Easier Ways to Pursue the Delinquent Majority?

I will apologise in advance for the complexity of this blog. However, if you are a shareholder involved in a dispute with the majority shareholders and directors in a company, you may want to try to bear with it! It may have some important news for you!

Generally minority shareholders in a company are in a weak position if the majority steamroller ahead and take unwanted action. The law has tried to develop a framework so that minority shareholders are protected.

I have blogged previously about sections 994 to 996 of the Companies Act 2006 (which in essence replace section 459 of The Companies Act 1985). These sections, as I have blogged elsewhere, provide a discretionary remedy for the court to order purchase of the minority or majority shares by another party at a particular level, or make orders in the interest of equity, including winding the company up. One of the practical difficulties with this remedy is that not only does unfair prejudice need to be shown by the shareholder (in theory any member of the company can apply) but the court action can be very, very costly and in circumstances where sometimes the minority is being excluded from the revenue and assets of the company, it may not be practical for them to pursue it.

There is sometimes an alternative. Following a case called Foss v Harbottle from 1843 when it was held that while generally minority shareholders could not pursue in the name of the Company if the directors blocked action, there were certain limited exceptions where they could. In summary, exceptions included the directors acting illegally, a fraud being committed on the minority as well as some less well known ones. The difficulty with the Foss v Harbottle exceptions was that the law was complicated and they were often hard to make out. Minority shareholders were often not equitably protected.

Given the complexities, new rules on derivative proceedings (i.e. where a member derives the right to pursue the company’s name) were brought in by the Companies Act 2006. In relation to Scotland these rules are found between sections 265 to 269 of the 2006 Act.

On the 26th July 2016 the second division of the Inner House of the Court of Session delivered a judgement in the case of Alam and Others v Ibrahim and Others in which they dealt with an appeal arising out of a derivative action in the Sheriff Court. The case is worth reading for anyone involved in shareholder disputes.

Firstly, it is useful from a procedural point of view, because the court sets out its interpretation of how the statutory procedure ought to be followed in terms of the Sheriff Court rules. Given the changes in the privative limit in the Court of Session, any claim worth less that £100,000 will now typically be pursued in the Sheriff Court. There will be a good number of Sheriff Courts around Scotland that have very little, or no, experience of dealing with complex derivative claims. The Lord Justice Clerk delivered the opinion of the court and it seems clear that the Sheriff Court concerned, and probably the Sheriff, were not experienced in dealing with such claims.

In very simple terms procedurally the application for leave to be allowed to pursue in the company’s name, ought to have been considered by the Sheriff on a paper basis to begin with. If there was a prima facie case the Sheriff should have ordered intimation to the company (the directors would then have an opportunity to oppose the application).

A hearing should then have been fixed where leave to proceed was determined, before any principal derivative action got underway. The difficulty in this case was that the leave application had never properly been dealt with and had effectively been practically combined with the principal source of action.

Ultimately in this case the Inner House were satisfied that the pleadings brought out a prima facie case that should be tried at proof. They therefore allowed an appeal against dismissal of the action.

Perhaps more importantly, however, they made some other interesting substantive observations. The Sheriff had decided that because the fraud on the minority exception to Foss v Harbottle had not been adequately made out in the proceedings there was no stateable case. The Inner House said:

“We cannot read the Sheriff’s decision as doing other than seeking to apply the rule in Foss v Harbottle or something akin to it… The Legislation clearly places restrictions on the circumstances in which such actions may be raised, but there is no basis for adopting any test of exceptionality as the Sheriff seems to have thought…

The court approved a previous decision in the Outer House to the effect that one of the objects of the 2006 Act “was to introduce more flexible criteria than the former fraud in the minority exception to the rule in Foss v Harbottle.”

Secondly, it is worth noting that the division dealt with the objection often raised that if a remedy in terms of section 994 to 996 of the 2006 Act is available, it is not proper to pursue a derivative action. The court held:

“It is quite true that it might be open to the applicants to seek to pursue a remedy utilising sections 994 and 996 of the 2006 Act, but it is not unreasonable for it to be suggested that this provides them with a less attractive option. These provisions provide only a discretionary remedy, in all the circumstances we think it likely that the court would make an order under section 996 (2)c thereby in effect authorising a derivative action on the part of the company.”

The court was clear that the availability of an alternative remedy is a factor to bear in mind but it is only one factor.

This case will not provide a silver bullet for all claims against the delinquent majority. However, where the directors are acting unlawfully (and in breach of duty, as opposed to simply unfairly) it does provide helpful guidance.

Eric Baijal is head of litigation at BBM Solicitors.

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