The advantages of derivative claims over unfair prejudice petitions

Introduction

An LLP member or company shareholder:

• who is in the minority and thus outvoted, and
• whose co-proprietors have misused or misappropriated business assets (including the misdirection of corporate opportunities),

may in some circumstances be able to pursue a claim against his co-proprietors on behalf of the LLP or company (even though the LLP or company is otherwise controlled by the misbehaving majority), in order to seize back the assets and/or to recover compensation for the LLP or company. Furthermore the LLP or company might well be ordered, at the outset of the claim, and throughout the conduct of the claim, to pay most of the member/shareholder’s legal costs incurred in bringing the claim, and to indemnify the member/shareholder against any obligation that he might otherwise incur to pay his opponents’ costs, in the event that somehow the case goes against him.

He would thus have a complete toolkit to enable him to obtain justice with limited expenditure and risk.

This happy state of affairs (for the claimant) can sometimes be achieved by pursuing a derivative claim.

The recent case of Bhullar v Bhullar¹ was pursued as a derivative claim. That case involved one of the directors of some family companies causing those companies to make substantial alleged loans to another company that was wholly owned by him. He was found to have acted in breach of his fiduciary duty to the family companies and was required to return the monies concerned.²

Why not just pursue an unfair prejudice petition?

Put-upon shareholders or LLP members have an alternative route to a remedy, being the unfair prejudice petition. But there can be problems involved in taking that route, including

• In order to be permitted to pursue an unfair prejudice petition, a member or shareholder must not have declined any offer by his co-proprietors to purchase his LLP membership share or (company) shares at a proper valuation (taking all relevant matters into account), and in many cases that is the remedy that is granted (an order requiring the majority to purchase the minority’s interest at an appropriate valuation). But in some cases, for good reason, the member or shareholder may not want to sell his (LLP membership) share or (company) shares.
• In relation to LLPs, the LLP members’ agreement may exclude the right to pursue an unfair prejudice petition (this right cannot be excluded in relation to companies).
• Unfair prejudice petitions usually involve reviewing and documenting the lengthy history of the claim. Often an investigation as to the true facts (known only to the opponent) needs to be carried out in the course of the proceedings. Thus unfair prejudice petitions involve considerable expense right from the outset, and throughout the proceedings, and there is also a risk of having to pay the opponents’ costs if things don’t go well. While it is possible to purchase adverse costs insurance, this is a substantial additional expense, which cannot under under circumstances be recovered from the opponent.

Permission required to pursue a derivative claim

Not every would-be claimant will be permitted to bring a derivative claim. The claimant has to obtain the court’s permission, in a two stage process³. The court can deny permission on a number of bases, some of them being absolute bars to permission, and others being discretionary.

The absolute bars include where it is found that no (notional, as opposed to actual) member/director acting in accordance with his duty to promote the success of the LLP/ company would seek to pursue the claim. Such a bar is unlikely to apply in most cases of fraud perpetrated against the LLP/company. In the case of an LLP, the claim must allege fraud on the minority (wrongly causing them to be disadvantaged) that has resulted in personal benefit to members of the majority (in contrast to company derivative claims where breaches of duty that result only in loss to the company, and no gains to the individuals, can nonetheless be the subject of a derivative claim).

Discretionary grounds include where the claimant has another form of remedy that he could pursue (though, in Hook v Sumner⁴ the claimant was permitted to proceed, on the grounds that while he could have pursued an unfair prejudice petition he did not want to sell his shares).

Costs

Once through the maze of possible objections to a derivative action the member or shareholder can apply for a pre-emptive costs order. Such an order requires the LLP or company to bear all of the claimant’s costs. Such orders are in the discretion of the court, but will normally be granted if the proceedings are entirely for the benefit of the company or LLP, the claim is such that a notional, reasonable board of directors (not the actual board of directors) would pursue such a claim, there is no benefit to the claimant (other than the recoveries by the LLP or company), and there is no inappropriate collateral purpose or motive.

A claimant can also seek an order that his costs should be paid by the LLP or company as the claim proceeds. This might for example include the monthly discharge by the LLP or company of the claimant’s solicitors’ interim bills, subject to a possible review at the end of the case (or as the case proceeds) to ensure that the costs are at a reasonable level. Interim payments of this sort may well not be available if the claimant has the means to pay the costs himself, though this issue is only likely to affect claimants with very deep pockets.

One problem that can arise is that the LLP or company has no or insufficient assets to enable it to pay the claimant’s legal costs, because its assets have been misappropriated by the majority. In such a case an early application against the majority seeking an interim payment in relation to the claim could be considered.

1. [2017] EWHC 407 (Ch)
2. Owing to Limitation Act 1980 s.21(1)(b) the defendant’s limitation defence failed because the misappropriated monies fell to be treated as trust monies in the hands of a trustee. Furthermore, though not found to have acted dishonestly, his attempt to be relieved of liability under Companies Act 2006 s.1157 also failed, as he had not acted reasonably.
3. See for example Wilton UK Ltd v Shuttleworth [2017] EWHC 2195 (Ch), which dealt with the consequences of failure to obtain permission before serving the proceedings, in circumstances in which by the time the error had been discovered the four month period for valid service and the limitation period had both expired.
4. [2016] B.C.C. 220