Management liability case update
Looking at the case of Hughes v Burley and others  EWHC 104 (Ch) and the application of derivative claims.
The claimant architectural consultant and the first defendant (collectively “the Directors”) went into business developing properties via the fourth defendant, a limited company in which they were directors and equal shareholders (“the Company”). Properties were purchased by the Company financed by secured loans from the first defendant. Profits were to be shared equally by the claimant and first defendant following sale of the properties and repayment of the loans.
The relationship between the Directors deteriorated. Initially they intended to complete the Company’s existing projects, but work stalled due to the COVID pandemic. The Directors agreed that they would cease working together but failed to agree terms. The first defendant appointed the third defendant, a licensed insolvency practitioner, as a fixed charge receiver over the Company’s properties. Rather than market the Company, the third defendant decided to dispose of the Company’s assets to the second defendant, a company controlled by the first defendant.
The claimant pursued claims against the first and third defendants in respect of alleged breach of duties owed directly to him. The claimant also pursued a derivative claim against the first and third defendant in respect of alleged breaches of duties owed to the Company. The claimant applied for permission to continue the derivative claim pursuant to Part 11 Chapter 1 of the Companies Act 2006 (“the 2006 Act”).
Pearce J rejected the defendants’ argument that the alleged causes of action were unarguable, notably finding that a derivative claim can be brought in respect of a director’s alleged breaches of duties arising outside his or her role as a director, such as (in this case) the first defendant’s alleged role as a participant in a joint venture:
“Whilst derivative claims against directors will often involve allegations of breach of duties said to arise from that role, it is perfectly possible to conceive of circumstances in which a company has a potential claim against a director arising from acts or omissions which are not incidental to the person's role as director. Indeed, if the claimant's case here is made out both in fact and in law, it is strongly arguable that the duties in respect of which the derivative claim is pursued do not arise from the first defendant's role as director, but rather from his role as co-venturer with the claimant. If the claim is otherwise maintainable by the company, is the claimant to be prevented from pursuing a derivative claim against the first defendant? To allow this would run counter to the justification for derivative actions enunciated by Lord Denning in Wallersteiner v Moir (No. 2). I am not satisfied that the right to bring a derivative claim is limited in the manner contended for by the defendants.”
Having determined that the various causes of action alleged by the claimant were at least arguable, Pearce J considered whether the court had jurisdiction to grant permission with reference to s.263 of the 2006 Act, which provides that “(2) Permission (or leave) must be refused if the court is satisfied - (a) that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim”.
Considering the position of a hypothetical director of the Company with regard to the criteria set out in s.263(3) and (4) of the 2006 Act, Pearce J concluded that the litigation would be drawn out and expensive and, given the Company’s insolvency, “a person having regard to their duty under section 172 of the 2006 Act would undoubtedly pause long and hard before deciding to proceed with the litigation”. Since the claimant had not offered any evidence that he had the means to fund pursuit of the litigation or any adverse costs order that may be made, and since he had also not indemnified the Company in relation to costs, Pearce J was not persuaded that it would be proper to give permission for this derivative claim to proceed.
While this case indicates that derivative claims are of potentially broader application than is immediately apparent, directors and their insurers will note the difficulties facing shareholders who seek to pursue derivative claims, especially where the objective of the litigation is of limited consequence to the company as opposed to the shareholders themselves.