A derivative action is brought for the company’s benefit by someone who will not receive the proceeds. Sections 144 to 146 of the Companies Act 1997 make that workable.
Section 144 — the company pays
The Court shall, on the application of the shareholder or director to whom leave was granted, order that the whole or part of the reasonable costs of bringing or intervening in the proceedings — including any costs relating to any settlement, compromise, or discontinuance approved under section 146 — shall be met by the company, unless the Court considers that it would be unjust or inequitable for the company to bear those costs.
The word is “shall”. The default is that the company pays the reasonable costs, and the burden lies on whoever says it would be unjust or inequitable.
That is the necessary counterpart of section 143. Without it, a shareholder would be funding litigation whose entire benefit accrues to the company — and, indirectly, to the very majority that refused to sue. It also explains the section 143(2)(b) factor: the Court weighs the costs of the proceedings in relation to the relief likely to be obtained before granting leave, because the company will be paying them.
Note that section 144 covers costs of a settlement, compromise or discontinuance approved under section 146 — so an applicant who properly compromises the claim is not left out of pocket.
Section 144 operates “on the application of the shareholder or director”. It is not automatic. The sensible course is to seek the costs order at the same time as leave under section 143, so that funding is settled before the litigation begins.
Section 145 — the Court controls the proceedings
(a) make an order authorising the shareholder or any other person to control the conduct of the proceedings; and
(b) give directions for the conduct of the proceedings; and
(c) make an order requiring the company or the directors to provide information or assistance in relation to the proceedings; and
(d) make an order directing that any amount ordered to be paid by a defendant shall be paid, in whole or part, to former and present shareholders of the company or related company instead of to the company.
The documents and witnesses are inside the company, which is controlled by the people being sued. An order requiring the company or the directors to provide information or assistance is often the single most important order in a derivative action, and should be sought early.
It complements the shareholder’s standing rights to inspect records under sections 216 and 219, and the power under section 220 to order an investigation of the company’s records.
Ordinarily the fruits of a derivative action belong to the company — which means they benefit the wrongdoing majority in proportion to their shareholding. Paragraph (d) lets the Court direct payment to former and present shareholders instead.
That neutralises the objection that a successful minority claim simply hands money back to the people who caused the loss. It also assists former shareholders, who may have sold out because of the very conduct complained of.
Section 146 — no settlement without the Court
No proceedings brought by a shareholder or a director, or in which a shareholder or director intervenes, with leave under section 143, may be settled or compromised or discontinued without the approval of the Court.
The claim belongs to the company, but it is being run by someone else. Without section 146, a defendant director could buy off the applicant personally — settling on terms good for the applicant and poor for the company — and the company would lose a claim it never controlled.
Court approval also protects the applicant: a settlement approved under section 146 carries the costs protection of section 144.
Running a derivative action in practice
- Gather the material first. Use the inspection rights in sections 216 and 219, and consider a section 220 application, before applying for leave.
- Ask the company to sue. Section 143(3)(a) turns on whether the company intends to act; a written request and the response are the evidence.
- Serve notice of the application as section 143(4) requires, and expect the company to state its position under section 143(5)(b).
- Address the four factors in section 143(2) squarely — merits, costs against likely recovery, what the company has done, and the company’s interests.
- Seek the section 144 costs order with leave, and the section 145(c) information order at the same time.
- Consider asking for a section 145(d) direction that any recovery go to shareholders, particularly where the wrongdoers hold a majority.
- Do not settle privately. Any settlement, compromise or discontinuance needs Court approval under section 146.
- Consider running section 152 in parallel. The prejudiced shareholder remedy requires no leave and produces personal relief, including an order that the company or another person acquire the shareholder’s shares.
Under section 154(3), ratification or approval by shareholders of a purported exercise of power does not prevent the Court from exercising a power which might, apart from the ratification, be exercised in relation to the action of the director or the board. A majority cannot ratify its way out of a derivative action.
Sources
- Companies Act 1997 — ss 141–146, 152, 154, 216, 219, 220
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.