Derivative actions and other ways of resolving disputes within small companies

If a director damages his company fraudulently, negligently or otherwise, the company can of course sue him.

However, the director who has done this will often have control of the company and will hardly cause it to bring an action against himself. Part 11 of the Companies Act 2006 provides a machinery, known as a derivative action, to get around this. Any member of a company can ask the court’s permission to bring such an action in the company’s name against a director or shadow director. Section 263 lists the factors, largely intuitive, that should be taken into account in determining whether to give permission for such a claim.

The process is procedurally complicated, perhaps unnecessarily so, consisting of three stages. Firstly, a determination of whether the application shows a prima facie case; secondly. a determination of whether permission should be granted to bring the action; and thirdly determination of the substantive claim. At the permission stage the company may be represented separately from either the Applicant or the prospective defendants.

Often the circumstances that bring this procedure into play will overlap with the right, under s994 of the 2006 Act, of a minority shareholder to petition on the basis of suffering unfair prejudice. This too is a complex and frequently expensive procedure. In some circumstances the more familiar remedy of a winding up petition will be available, particularly where there are two equal shareholders and no deadlock provision. Such a petition is unlikely to succeed where the company is still viable under the control of the majority.

The reality underlying most claims involving small companies is that they are between individuals who have fallen out. In practice, though obviously not in legal theory, these are partnership disputes, which would be better resolved without being drawn into complex company law remedies. Usually such falling outs are as bitter as divorces and the parties keen to enter into a mutually destructive process from which lawyers can be the only winners. In the minority of cases where a sense of proportion is retained, an arbitrator can be appointed and terms of engagement designed to treat the dispute as being directly between the individuals involved without the distracting, but artificial presence of the company.


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