Kenneth Sinclair on behalf of C.J.C. Media (Scotland Limited v Gary Clark and CJC Media (UK) Limited 2020 SAC (Civ) 11

There is a general rule that members of a company cannot bring actions against the company directors for breaches of duty or negligence. The company itself is the correct claimant in any action seeking restitution to the company.

The derivative action is one of few exceptions to this rule. If the company is not taking justified remedial action (perhaps because the wrongdoing party controls the company) the Companies Act 2006 potentially enables a member to step in and raise derivative proceedings on the company's behalf, with the benefit of an indemnity from the company for the litigation costs. However, prior consent of the court is required before derivative proceedings can be raised. That consent is not easily obtained.

This recent decision from the Sheriff Appeal Court serves as a useful reminder of some of the statutory safeguards designed to prevent members from abusing this form of proceedings.

Background

In March 2013, Mr Sinclair resigned as a director of CJC Media (Scotland) Limited ("CJC"). He maintained a 50% shareholding in CJC, with the other 50% shareholding being held by the sole remaining director, Mr Clark.

Mr Sinclair immediately incorporated a new company. Within 3 weeks, his new company had secured a significant contract at the expense of CJC. In subsequent Court of Session proceedings raised by the Company (C.J.C. Media (Scotland) Limited v Sinclair [2019] CSOH 8) it was held that Mr Sinclair had breached duties owed to CJC before and after his resignation. He was ordered to pay damages.

The derivative proceedings

The Sheriff Appeal Court judgement concerns separate (but related) proceedings brought by Mr Sinclair. Mr Sinclair sought remedies, on behalf of CJC, primarily against Mr Clark. Mr Clark was also now running a new business with similar commercial interests to CJC, though he was apparently no longer trading under CJC following the fallout with Mr Sinclair.

The appeal challenged a Sheriff Court's decision to grant Mr Sinclair leave to raise proceedings on CJC's behalf. The application for leave had been granted without prior service on CJC. The Sheriff Appeal Court found that CJC had been deprived of its statutory right to take part in the proceedings and that there had been a failure to exercise an essential control on the potential abuse of derivative proceedings. The court therefore held that leave had not been granted competently.

The court then considered whether it should grant leave retrospectively. The 2006 Act sets out a number of factors which the court has to take into account in deciding whether to grant leave. Some of these factors operate as absolute bars to the claim. One such mandatory bar is where the court is satisfied that a hypothetical director seeking to promote the company's best interests would not bring the claim. Other factors are discretionary: the judge has to weigh them up and decide whether, on balance, leave should be granted. One of the discretionary factors is whether the member is acting in good faith.

The court took the view that, had the correct procedure been adopted at the outset, there would have been considerable doubt as to whether Mr Sinclair was entitled to leave to raise derivative proceedings. Against a background of Mr Clark and Mr Sinclair both having clearly moved on from CJC, the court considered that granting leave (and the cost indemnity that comes with it) would unfairly privilege Mr Sinclair at Mr Clark's expense. With reference to the Court of Session's earlier decision against Mr Sinclair, the court also expressed doubts as to whether he was acting in good faith.

Summary

Whilst derivative actions often seem to be an attractive option to disgruntled shareholders, courts in England and Scotland are usually unwilling to grant leave for such proceedings if the dispute is truly one between warring shareholders. In that scenario, an aggrieved party may be better to consider proceedings under sections 994 and 996 of the Companies Act 2006, alleging unfairly prejudicial treatment.

For more information on shareholders rights and remedies, contract Ryan Openshaw or your usual Brodies contact.

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