Franbar Holdings Ltd v Patel

• The shareholders bringing the claim (Franbar) had a 25% stake in the company • The remainder of the shares were held by Casualty Plus • Franbar alleged that the directors of the company that had been appointed by Casualty Plus had diverted business opportunities away from the company to Casualty Plus, had wrongfully suspended one of Franbar's nominated directors and had failed to provide adequate financial information

Facts

• See the case note on Mission Capital plc v Sinclair (2008), where the court dismissed the derivative claim having decided that a hypothetical director would not continue the claim and there were alternative remedies available to the claimants as shareholders. • Similarly, in Stimpson v Southern Landlord Association (2010), HHJ Pelling QC found that a hypothetical director acting in accordance with the s172 duty would not seek to continue the claim under s263(1)(a) CA 2006 o The judge also noted that the list of factors contained in s263(3) were not exhaustive, and it was open to the courts to take account of other factors • Unlike in this case (where the court looked at evidence before it to decide whether there was a prima facie case), the Scottish Court of Session in Wishart v Castlecroft Securities Ltd [2010] said at the first stage of the process there should be a "low threshold", stating that "no onus is placed on the applicant to satisfy the court there is a prima facie case; rather the court is to refuse the application if it satisfied that there is no prima facie case" • In Parry v Bartlett and Another [2011], the judge held that the existence of an alternative remedy under section 994 of the Companies Act for unfair prejudice was only a factor to be taken into account, not an absolute bar to the grant of permission to continue a section 260 claim

Impact of case on case law, legislation and practice

• The statutory derivative claim is the only proceeding by which a minority shareholder, notwithstanding his lack of control over company decision making, can commence legal action in respect of a cause of action vested in the company, seeking relief on behalf of the company, to remedy a wrong done to the company o In short, then, a derivative action is a claim brought by an individual shareholder, acting on behalf of a company, against the company's directors • The Companies Act 2006 has expanded the grounds on which a derivative claim may be brought but requires the court's permission for the continuation of such claims (s260(1) CA 2006) • A two-stage process exists by which the court decides whether or not to permit the claim to continue: o 1) The Court must first be satisfied that the particulars of the claim and the evidence submitted to support it disclose a prima facie case for giving permission to continue o 2) If the shareholder succeeds at the first stage, the court will then consider evidence from the company before deciding whether permission to continue the claim should be granted • The Companies Act 2006 (s263(2)) sets out two factors which, if present/found at any point during the process, mean the court must deny permission for the claim to continue (the "mandatory factors"): o A person acting in accordance with the s172 duty to promote the success of the company would not seek to continue the claim (s263(2)(a) CA 2006); or In other words, permission to continue must be refused if, on the balance of probabilities, a hypothetical director would decide not to pursue the claim o The act or omission has been authorised (ahead of time) or ratified (after the event) by the company (s263(2)(b) and (c) CA 2006) If it has, then permission to continue must be refused • In addition there are six factors (under s 263(3) CA 2006) to which the court should have regard when exercising its discretion to deny permission (the "discretionary factors"): o Whether or not the claimant is acting in good faith in seeking to continue the claim (Nurcombe v Nurcombe [1985]); o The importance that a person acting in accordance with section 172 CA 2006 would attach to continuing the claim; o Whether or not the act or omission could be, and in the circumstances would be likely to be, authorised or ratified by the company; o Whether the company has decided not to pursue the claim; o Whether the act or omission in question is one in respect of which the shareholder could pursue an action in his own right (this would most likely be under section 994 CA 2006) rather than on behalf of the company (Barrett v Duckett [1995]); o Any evidence before it of the views of shareholders who have no personal interest in the matter (Smith v Croft (No 2) [1988]) • The legal issue in this case was about how the two-stage process and the relevant factors should be considered when deciding whether or not a derivative claim should have permission to continue

Legal Issues

• In this case the two-stage process was effectively telescoped into one: counsel for the defendant accepted that "it would be appropriate... to deal with the entirety of the application for permission to continue at a single hearing" o In other words, the company agreed that stage 1 and stage 2 could be considered together rather than waiting to see if the court decided that the shareholder had a prima facie case for permission before getting involved o This is not really that surprising; it is unlikely that it will only be in very clear cases that a court will feel able to use either the mandatory factors or the discretionary factors to knock out a claim without any evidence being given by the company

Obiter, Dissent, and Other Judges

• It is noteworthy that during the course of the Parliamentary debates before the Companies Act 2006, the point was made that the new statutory procedure carried the risk of increased litigation against directors, which could impede the efficient management of companies. However, on the other hand, derivative actions exist to ensure that minority shareholders are adequately protected.

Policy Considerations

• The court refused Franbar permission to continue with the derivative claim • The court first found that neither of the mandatory factors were made out (i.e. there was no need to deny permission for the claim to continue by looking at the mandatory factors alone), so the court went on to consider the discretionary factors • The first discretionary factor of importance in this case was the factor considering the importance that a person acting in accordance with s172 CA 2006 (i.e. directors' duty to promote the success of the company) would attach to the claim o The court found that such a person (i.e. a hypothetical director) would not attach much importance to continuing the claim o The court identified a number of factors that directors would take into account in deciding whether or not to continue to pursue a claim, including, its prospect of success, the enforceability of any judgment obtained, disruption of the litigation to the company's business, costs of proceeding, and the impact on the company's reputation • The other discretionary factor that was decisive was whether the alleged wrongdoing gave rise to a cause of action that the shareholder could pursue in his own right rather than on behalf of the company o The court found the applicant had alternative means of recourse in his own right o Franbar had already brought an unfair prejudice claim under section 994 of the Companies Act 2006 as well as a claim for breach of its shareholders agreement with Casualty Plus

Ratio Decedendi

• A derivative action was struck out in Smith v Croft (No 2) (1988) because a majority of the independent shareholders' votes would have been cast against allowing the action to proceed and there was no evidence to suggest that they would have cast their votes in any way other than that which they believed was in the company's best interest • It is apparent that the new approach taken in this case (and other cases) reflects the stance established by case law pre-dating the 2006 Act o For example, in Mumbray v Lapper (2005) the availability of alternative remedies, for instance s994 CA 2006, and the fact that the derivative claim would not have been in the interests of the company, were factors taken into account in deciding to refuse leave o Similarly, in Jafari-Fini v Skillglass (2005) the Court of Appeal upheld the judge's refusal to allow the derivative claim to continue - Chadwick LJ explained that the company itself would not benefit from the action and the claimant shareholder had alternative avenues open to him, in particular, a personal claim

Relationship to previous cases