Statutory Derivative Proceedings in the Inner House – Wishart v Castlecroft Securities Ltd. [2009] CSIH 65

Wishart v Castlecroft Securities Ltd. [2009] CSIH 65 is the first case in the United Kingdom where an appeal court has had the opportunity to consider and apply the statutory derivative proceedings under Part 11 of the Companies Act 2006 ("the Act"). Wishart was decided by the Inner House of the Court of Session on 21st July 2009 and Lord Reed delivered the judgment. Part 11 of the Act provides for a procedure which enables a shareholder of a company to take action against a director of the company or other third parties. The shareholder's claim is to the effect that a director has engaged in an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust. If successful, the company obtains the remedy, rather than the individual shareholder. Of particular note is the fact that the Inner House granted the shareholder's application for leave to raise derivative proceedings in Wishart v Castlecroft Securities Ltd.

Part 11 of the Act is divided into provisions which apply to England and Wales (ss. 260-264 of the Act) and provisions which apply to Scotland only (ss. 265-269 of the Act). In terms of the Scottish procedure, a shareholder must first make an application for leave to raise derivative proceedings by presenting a petition to the Outer House of the Court of Session. The application for leave procedure is split into an ex parte (section 266(2)) and an inter partes stage (section 266(4) and (5)). The former does not involve a hearing with the parties present, whereas the latter does.

At the ex parte stage, the Outer House judge must refuse the application if the application and the evidence produced by the applicant in support of it do not disclose a prima facie case for granting it. In the Outer House (2009 SLT 376), Lord Glennie decided that the effect of the combination of sections 266(3) and 265(3) of the Act was such that the court was specifically required to be satisfied about two matters: First, that there has been a relevant act or omission by one or more directors of the company in terms of section 265(3) of the Act; secondly, that the applicant has established wrongdoer control, i.e. that the wrongdoer director has majority control over the shareholders of the company (directly or indirectly) which is or would be exercised to prevent a proper action being brought against the wrongdoer. On the latter point, Lord Reed in the Inner House disagreed with Lord Glennie. It is submitted that Lord Reed was correct on this point and support for this view is supplied by the speech of the Solicitor-General, Mike O'Brien MP, on 17th October 2006 which is reported in Hansard. At column 832, O'Brien stated:

"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."

This is fortified by the fact that in Franbar Holdings Ltd. v Patel (a case decided in the High Court in England [2008] B.C.C. 885), it was implicit in William Trower QC's judgment that the issue of wrongdoer control must be taken into account at the inter partes (rather than the ex parte) stage in evaluating whether the director's act or omission was capable of ratification in terms of section 263(3)(c) (section 268(2)(c) is the equivalent provision which applies to Scotland) of the Act.

In evaluating the criteria to be applied at the ex parte stage for the purposes of determining whether there is no prima facie case disclosed for granting the application for leave, Lord Reed took the position that the mandatory and discretionary criteria which are specified in section 268(1), (2) and (3) of the Act, ought to be taken into account, together with ‘any relevant circumstances', since the language of section 268(2) is ‘non-exhaustive' (paras. [33] and [36]). Having taken such criteria into account, if the court is of the view that the application for leave should not be refused, section 266(4) of the Act directs that the applicant is entitled to serve the application on the company (rather than the prospective defenders in future derivative proceedings) and the court may make an order requiring evidence to be produced by the company. It is submitted that the reasoning for this particular aspect of Lord Reed's judgment is correct, since it rests on the proper statutory construction of sections 266(3) and 268(1) and (2). Section 266(3) deals with the approach which the court should apply at the ex parte stage. Here, it is provided that ‘if it appears to the court that the application and the evidence produced by the applicant in support of it do not disclose a prima facie case for granting it, the Court… must refuse the application…' Further, the relevant parts of section 268(1) and (2) stipulate that ‘The court must refuse leave to raise derivative proceedings or an application under section 267 if satisfied…' and ‘In considering whether to grant leave to raise derivative proceedings or an application under section 267, the court must take into account, in particular…' On this basis, it appears that the criteria in section 268(1) and (2) must be applied at both the ex parte and inter partes stages by virtue of the words  in section 266(3) of the Act which have been marked in bold (by the blogger) – since the application for leave procedure is made up of two distinct stages, namely the ex parte and inter partes phases. If it was Parliament's intention that the mandatory and discretionary criteria were only to be taken into account by the court at the inter partes stage in terms of section 266(4) and (5), the wording of the statute could have easily reflected that fact. But it didn't and the wording doesn't.

The application thus proceeds to the second stage which entails a hearing inter partes the member and the company. At this point, the court must again consider the mandatory and discretionary criteria which are specified in section 268(1), (2) and (3) of the Act and grant, refuse or adjourn the application for leave to raise separate derivative proceedings. Lord Reed's judgment was clear to the effect that the defenders (i.e. the director(s) and any third party against whom the substantive derivative proceedings will be directed) are disentitled from being involved in the inter partes hearing (paras. [18]-[26]), i.e. to lodge answers or to be heard. A number of reasons for this approach were advanced, not least of which was the contention that the application for leave proceedings is not concerned with the determination of their rights and obligations or any liability which might attach to them. Moreover, the Inner House was concerned to avoid engagement with the full merits of the claim at the inter partes phase, since this would entail a ‘dress rehearsal', leading to wasteful duplication of evidence and costs since the same points must necessarily be revisited at the full hearing in the substantive derivative proceedings (paras. [27]-[28] and [39]). Thus, it formed the view that affidavits and productions should be lodged and considered by the court.

With regard to the discretionary criteria which the court must take into account at both the ex parte and inter partes stages, Lord Reed made two interesting observations. First, section 268(2)(a) of the Act, which is the initial discretionary criteria which the court ought to consider, directs that the court should assess whether the petitioning member is in good faith in seeking to raise substantive derivative proceedings. Whilst Lord Glennie's judgment in the Outer House that the member was in good faith had not been challenged at the appeal, that conclusion had been reached without recourse to an evaluation of that member's subjective viewpoint or motivations. On this particular issue, Lord Reed had the following to say at para. [36]: –

"We observe however that it is possible that, at least in certain circumstances, that provision might require the court to give consideration to the view which the petitioner might reasonably hold of the merits of the proposed proceedings. In that regard, we note the approach which has been adopted by the courts of other jurisdictions (notably in Canada and Australia) where similar provisions exist."

That is to say that subjective considerations will be relevant for the purposes of the court's determination of the member's good faith. Bearing in mind that the inter partes stage is to be conducted by reference to affidavits and productions only, it is opined that this subjective assessment may prove to be slightly difficult for a court to discharge in practice.

Secondly, section 268(2)(f) of the Act provides that the court must have regard to whether the cause of action is one which the member could pursue in his own right rather than on behalf of the company, i.e. whether the claim could be best progressed as a personal action or a section 994 unfair prejudice petition. Interestingly, unlike the English case of Franbar Holdings Ltd. v Patel [2008] B.C.C. 885, where William Trower QC ruled that the availability of section 994 proceedings disentitled the shareholder claimant from being given permission to continue the derivative proceedings, Lord Reed was prepared to hold that Wishart should be given leave to raise substantive derivative proceedings in the following terms (para. [46]:

"In the circumstances of the present case, we accept that the allegations made by the petitioner against [the director] might form the basis of a petition under section 994. Such proceedings would however constitute, at best, an indirect means of achieving what could be achieved directly by derivative proceedings; and they could not provide any remedy against [the third party]. The petitioner's complaint is that [the director] has acted unlawfully, with [the third party]'s knowing assistance; not that the Company's affairs have been mismanaged. The relief the petitioner seeks is to have the Company restored to the position in which it ought to be, by an order for restitution or damages; not that he should be bought out. In that regard, we note that an order requiring him to be bought out at the present time, when the commercial property market is depressed, would not be an attractive remedy. The order sought in the proposed derivative proceedings, that the properties in question be declared to be held by [the third party] upon a constructive trust for the Company, would in reality be a more valuable remedy, since the petitioner could then benefit from any rise in the value of his shareholding over the longer term, consequent upon a recovery in the market. Furthermore, any inquiry into whether there had been mismanagement, or into the price at which the petitioner should be bought out, would require the court to establish the truth or otherwise of the petitioner's allegations, and the value of any property held by [the third party] which had been acquired through [the director]'s breach of his duties to the Company: the same issues as would be raised more directly, and with the possibility of [the third party]'s participating in the action and being ordered to make restitution or to pay damages, if derivative proceedings were permitted. We also note that the Company does not appear to be deadlocked, and that it continues to trade. In these circumstances, the availability of an alternative remedy under section 994 does not appear to us to be a compelling consideration."

The above section from the judgment of Lord Reed is extremely significant, since it underlines the types of circumstances in which the availability of a section 994 petition will nevertheless be insufficient to disempower a petitioner from proceeding with substantive derivative proceedings. To that extent, it acts as useful guidance to shareholders and their advisers in future cases.

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