Directors Beware! The Rise of the Activist Shareholder
Shareholders are now able to make a claim against the directors of their company “in order to protect the interests of the company and obtain a remedy on its behalf”, according to The Companies Act 2006. Along with other protections for shareholders in the Act, this right is available to the shareholder who is seriously concerned about the way in which the directors are conducting the affairs of the company.
It would seem that the original policy objective of the Government was an attempt to catch out the much–derided "fat cats" among directors. The practical result is, however, the greater enforcement, by shareholders, of Section 172 of the 2006 Act (the Directors' duty to promote the success of the company) and Section 174 (the Directors' duty to exercise reasonable care, skill and diligence).
The procedure for derivative actions is a two stage process. The Court (in any of the UK jurisdictions) has to decide if there is, in the first place, a prima facie case. So far, the Courts have not seen fit to provide any guidance as to what is, or is not, a prima facie case. That said, a spokesman for the English High Court has provided the assurance that "the Court is alive to the possibility of claimants testing the tactical possibilities of the legislation". The possibility of this procedure becoming a bandwagon for pressure groups, trying to influence the management of companies, has therefore been recognised.
Several themes are already clear from the new legislation and from the earlier cases before the Courts.
1. A shareholder pursuing a derivative action is more likely to succeed if they can prove that the main purpose of the action is to promote the interests or success of the company. This implies an allegation that the Directors are not fulfilling this important duty. Companies should therefore be careful to look out for nice, polite letters from shareholders, which could be the basis for a derivative claim. Experience of dealing with derivative actions before the 2006 Act suggests that letters from "outraged of Brigadoon" tend not to get anywhere as a basis for these claims.
2. The best defence to a derivative action is evidence – not just documentary evidence from Board Minutes, but how it looks and how it is – that Boards of Directors are fulfilling their obligations. This should not simply be a rote repetition of the various elements of regard for employees, business relationships, the environment etc. which directors have to take into account, but rather a narrative demonstration of how exactly a Board is fulfilling its obligations, and the directors, as individuals, are fulfilling their respective duties under the new Statutory Statement of Directors’ Duties introduced by the 2006 Act.
3. If you are a director of any company but, particularly, a public company or a larger private company or even involved in their executive management, you should take time to ensure that you and your Board are fully briefed on the new statutory Directors' Duties and on the possibility of derivative claims being made.
4. The continuing failure of the Government to implement the part of the Act that deals with conflicts of interest between a director and their Company does leave directors in something of a limbo and, the latest indications from Government would suggest that this will continue until October 2008. At the moment, there is no way of authorising a director in respect of any conflict of interest which may arise between a director of a company and the interests of the company e.g. in relation to a commercial opportunity which the company does not want to take up but a director could – a possible fruitful area for derivative actions in the future. The longer this area remains unimplemented, the longer therefore it is before both private and public companies can take the action necessary to put a form of retrospective validation of such conflicts (in the case of public companies into their Articles: in the case of private companies to be permitted to do this at Board level) the more exposed Directors will be. The continuing delay in bringing this provision into law is unwelcome, to say the least.
5. The biggest deterrent to derivative actions, going forward, is the fact that any proceeds of a successful action go to the company. There is no personal benefit to be gained for the shareholders involved. This would seem to be the pattern from the Canadian experience of similar legislation where, because the proceeds go to the company, it is only the really determined shareholder with an obvious and proper claim who gets to Court.
6. Derivative actions against directors are bad enough when the act or omission for which the directors are responsible has, indeed, been carried out by the directors. Where that act or omission has been endorsed by the directors or, by law is the responsibility of the directors, but has actually been carried out by management below Board level, this can be harder to police. It is not enough therefore in larger, public or private companies, simply to educate the Board in the requirements of the new Statutory Statement of Directors' Duties. Those executive managers dealing with issues which have been delegated to them by the Board (or even where there is no formal delegation) should be aware of the terms of the Statutory Statement and of the need to properly provide evidence, both in writing and by action, of the steps which have been taken to comply with these duties. This could be an area which could give rise, albeit inadvertently, to claims. Boards should therefore think about all of those in their executive management team who could possibly be involved in areas where derivative actions might arise and conduct appropriate training. In the brave new world of the Companies Act 2006, the guiding motto has to be – not just providing documentary evidence but… "How does it look – even if it's legal?"
FOR FURTHER INFORMATION PLEASE CONTACT: SCOTT KERR