has not been authorised or ratified by the company. Together with part 10, we believe that this has significant potential to increase liability for directors. Before I go any further, I should like to explain the current common law position and set out what the Government aim to do in this area. Derivative claims are proceedings brought by a shareholder. Under the new Bill, they must be either"““in respect of a cause of action vested in the company and seeking relief on behalf of the company””" and"““brought only in respect of causes 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 the company.””" This is significantly wider than the current common law position. There are two major concerns in relation to part 11. First, that it does not advance the common law and, secondly, that its effect, particularly when it is combined with part 10, will be detrimental to directors. We have tabled amendments that seek to deal with those concerns, which I shall discuss in due course. The leading common law case on which this codification attempts to build is that of Foss v. Harbottle. If the Bill’s intention is to enshrine in statute the well-established exceptions to the rule set out in the case of Foss v. Harbottle, our view and that of the lawyers who have advised us is that that is not immediately achieved by the current drafting. The rule in Foss v. Harbottle is that a member cannot bring an action on behalf of the company for an injury done to the company; the company is the injured party and the action vests in it. The exceptions to the rule in Foss v. Harbottle include circumstances in which the transaction constitutes a fraud on the minority. That includes fraud proper as well as breach of fiduciary duty as a director and circumstances in which the wrongdoers are in control of the shares of the company. The non-inclusion of this fraud control test in the Bill represents a radical departure from the previous thresholds to a member making a derivative claim. The result of this non-inclusion is that it will be easier for shareholders to bring claims against directors. Although the court will now be required to consider the evidence and merits at the earlier stage, there is a danger that this part of the Bill will simply create a more complex procedure without any corresponding reduction in the potential administrative burdens for companies. It therefore makes sense that part 11 should be amended to preserve the traditional thresholds of fraud on the minority and wrongdoer control, as that would make it clear in statute that this new regime is not intended to sweep away the existing case law. As the new legislation does not replicate existing case law, it will take some time for a body of case law to develop. We feel that this will create uncertainty for some period as to the extent of the derivative claim provisions and the burden of this will largely fall on the company. This could, in part, be remedied by the legislation mirroring more closely existing law. In practice, derivative claims have to date been relatively rare, but any potential benefit this codification will have, which will be minimal, will be far outweighed by the possible damage that will be wrought by increased shareholder litigation and reducing the number of people who are willing to take up company directorships in the UK. A further key change in this Bill is that the persons engaging in fraudulent conduct need not have received a benefit. Members will therefore be allowed to make claims for an honest act or omission of a director where that results in a breach of duty, regardless of whether the individual has received a benefit. Under the existing common law, it is not possible to make a derivative claim as a result of negligent action unless the person in breach of duty has received a corresponding benefit. This represents a shift from the existing position and the focus is much more on allowing member control of directors’ actions. The range of circumstances under which a derivative action may be brought will be much wider than is currently the case. This is once again an area of the law where the Government have said that the intention of putting in new clauses has been to codify the existing common law position, but this is, unfortunately, once again an area where the Government are overturning the common law position. The codification of the basis of bringing a claim and the means of bringing that claim will serve only to make it easier for claims to be brought against company directors. Company directors also fear that increased litigation may lead to increased insurance premium costs—that is a very real fear for company directors. Should the rates that directors and officers have to pay go up, there will be a further disincentive to people becoming company directors. I am afraid that that is becoming a theme of parts 10 and 11, and it is not a happy one. The concern that part 11 will increase potential liabilities for directors and the chance of tactical and vexatious litigation by activist shareholders has been raised by many others. The City law firm, Lovells, says:"““The Explanatory Notes to the Bill explain that ‘the””" derivative action"““clauses do not formulate a substantive rule to replace the rule in Foss v Harbottle, but rather a new procedure for bringing such an action which set down criteria for the Court distilled from the Foss v Harbottle jurisprudence’. It is hard to see how this can be correct. As the Explanatory Notes themselves make clear, the rule in Foss v Harbottle is that is for the company to bring proceedings where a ‘wrong has been done to the company’, and that an exception can be made where there is conduct amounting to a fraud on the minority. The case of Estmanco (Kilner House) Ltd v Greater London Council made clear that ‘fraud’ in this context extends beyond fraud at common law to include ‘the equitable concept of fraud on a power’, including an abuse or misuse of power. It is generally considered that fraud, in this sense, does not include negligence. Other grounds include where the director’s act is illegal, ultra vires and not ratifiable, or where the shareholder has acquired a personal right against a relevant director.""Whilst the Explanatory Notes say that Part 11 does not seek to overturn these previous ‘well established principles’, it is hard to see how this can be. If Part 11 comes into law, individual shareholders will be able to bring proceedings against directors, including in respect of negligence, which cannot be summarily struck out for want of locus standii, but only under a brand new test, which is unconnected to these common law factors. As a result, there is a clear risk that multiple stakeholders might make good use of Part 11 to further their own various platforms, at the expense of companies’ time and money, and their directors time and money, personal stress, and claims upon their D&O insurance. It may even be possible for such a shareholder to use the provisions of this Part to apply for an order that the company pay his costs of bringing the proceedings, along the lines of the application upheld in Wallersteiner…If so, this could produce the very odd result that a number of activists could each buy a single share in the company, and each bring separate proceedings against directors, in respect of conduct predating their shareholding, at the company’s expense. Such claims may well, however, be struck out by the Court under the first stage of section 242 referred to above.””" We hope that that would be the case, but clearly the risks are there. Let me turn to our amendments, which seek to rectify the problems that I have highlighted. Clause 260(3) states:"““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 the company.””" That wording is not sufficiently precise and is too wide. In particular, the use of the words, ““or proposed””, go too far. A member should not have the statutory right to make a derivative claim to restrain some proposed act or omission. The intention should be to provide a remedy for a member where there has been an actual act or omission. To include the words, ““or proposed””, may be a charter for members at any time to take action to restrain what they thought was a potential future breach of the relevant duties. We therefore propose to amend the wording of the clause as set out in amendment No. 412. In Committee, the Solicitor-General said that this approach is too restrictive, but we are yet to be convinced by his arguments. Amendments Nos. 413 and 414 were brought to us by the Institute of Chartered Accountants, which sets out its position in its brief of 10 October:"““We are concerned that the draft clauses do not reflect the Government’s intention, as stated in its explanatory material and agreed to in the House of Lords Committee stage debate, of codifying existing common law principles on derivative actions. These clauses create new rights for members to bring a derivative action against persons other than directors. An actual or alleged breach of duty by a director””—"