A derivative action permits a minority shareholder, to institute proceedings on behalf of the company in an attempt to address a wrong doing perpetrated by the directors or the majority shareholders in the company. The main question is whether the court can aptly assess the matter and decide whether to permit a minority shareholder to bring a derivative action or not as per the terms dictated by the terms of the available laws. Admissibility of such a claim fell squarely on the court. Initially, the components of the common law were applicable in determining the terms. However, the common law has been criticized and said to be unprotective of rights of the minority shareholders. The Statutory derivative claim than was crafted and came into force in 2007 to seal the loopholes in the common law derivative action. This paper critically evaluates the statutory derivative claim against the common law derivative action to determine the gains (if any) in the new statute. The findings veal only minimal gains brought by the change in the law; thus statutory derivative claim seems better in the making but requires several important changes and court action make it what it was intended for- to minimize the challenges posed by the common law derivative laws.
Derivative action at common law was the representative claim on behalf of all the shareholders apart from the defaulting ones against the wrong doers and the defaulting shareholders while the company remains the nominal defendant.1 The concept of derivative come into being due to the fact that the right to sue is not vested directly on the shareholder who forwards the derivative claim; this implies that the shareholder derives the right from the rights vested on the company in question.
The Foss v Harbottle and its exceptions case led to the thought of reviewing the obscure, complex, rigid, and old-fashioned terms with which cases were handled.2 The Law commission of the United Kingdom recommended a new derivative procedure which would be more modern, flexible and accessible to allow a shareholder pursue an action. The new statutory derivative claim in the Companies Act 2006 (CA 2006) came into effect in 2007 taking over from the Common Law Claim. The Foss v Harbottle case was hinged on two rules that have since been viewed as retrogressive. First, the proper plaintiff rule that stated that the right person to forward acclaim for wrongs done against a company is the company itself. This rule viewed a company as a separate legal entity from its members. This means that a company is treated as any other independent person with its rights and liabilities.3 Likewise, the proper plaintiff in an action for a wrong done against a company is prima facie the company.
In the Foss v Harbottle case, two shareholders brought an action against the company directors by alleging that the directors had defrauded the company by selling it a piece of land at an exorbitant price which led to losses. The two shareholders instituted proceedings on their own behalf as well as on behalf or other shareholders apart from the defaulting shareholders.4 The court held that the action of the two shareholders could not proceed because the individual shareholders were not “proper claimants”; the proper claimant was the company which has suffered the alleged wrongs. Sir James Wigram VC stated in his ruling that; “The corporation should sue in its own name and in its corporate character, or in the name of someone whom the law has appointed to be its representative”, An understanding of this ruling was even made clearer in the Edwards v Halliwell case where Jenkins LJ stated;
“The rule in Foss v Harbottle, as I understand it, comes to no more than this. First, the proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself. Secondly, where the alleged wrong is a transaction which might be made binding on the company or association and on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company or association is in favour of what has been done, then cadit quaestio.”5
The Foss v Harbottle case highlights the highest degree of unfairness because the rules applicable were only accessible to the specialist practitioners because it was essential to analyze case law spanning 150 years. It was evident in the case that restrictive attitudes raised questions over the capacity of the courts to develop coherent set of legal principles that would enhance shareholder confidence yet not imposing burdens on company management. At the time of the case, there was no coherent principle underlying the rules and exceptions thus making it difficult to allow a shareholder without enough experience on law to build a strong derivative claim.6 The two main justifications for the Foss v Harbottle ruling was first, the proper plaintiff principle prevents a deluge of “unnecessary” suits, and that it is pointless for shareholders to forward a derivative claim yet the companies have proper organs to ratify the wrongs in their capacities.7 Two risks posed by the ruling above include the rule on proper plaintiff where only the organs of a company are allowed to proceed with a derivative action- this is dangerous because such company organs may be in control of the wrongdoers hence the company may not act in the best interest of the company. The second risk arises from the ratification rule which provides for ratification of the so-called wrong doings in a company by its members/shareholders in their internal meetings; this may limit the scope of derivative actions because most wrongdoings can be easily ratified through lobbying and canvassing.8