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The Solicitor-General:
It is always possible that there will be exceptional circumstances. In effect, however, those people would be seeking to mount a claim, any
costs from which would go back to the company. The beneficiary would therefore be the company.
Mr. Djanogly: My point is that the Minister is speaking about individuals winning or losing—as in America—or about the company winning or losing. However, individuals who own only one share making a claim might not have any desire to win individually. They might be taking the company to court to make a point, and if they are funded by a third party, they will be able to do that much more easily under these provisions than under the present legislation.
The Solicitor-General: I do not necessarily accept that it would be that easy. The hon. Gentleman should look at the details of the derivative claims provisions. I think that they provide sufficient safeguards against the development of a litigation culture, as our aim is to prevent a pressure-group level of litigation against particular companies. When I have developed my argument, perhaps he will see how we intend to do that.
A breach of a director’s general duties to the company is a serious matter. Indeed, it may be extremely serious for the company, whose very existence may be put in jeopardy by the breach or threatened breach of duty. The general duties set out in chapter 2 of part 10 do not constitute guidance or a wish list. They are statutory duties, and every director must comply with them. It is therefore important that there be a clear and accessible mechanism by which shareholders can, if necessary, bring an action in the name of the company against a director for breach of one of those duties. For shareholders, there are two main problems in current law. First, as the hon. Member for Cambridge knows, the law is to be found in case law that stretches back more than 150 years and is anything but clear and transparent. That is why the Law Commission recommended that the right to bring a derivative action at common law should be replaced by a
“new derivative procedure with more modern, flexible and accessible criteria for determining whether a shareholder should be able to pursue the action”.
It is essential that the procedural requirements for bringing a derivative action are accessible and clearly set out, so that they can be understood by both directors and shareholders.
Secondly, the law is built on somewhat arcane legal principles relating to the concept of fraud on the minority. Those principles are difficult and obscure, even to lawyers, but they restrict the ability of shareholders to bring meritorious claims. That is why the new statutory procedure differs from the common law in two key respects. We do not want the claimant to have to show “wrongdoer control”—that is, to show that the company is controlled by the directors whom the claimant believes to have acted in breach of their duties—as that might make it impossible for a derivative claim to be brought successfully by a member of a widely held company, including almost all major quoted companies.
We also want it to be possible to bring a claim in cases of negligence, even if it cannot be shown that the directors have profited from the negligence. As the hon. Member for Huntingdon says, it is important that the Bill should not permit shareholders to bring a
derivative claim that is motivated by reasons other than the commercial success of the company. We have made it clear from the beginning that we want such claims to be dismissed by the courts at the earliest possible opportunity, without the companies being involved. However, the general reforms to civil procedure introduced by Lord Woolf may mean that unmeritorious cases proceed further before being thrown out. Under those reforms, there is no requirement to obtain leave before a claim is issued. Instead, the claimant must apply to the court for “permission to continue” the claim. For that reason, in the other place, we tabled a package of reforms that ensure that the courts can dismiss unmeritorious claims at an early stage.
The amendments in the other place introduced a two-stage procedure for permission to continue a derivative claim. At the first stage, the applicant would be required to make a prima facie case. The court would be required to consider the issue on the basis of the evidence filed by the claimant alone, without requiring any evidence from the defendant. The courts must dismiss applications at that stage if what is filed does not show that there is a good case. At the second stage, but before the substantive action begins, the court considers whether the decision of the directors was one that the company could reasonably and independently have taken. In addition, the Government amendments that were tabled to part 11 in another place made it clear that the court may
“make any consequential order it considers appropriate.”
Examples include a cost order or a restraint order against the applicant. That would give the court explicit power to adjourn the permission application, either for a specific event, such as a general meeting of the company and other soundings, or more generally, so that it can revisit the question of permission at a later stage.
Thirdly, it provides that, in deciding whether to permit a claim to continue, the court should have particular regard to any evidence as to the views of members of the company who have no personal interest, direct or indirect, in that particular matter. That will help to address concerns that it is not practical or desirable for major quoted companies to ask shareholders formally to approve directors’ commercial decisions.
I believe that these clauses, as amended in another place, strike the right balance between the ability of directors to take business decisions in good faith and shareholder rights, and they make this important area of law clearer and more accessible. I emphasise that they do not oblige the courts to involve themselves in business judgments or to reverse the burden of proof in any way.
Mr. Djanogly: The Minister says that the procedure will be clearer and more accessible. One of our concerns is that the fact that the procedure is clearer and more accessible will mean that more people will want to use it and therefore there will be more litigation.
The Solicitor-General:
It will be clearer and more accessible in the sense that the constraints on someone using it in a way that we would not regard as
justified—I am not sure that there is much difference in our view on that—are quite strong. Yes, the procedures that I have set out and the amendments that were tabled in another place make the procedure more accessible. If the hon. Gentleman’s argument is—I trust that it is not—that we ought to make the law inaccessible to ordinary shareholders in case they exercise their rights, it is a bad argument. Our aim should be to try to create clear law so that the directors know where they are, the shareholders know what action they can take and the general public can understand it.
We are seeking to set out our view that the shareholders should, in restricted circumstances, be able to take a derivative action, but that the courts should have the ability to intervene to prevent frivolous actions or actions that are not aimed at ensuring the commercial success of the company. In other words, they are aimed at a pressure group pursuing a viewpoint that is not about the commercial success of the company.
I think that we have struck a proper balance. The amendments that we have tabled and have had accepted in another place are able to deal with the main concerns that the hon. Member for Huntingdon raised. As I say, I do not think that there is any great difference of view of what we want. The hon. Gentleman fears that things will happen which we say we have provided protections against. Our view is that those protections will ensure that we are able to achieve the benefits of more accessible and clearer legislation without the problems caused by unnecessary litigation.
I shall now look at the amendments to clause 260, beginning with amendment No. 412, which attempts to delete “or proposed”. Amendment No. 412 is based on a misunderstanding of the current law and the position under the statutory statement of directors’ general duties. Clause 179 provides that the consequences of breach or threatened breach of the statutory duties are the same as would apply if the corresponding common law or equitable principle applied. The reference to threatened breaches is important. Under the present law, companies may be able to take pre-emptive action to stop a breach of duty from taking place before it actually happens and the damage is done. There could, for example, be a threatened breach of duty if a director was refused permission to exploit a corporate opportunity but then announced that he was going to go ahead and do it anyway. The remedies in such cases, which include an injunction or a declaration, provide an important safeguard of a company’s interest against wrongdoing by a director. A derivative action is an action brought by the company, and there is no sensible basis on which the remedies available to the court should be limited in the way proposed in the case of a derivative claim.
Amendment No. 413 would remove the right to bring a claim against a third party. That provision in clause 263 flows from a clear Law Commission recommendation, which is explained in detail in part 6 of the Law Commission’s report on shareholder remedies. The principles are important. The claim should be allowed only if there has been a breach of a duty by a director, but the relief sought may be against a third party as well as against the director personally.
It might be helpful if I set out a couple of examples that have been cited by the Law Commission in its report on shareholder remedies. In the first example, a relief is sought from a third party for knowingly being in receipt of money or property or for property transferred in breach of trust or for knowing assistance in a breach of trust. It seems to us correct that the member should be entitled to pursue a remedy against the third party in circumstances where he is holding assets belonging to the company, which he has obtained in those particular circumstances.
In the second example, a profitable company is a victim of a tort by a third party—perhaps another company. The directors, while otherwise committed to the well-being of the company, have ulterior motives of their own for not wishing to enforce a remedy for the tort. Although the directors would in those circumstances be in breach of duty, that breach would not have given rise to the claim, so it would not be open to a member to bring derivative proceedings against a third party. Again, we believe that that is an appropriate outcome.
I hope that those examples show that it is possible to uphold important principles while placing reasonable constraints on the application of the provision and that this would not result in members seeking to bring derivative claims against third parties simply where they disagree with a decision of the board not to sue a third party. I believe that clause 263 achieves that.
I now wish to deal with the provisions in clause 264, which respond to the requests from some respondents to the company law reform White Paper, including the Law Society, that part 11 should state clearly that it is immaterial whether the cause of action arose before or after the person seeking to bring or continue a derivative claim became a member of the company. That reflects the position in the common-law derivative action, and the provision also makes it clear that current members, even if not members at the time that the corporate cause of action arose, are the only plaintiffs entitled to bring proceedings. In doing so, it accurately reflects the nature of the derivative action that is the company’s cause of action. As such, the point in time at which the member became a member is immaterial. I cannot therefore support the amendment proposed by the hon. Member for Huntingdon.
Amendment No. 415 provides that a derivative claim may be brought only if the directors have refused a request by a member to bring a claim. The amendment goes to the heart of what we are seeking to achieve in our reform of the law in this area. At present, a derivative claim will not be available to the minority shareholder unless he can show that, to put it briefly, the wrongdoers are in control. The onus is thus on the claimant minority shareholder who seeks to bring a derivative claim to allege in his statement of case, and then to demonstrate, that those whose actions he complains of are in control of the company and will not permit its name to be used as claimant in the action.
If the minority shareholder cannot demonstrate control, the action will be dismissed. However, the minority shareholder does not need to be able to
demonstrate that the company has rejected a formal application to instigate proceedings, nor show that he has procured the summoning of a general meeting to consider the question, which has then rejected his request.
As the Law Commission observed, the meaning of “wrongdoer control” is not clear, and as long ago as 1962, believe it or not—it sometimes takes us a long time to achieve things in this place—the Jenkins committee said that it would be
“extremely difficult to devise a satisfactory general provision”
expressing this concept and the remainder of the exception to the rule in Foss v. Harbottle in wider terms. That is why the Law Commission has proposed a new statutory remedy.
Under the proposed statutory procedure, a member need not demonstrate wrongdoer control, but one of the factors that the court must take into account in considering whether to give permission to continue the claim is whether the company has decided not to pursue the claim. It may therefore be advisable for a member seeking to bring an action to ascertain the company’s intentions with regard to pursuing its cause of action before bringing a derivative claim, but we do not believe that that need be a mandatory precondition.
The hon. Member for Huntingdon proposes that we enshrine in law such a mandatory condition. He takes the view that permission should be sought, at least. I have some sympathy with the proposal, but we do not believe that such a mandatory precondition would be helpful or necessary to bring a claim. We fear that going down that route would bring us right back to a number of the unsatisfactory and undefinable concepts that I have just mentioned. Although I have every sympathy with the aim in amendment No. 415, I cannot accept its mandatory nature, so I hope that it will not be pressed to a vote.
Mr. James Gray (North Wiltshire) (Con): I am grateful to the Minister for giving way, but I know that he wants to read the note that his colleagues have passed to him. Does he agree that the net upshot of the clause is that more people can be sued under it than previously?
The Solicitor-General: If the hon. Gentleman had been here earlier in the debate, he would realise that I do not agree with that point at all. If the director has behaved inappropriately, we want the shareholder to be able to take a course of derivative action that will enable them to enforce the company’s rights. The shareholder is seeking to enforce the company’s rights—that is the key thing, and it is where I began. We need to ensure that we have the proper balance in place, and I fear that the provisions that the Opposition seek to insert in the clause would create a lack of balance, so the shareholder could not take action when they needed to do so if there were impropriety by a director. This is about balance and the need for care. We have got the balance right, and although the Opposition are taking points from outside organisations, they might not have got that balance right.
Clause 263 sets out the criteria that must be taken into account by the court in considering whether to give permission to continue a derivative claim. Subsection (2) provides that the court must—I emphasise the word “must”—refuse leave to continue a derivative claim if it is satisfied that a person acting in accordance with the duty to promote the success of the company would not seek to continue the claim; or where the cause of action arises from an act or omission that has not yet occurred, that act or omission has been authorised by the company; or where the cause of action arises from an act or omission that has already occurred, that act or omission has been either authorised or ratified by the company.
Amendments Nos. 416 and 417 seek to add to the list of factors matters that, if established to the satisfaction of the court, would constitute a bar to the continuation of a derivative claim. The Bill’s approach follows the Law Commission’s recommendation that whereas ratification of a breach should constitute a bar to the bringing of a derivative action, the fact that a breach of duty is ratifiable should not constitute a bar, but should feature as one of a list of factors to which the court should have regard in considering whether to grant permission to continue the claim.
Amendment No. 416 would add three further grounds that, if established to the court’s satisfaction, would constitute a bar to the continuation of a derivative claim. Therefore, let me consider each briefly. The first new bar to the bringing of a derivative claim would be a decision by the directors not to pursue the claim, unless the court considered that there was a substantial risk that, in reaching their decision, they had acted in breach of their duties to the company. That factor already appears on the list of matters that have been taken into account.
The second new factor under the amendment would be a claim that the company in general meeting could validly decide not to pursue, unless the court considered that there was a substantial risk that a decision not to pursue the claim would be taken only as a result of votes cast by members with a personal interest, direct or indirect. It is not clear from the drafting whether the amendment refers to a claim relating to a breach of duty that the company might ratify in general meeting, or to something short of that. In either case, we do not consider that this is a matter that should bar a derivative claim. The clause already provides that where a breach of duty has been ratified, that will constitute a bar and the claim will go no further.
The third factor that the amendment would insert into clause 263 is that pursuing the claim would not be in the interests of the company. That overlaps in an unhelpful way with the existing factor in subsection (2)(a), namely,
“that a person acting in accordance with section 173...would not seek to continue the claim”.
It is important that clause 173 and part 11 use consistent wording.
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