Home Knowledge Commercial Court Considers Company Law Rules Regarding Shareholder Derivative Actions

Commercial Court Considers Company Law Rules Regarding Shareholder Derivative Actions

If a company suffers a legal wrong, it is the company itself (not the shareholders) which must sue in respect of the resulting damage. This is because the company is a legal person with a corporate identity separate to the identities of its shareholders. This is a long-established company law principle known as the rule in Foss -v- Harbottle.

There are limited exceptions to the rule where a shareholder can take an action in the name of the company (known as a derivative action).  One such exception arises where the wrongdoer has control of the company and exercises that control to prevent the company from taking action against the wrongdoer.  For example, if a majority shareholder who also controls the board of a company defrauds the company, the courts may allow a minority shareholder to bring proceedings in the name of the company to recover the loss arising.

In a recent Commercial Court case, a 49% shareholder in a company applied to bring proceedings against the 51% shareholders (who also controlled the board of the company) for allowing a situation to develop where the company was allegedly owed over €5m by another company (also controlled by the 51% shareholders), which was unlikely to be paid back.  The 49% shareholder claimed that it was in the interests of the 51% shareholder-directors to ensure that the company did not bring proceedings against the company owing the debt, which they controlled.  He therefore sought to bring a derivative action on behalf of the company against the 51% shareholder-directors and against the debtor company.

There was a dispute as to whether the debtor company in fact owed the €5m to the company, based on a disagreement as to the interpretation of the relevant commercial agreement between the company and the debtor company. 

The Court found that for a shareholder to take a derivative action, the shareholder must demonstrate that one of the exceptions to the rule in Foss -v- Harbottle applies (in this case, the fact that the wrongdoers controlled the company, which would otherwise prevent an action being taken).  It also ruled that before the derivative action will be permitted, the shareholder must have a “realistic prospect of success”.  On the facts (especially the disputed nature of the debt), the Court held that the 49% shareholder had not satisfied this test of showing a realistic prospect that the claim of wrongdoing would succeed.  The application therefore failed.

There is also some support in recent Irish case law for a more general exception to the rule where the justice of the case so requires.  The Court clarified that any such exception would require “a very strong case to be made out”, and would also have to be consistent with the principles underlying the decision in Foss -v- Harbottle, including a reluctance by the courts to interfere in the internal management of companies.

Contributed by Mark Quealy.

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