Derivative Actions In The Uk
1. Introduction to Derivative Actions
A derivative action is a lawsuit brought by a shareholder on behalf of the company against directors or third parties for wrongdoing committed against the company.
The claim is derivative because the company itself is the true claimant, but the shareholder is allowed to bring the action if the company fails to act.
Governed primarily by Companies Act 2006 (Part 11, Sections 260–264).
2. Legal Framework
A. Companies Act 2006 – Key Sections
Section 260:
Right of a member to bring proceedings in respect of a cause of action arising from negligence, default, breach of duty, or breach of trust by a director.
Section 261:
Definition of “eligible derivative claim” — must relate to acts or omissions of directors in breach of duty.
Section 263:
Court may authorize derivative action if:
Shareholder is acting in good faith, and
It is in the company’s best interest.
Section 264:
Court can impose conditions, including costs, security for costs, or settlement terms.
3. Procedure for Derivative Claims
Application to Court for Permission
Shareholder applies for permission to continue derivative action.
Court examines:
Good faith of applicant
Whether the act is truly a breach of duty to the company
Whether the action is in the company’s interest
Court Authorization
Only with court approval can the derivative claim proceed.
Outcome
Any judgment or damages are awarded to the company, not the individual shareholder.
4. Key Features
Only applies to wrongdoing against the company, not personal grievances.
Must demonstrate failure or unwillingness of the company to act.
Designed to prevent minority oppression while avoiding frivolous litigation.
Section 263 gives courts broad discretion to authorize or deny the claim.
5. Key Case Laws on Derivative Actions
| Case | Principle |
|---|---|
| Foss v. Harbottle (1843) | Established the “proper plaintiff rule”: company, not individual shareholders, sues for wrongs done to the company. |
| Daniels v. Daniels [1978] | Recognized minority shareholder’s derivative action for director misconduct. |
| Smith v. Croft (No. 2) [1988] | Court considers whether shareholders are acting in good faith; derivative claims must benefit the company. |
| Stainer v. Lee [2001] | Affirmed derivative action can proceed even if majority opposes, but requires court authorization. |
| Iesini v. Westrip Holdings Ltd [2009] | Court clarified threshold for “good faith” and company interest in Section 263 authorization. |
| Kleanthous v. Furlonger [2016] | Confirmed derivative action applies to breaches of directors’ fiduciary duties, even in private companies. |
| Wallersteiner v. Moir (No. 2) [1975] | Established principles on funding and indemnification for derivative actions. |
| Foss v. Harbottle principle revisited: Re HLC Environmental Projects Ltd [2012] | Emphasized court discretion under Companies Act 2006 for minority shareholders to pursue derivative claims. |
6. Advantages of Derivative Actions
Protects Minority Shareholders
Provides a mechanism when majority refuses to act.
Enforces Directors’ Duties
Ensures directors remain accountable under Sections 171–177 (fiduciary duties).
Reduces Frivolous Litigation
Court authorization prevents misuse of derivative claims.
Maintains Corporate Governance
Encourages transparency and proper decision-making.
7. Limitations
Only for wrongdoing to the company, not personal grievances.
Requires court approval, which can be time-consuming and costly.
Success depends on proving good faith and that action benefits the company.
Case Reference: Smith v. Croft (No. 2) [1988] – derivative action dismissed where shareholders acted primarily for personal gain.
8. Summary
Derivative actions are safeguards for minority shareholders against director misconduct.
Governed by Companies Act 2006, with key provisions in Sections 260–264.
UK courts have developed principles emphasizing:
Good faith of shareholders
Company interest
Director accountability
Prevention of frivolous litigation
Landmark cases like Foss v. Harbottle, Daniels v. Daniels, and Iesini v. Westrip remain cornerstones of derivative action jurisprudence.
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