Derivative actions are legal mechanisms that allows shareholders to bring an action on behalf of the company in addressing its own directors or managers’ wrongdoing. The word “derivative” in the name comes from the fact that the shareholder derives their right to sue from the companies’ rights.
Under the Companies Act 2006, shareholders do not need to own a minimum number of shares to qualify for bringing a claim.
What are the grounds for bringing a derivative action claim?
Derivative actions can fall into the following categories:
- Where a director was negligent and failed to exercise a reasonable standard of care and skill, which subsequently caused loss to the company
- Where a director failed to comply with an obligation under the Companies Act, or the company’s constitution
- Where a director breached their duties to the company, regardless of whether it was statutory, fiduciary or other legal duties.
- Where a director misused or misapplied company funds, property or assets
Before a derivative action claim can proceed, court permission must be sought where a prima facie (at first glance) case is demonstrated. Essentially this is classed as a valid claim based on the face value of facts. This is to prevent any unfounded or unreasonable claims being made to the court.
Derivative action VS unfair prejudice
Unfair prejudice claims are an avenue for shareholders to bring legal action on the grounds of personal harm experienced from directors or other shareholders of the company. Where derivative actions are successful, the damages recovered go back into the company’s coffers.
Unfair prejudice petitions are generally more common for shareholders in seeking redress for wrongdoing, as the reward from a successful case is enjoyed by the shareholder alone. The threshold is also lower for these claims and court permission is not needed.
Importance of derivative actions
Derivative actions serve as a safeguard in corporate governance as a check of directors’ powers. In situations where the directors are the wrongdoers themselves, there may be difficulties or reluctance in taking accountability for misconduct, or taking legal action against a fellow director for more complex reasons. In these situations, shareholders are empowered to step in to ensure the protection of the company’s rights and the upholding of the regulations, compelling remedies that benefit the company. This is crucial in preventing directors from abusing their power and stifling minority shareholder voices.
Though they are relatively rare in practice, derivative actions are the only legal action that offers justice in situations where the company itself has been wronged by its own directors. It is a mechanism to ensure proper conduct in companies, and its existence acts as a deterrent for directors from breaching their legal and fiduciary duties.
At Nath Solicitors we provide legal expert advice on derivative actions. If you need assistance, please call us on 0203 983 8278 or email us at enquiries@nathsolicitors.co.uk.