SHAREHOLDERS REMEDIES [1997] EWLC 246(APPENDIX D) (24 October 1997)

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The Shareholders Action in Scotland, views and recommendations of the Scottish Law Commission

Introduction

1. This appendix contains the views and recommendations of the Scottish Law Commission on the shareholders action in Scotland which achieves a similar practical result to the derivative action in England and Wales discussed in Part 6 of the Report.

Background

2. In the consultation paper, the proposal was made to introduce a new right of action by a shareholder on behalf of the company which was described as a derivative action. It was recognised that Scots law, however, did not have a derivative action and that Scots procedure differed from that of England and Wales.(1)In Scotland a shareholder has a right to raise an action in certain circumstances to protect the interests of his company and to seek a remedy on its behalf.(2) The shareholders right of action is conferred by substantive law and not by procedural rules.

3. In Scots law, title to sue is a matter of substantive law and not of procedure. As several consultees pointed out in their responses to the consultation paper, this affects the way in which the proposed reforms can be implemented in Scotland. While in England and Wales the new remedy may be introduced in large measure by adopting new rules of court, that mechanism is not available in Scotland.

4. Our policy is to achieve, so far as possible and reasonable, consistency in substantive company law throughout the United Kingdom, as the United Kingdom is an integrated economy. It is also our policy that the mechanism for the proposed reforms should be capable of being adapted to take account of developments in company law. Although the proposed mechanism to implement the reform differs from that of England and Wales, the aim is to achieve the same practical result as a matter of substantive company law.

5. In this appendix we set out, first, the reasons why it is necessary to legislate to provide the proposed solution for Scotland, secondly, the scope of the proposed new statutory right and, thirdly, the mechanism by which the right may be implemented.

The need for legislation

6. Scots law recognises the right of a shareholder to raise an action to protect his own interests and also his separate right to raise an action to obtain a remedy for the company. However, the reasoning in the few reported cases which deal with these actions is neither consistent nor developed.

7. A shareholder in Scotland can raise an action on his own behalf to protect his personal interests. Thus the shareholder can raise an action against his company to prevent or nullify an ultra vires act.(3) He can enforce personal rights in the companys articles of association.(4) It is likely also that a shareholder can raise an action where there has been an irregularity in a resolution requiring a qualified majority.(5)A shareholder may also raise an action against an individual director or directors for damages for fraud or fraudulent misrepresentation.(6)

8. A shareholder also has title as a matter of substantive law to raise proceedings in respect of a directors breach of duty to obtain a remedy for the company. In our view, his title to sue arises from his status as shareholder which gives him an interest in the company. The rights which the shareholder can enforce against a director or a third party are those of the company. The remedy is obtained for the company. The shareholders right to raise proceedings is available where the action complained of is fraudulent or ultra vires the company and so cannot be validated by a majority of the members of the company. It is not available where a majority of members acting in good faith have validated or may validate the act complained of.(7)

9. As a matter of substantive law two rules apply to both actions to protect a shareholders personal interests and actions to protect the companys interests, namely that the directors of a company owe duties to the company and not to the shareholders and that the court will not interfere in matters of internal management which a majority of shareholders may sanction.(8) Thus, Scots law achieves results which are similar in effect to the first two limbs of the restatement of the rule in Foss v Harbottle.(9) In our view, this similar result in Scotland is not based on the procedural principles of Foss v Harbottle but is a matter of substantive law. However, in two cases the courts have adopted the principles of Foss v Harbottle.(10)This has given rise to significant doubts as to the basis on which a shareholder is acting when he raises proceedings alleging that the company has acted ultra vires or that it has purported to pass by simple majority a resolution which requires a special majority or where there has been fraud on the minority.(11) These doubts could hamper future development of Scots law in this field.

10. The proposed reform of shareholder remedies offers an opportunity to remove these doubts and place the shareholders right of action to protect the interests of the company on a more secure foundation. Consultees for the Scottish interest expressed different views. Some considered that a new statutory right of action to protect the interests of the company is not necessary. The majority, however, considered that the importation of the principles of Foss v Harbottle into Scots law was both unsatisfactory and unnecessary. They considered that there is a need to clarify the basis and scope of the shareholders right of action under Scots law. In our view, the paucity of case law and the reference in the minority of cases to Foss v Harbottle lead to actual and potential confusion. We consider it appropriate that this confusion should be laid to rest. Accordingly, as respects Scotland, we recommend: (12)

(1) that the right of a shareholder to raise an action to protect the interests of his company and to obtain a remedy on its behalf should be put on a clear statutory basis (clause 1: new section 458B).

The scope of the proposed new statutory right and the mechanism by which it may be implemented

11. The Law Commission explain the guiding principles for their recommendations in relation to the reform of the law and procedure relating to shareholder remedies. Scots law has substantive rules which have the same effect as some of those guiding principles.(13)

12. The discussion which follows of the circumstances in which an action may be brought under the new statutory provision recommended for Scotland and other matters in relation to this right of action is structured to fit with the order in which the discussion in Part 6 of the Report is set out. For ease of understanding, the discussion in this appendix, where appropriate, follows the same headings as are used in that Part.

Should the right of action under the new statutory provision be available only in respect of breaches of duty by a director (including claims against third parties as a result of such breaches)

13. The recommendations of the Law Commission(14) encapsulate a number of policy issues. Much of the related discussion, though set in the context of the different background applicable for England and Wales (that of the derivative action which for England and Wales is a procedural mechanism), is equally relevant for Scotland. We agree with the policy which the Law Commissions recommendations seek to implement.

14. In summary, the relevant issues encapsulated in the Law Commissions recommendations are as follows:

- whether breach by a director of a duty which he owes to the company should be a necessary pre-condition for the right of action under the new statutory provision which we recommend for Scotland;

- what should constitute breach of duty for the purposes of this new provision; and

- should the right of action be available for breaches of duty by officers and employees who are not directors.

Whether breach by a director of a duty which he owes to the company should be a necessary pre-condition for the right of action under the new statutory provision which we recommend for Scotland

15. We agree with the Law Commission that if there is no breach of duty by a director, a shareholder should not be bringing the action.(15) An action should be able to be brought under the new statutory provision in respect of a breach or threatened breach of duty by a director, against the director and against a third party, where the company otherwise would be entitled to raise an action against the third party, and where that cause of action - the fact or combination of facts which must be proved to entitle the company to succeed - arises directly or indirectly as a result of the directors breach or threatened breach of duty.(16) It should be possible to raise an action against both a director and a third party, so with the possibility of joint and several liability. A director for this purpose should include a "shadow director"; we agree that de facto directors should be included and that they are capable of coming under the definition of director in section 741 of the Companies Act 1985.(17)

16. Some concern was expressed on consultation for the Scottish interest that the scope of the right to raise an action under the new provision against a third party should be free from doubt. The directors breach of duty itself would not be sufficient as a cause of action against the third party in most cases where the right of action should lie. An attempt to recover company funds or assets from the third party normally would require proof of facts other than the directors breach of duty, yet should be competent under the new statutory provision.

17. We agree that in such cases, the cause of action against the third party will not merely be the directors breach of duty. Rather, the action will be for eg, vindication of the companys real right of ownership of company assets held by a third party on a void title; restitution of property held by a third party on a voidable title; repetition from a third party of company funds received by him in bad faith or gratuitously; recompense, where the third party has obtained the benefit of company funds or other assets but no longer holds or has consumed these; or a delictual claim where the third party has participated in the directors breach of duty, eg by complicity in theft by the director of company funds or other assets.

18. In all such cases, however, the breach of duty will be the underlying problem, giving rise to the third partys own bad faith or other actionable conduct. Where that is not the case, eg a delictual claim against the third party does not arise from a directors breach of duty,(18)we agree that the action against the third party should not be a matter for the new statutory provision. We do not envisage an action proceeding against a third party under the new statutory provision in all circumstances where the directors breach of duty is one of the facts to be proved to succeed in a claim against the third party. For example, the shareholders action should not proceed against an auditor for professional negligence where an auditor fails to detect a misappropriation of funds by a director. In such a case there is not a sufficiently close connection with the directors breach of duty, the auditor having neither received, nor had the benefit of, the companys assets nor having participated in the directors breach of duty. In other words, the directors breach of duty is not the underlying problem which gives rise to the auditors actionable conduct. The policy of the Law Commissions is consistent in this respect.(19)

19. So, too, we consider that the ordinary common law defences in relation to the cause of action against the third party should still be available. In an action of restitution, repetition or recompense, therefore, the pursuer should still have to prove the third partys knowledge of the directors breach of duty - so bad faith - or that the third party did not give value for the companys funds or other assets,(20)and in a delictual claim, he should still have to prove that the third party knowingly participated in the directors wrongful conduct.

What should constitute a breach of duty for the purposes of this new provision

20. We have explained above(21) that we agree that an action should be capable of being brought under the new statutory provision in respect of a directors breach of duty. We agree similarly that it should be made clear that breach of duty includes negligence(22) (regardless of whether or not any director has benefited personally) and statutory default,(23) and accordingly that the relevant legislation implementing the recommendation (and the parallel recommendation(24) made in this appendix for Scotland) should adopt the expression used in sections 310 and 727 of the Companies Act 1985, namely "negligence, default, breach of duty or breach of trust".(25)

21. We share the Law Commissions view that it is not appropriate, in the limited context of the shareholder remedies exercise, to seek to resolve the issue of whether the obligation of a director not to place himself in a position where his personal interests conflict with his duties to the company amounts to a duty and not merely a disability.(26) This is an issue of wider significance. We agree, however, that it is appropriate for the legislation implementing our respective recommendations to make clear that a shareholder has title to bring whatever action the company could bring in respect of such conduct.

Should the right of action be available for breaches of duty by officers and employees who are not directors

22. Consultation responses for the Scottish interest disclosed mixed views as regards whether the new statutory provision should allow actions to be brought against officers and employees (other than directors) in respect of a wrong or threatened wrong by them towards the company, and the circumstances in which such an action should be competent.

23. The Law Commission conclude(27) that the new derivative action for England and Wales should not extend to claims based on breach of duty by such employees and officers (unless, of course, they arise also out of a breach of duty by directors). Employees and officers other than directors, therefore, would be in the same position as other third parties.

24. We agree with that view and consider that, for Scotland, the right of action of a member of a company under the new statutory provision should be similarly confined in scope.

25. Accordingly, we agree with the Law Commissions recommendations(28)on the matters discussed in this part of the appendix. Given that, for Scotland, the context for the new statutory provision is different from that for England and Wales,(29)it is appropriate to set out equivalent recommendations framed to fit the Scottish background. Accordingly, we recommend:

(2) that a shareholder should be entitled to raise an action under the new statutory provision for Scotland if the cause of it arises as a result of an actual or threatened act or omission involving

(a) negligence, default, breach of duty or breach of trust by a director of the company, or

(b) a director putting himself in a position where his personal interests conflict with his duties to the company (clause 1: new section 458B, subsection (1)); and

(3) that

(a) the action might be against the director or some other person, or both (clause 1: new section 458B, subsection (2)); and

(b) for the purposes of the new statutory provision, "director" should include a shadow director (clause 1: new section 458B, subsection (9)(a)).

26. The Law Commission recommend(30) that the new derivative action for England and Wales should be available only to members of the company, and not to those who have ceased to be members of it.

27. No qualifying period of membership is recommended.(31) A majority of the consultees for the Scottish interest considered that there should be no such requirement, with one considering that there should be. On balance, we agree that such a requirement is not appropriate. Any current member should have the right to raise an action under the new statutory provision. Accordingly, we similarly recommend:

(4) that the right of action under the new statutory provision for Scotland should be available only to members of the company (clause 1: new section 458B, subsection (1)).

Extent to which common law right of shareholder to raise action to protect interests of company and obtain remedy on companys behalf should be replaced

28. The Law Commission recommend(32) that, for England and Wales, the new procedure should replace entirely the common law right to bring a derivative action, with section 459 of the Companies Act being available for any exceptional cases of hardship.

29. We agree that it is important also for Scotland that the existing common law right of a member to raise an action to protect the companys interests and to obtain a remedy on its behalf and the new statutory right to raise such an action do not co-exist. If they did, this would lead only to confusion. Rather, our aim is to make the law more accessible and simpler. If the existing shareholders common law right of action were to remain, alongside the new statutory right, then abrogation for England and Wales of the common law derivative action as an exception to the rule in Foss v Harbottle would necessarily lead to speculation and uncertainty as to the effect for the future of the Scottish cases which appear to have imported that rule and that exception into Scots law.(33) Further, it would be reasonable to expect that there would be attempts made to clarify what the distinction was between the scope of the common law right and that of the new statutory right. We consider that this would lead to unsatisfactory results.

30. As discussed above,(34) we consider that there is clear authority under Scots law that a shareholder has a direct right of action to protect the interests of the company and to seek a remedy for it in respect of a directors breach of duty. We have also explained our view that we consider that the case of Foss v Harbottle and what have become known as the qualifications and exceptions to the rule in that case do not need to be relied on to ascertain or confine the scope of that right of action. We consider it appropriate, therefore, that for Scotland what has become known as the rule in that case and the qualifications and exceptions to it are laid to rest in respect of such an action. Accordingly, we recommend:

(5) that the right of action under the new statutory provision for Scotland should replace the common law right of a shareholder to raise an action to protect the interests of the company and seek a remedy for the company in respect of a directors breach of duty (clause 1: new section 458B).

Actions by a shareholder of a company to protect his own interests and to seek a remedy for himself

31. As discussed above, a shareholder has a separate right to raise actions to protect his own interests.(35)We propose no changes to the law in respect of such personal actions. We recognise that dicta in Brown v Stewart(36) which refer to the principle of Foss v Harbottle have created doubts about the basis on which the shareholder raises such proceedings. We consider however that the case goes no further than to confirm two substantive rules of common law, namely that a director owes his duties of good faith etc to the company and not to individual shareholders, and that a minority shareholder who wishes to challenge a transaction, which may be made binding on the company, may be overruled by the majority of shareholders if they choose to ratify the transaction.

Additional restrictions which should apply to right to bring action under new statutory provision

32. The existing common law right of a shareholder under Scots law to bring an action to protect the companys interests and to seek a remedy for the company, in respect of a directors conduct, is not unfettered. In substance, the right has been circumscribed by the courts by the application of criteria and the balancing of a number of matters. For instance, there appears to be a substantive requirement for the pursuer to give the company an opportunity to consider whether to ratify the alleged wrong or to raise the action;(37)effective ratification of the directors conduct bars a shareholders action;(38) the court looks at whether the action is in the interests of the company in considering whether a shareholders action is competent - and thus to permit an exception to the substantive rules of Scots law described above.(39)

33. In substance, a similar practical result has been achieved to that applied for English law by the application of the rule in Foss v Harbottle and the qualifications/exceptions to that rule.

34. As discussed above,(40) in some Scottish cases, these restrictions appear to have been applied expressly in reliance on the Foss principles, and so have been regarded by some as dependent on that case. The paucity of case law and the reference in the minority of cases to Foss v Harbottle lead to actual and potential confusion.

35. Replacement of the existing common law right of action, therefore, with a new statutory right has the further additional benefit of enabling the difficulties and doubts to be laid to rest. The substantive criteria which the courts should apply, therefore in determining title to sue and the matters which should be balanced by the court could usefully be clarified and made accessible.

The appropriate legislative vehicle

36. The Law Commission explain(41) that in English law the derivative action is a procedural mechanism, that the conditions in which it may be brought are procedural matters, and that accordingly these can be set out in, and so in future changed also simply by, rules of court.

37. Under Scots law, title and interest to sue are matters of substantive law.(42) Before being allowed to enter on the merits of this case, a pursuer, if called on by the defender, must satisfy the court not only that he is the proper person to pursue that action, but also that he has a real interest in its result. In respect of title, he must satisfy the court that he has a formal legal right to pursue the action. He must have both title to sue at the date of raising the action and a continuing title to pursue the action to the final judgment.

38. In our view, it is not competent for substantive matters concerning title to sue to be dealt with by rules of court under cover of the provisions of section 5 of the Court of Session Act 1988 or section 32 of the Sheriff Court (Scotland) Act 1971. Substantive matters of title to sue are outwith the competence of those sections which enable, rather, procedural matters to be dealt with in rules made under them.

39. Significant problems could arise, however, if the relevant criteria and matters were enshrined in primary legislation. They would be crystallised, and the ability to change them in the future would be restricted - further primary legislation would be required. In contrast, for English law, changes to the rules of court would be a relatively simple matter, and could readily be made to keep abreast of the courts application of and development of the relevant criteria and matters.(43)

40. In an area of law such as this, we consider it highly desirable that there should be consistency in policy between English law and Scots law. In order to achieve that consistency, where appropriate, it is important that, for Scots law, the relevant criteria and matters similarly can be changed to keep abreast of future developments.

41. One alternative means of stating the criteria and matters, therefore, would be for primary legislation to confer express power for the relevant criteria and matters to be prescribed by Act of Sederunt. The Lord President of the Court of Session has advised us that he would not be happy with any suggestion that the Court should be involved - even by way of the grant of a specific power, in making what would in effect be changes in substantive law. He has expressed the view that any necessary powers should lie in the hands of the Secretary of State.

42. We agree with this view. Before discussing further our views as to the manner in which the Secretary of States enabling powers should be set out in the legislation, it is appropriate to discuss what the relevant criteria and matters should be.

The relevant criteria and matters

43. As discussed above,(44) where a shareholder raises an action to protect the interests of his company, the Scottish courts have required that he has given the company an opportunity to consider the matter, to decide whether to put it right or alternatively to raise an action. Effectively, therefore, they have established a requirement of notice.

44. We consider that there should remain a requirement of notice. The flexibility of the current law should be retained by the court having power in appropriate circumstances, eg where urgency can be shown, to waive the requirement or to modify it - eg, by permitting a shorter period of notice. In relation, therefore, to the equivalent recommendation by the Law Commission,(45) as respects Scotland, we recommend:

(6) that, unless on cause shown the court orders otherwise, the applicant should be required to give the company notice of his intention to raise the action 28 days before the action is raised; and that the notice should specify the grounds of action and state that, if the company does not bring proceedings in respect of the cause of action, the applicant intends to raise the action (clause 1: new section 458B, subsections (3) to (5)).

45. For Scotland, it is necessary to include the notice requirement expressly in primary legislation. To leave the requirement to be prescribed by the Secretary of State could give rise to problems of vires when the relevant statutory instrument falls to be made. As a matter of policy, it is necessary that the court should have power to dispense with or modify the requirement, but for the Secretary of State to confer that power on the court in a statutory instrument would amount to sub-delegation. To frame the Secretary of States enabling power to confer express authority for this, in our view, would be not be a satisfactory approach. In our view, no flexibility is lost(46) by including the requirement of notice in primary legislation, given the express power which it can confer on the court to dispense with or modify the requirement.

Concept of leave to raise action

46. As discussed above,(47)at present, the Scottish courts both apply criteria and balance a number of matters. The criteria are generally determinative of whether the action is competent. The matters, on the other hand, appear not to be determinative, but to be such as should be balanced. The court has and will continue to have to consider a number of factors at the outset, in addressing at that stage the question of title to sue. In our view, it is appropriate to deal with this by means of a requirement for the granting of leave to bring proceedings. The concept of leave in the field of company law is not something new for Scots law. Leave of the court is required to bring proceedings where an administrator or provisional liquidator has been appointed, where a winding up order has been made by the court or on the application of a liquidator in a voluntary winding up.(48) Accordingly, we recommend:(49)

(7) that leave of the court should be required to raise an action under the new statutory provision for Scotland (clause 1: new section 458B, subsection (1)).

47. A number of matters will be relevant to the grant of leave. They will also of course be relevant to all other stages of an action if leave is granted. They are generally matters which the court will require to balance.

Court to consider all the relevant circumstances

48. We agree with the view expressed by the Law Commission that it would be unsatisfactory to require the court to apply fixed or definitive criteria for the granting of leave.(50)It is essential that the court has flexibility to look at all of the relevant circumstances.

49. Consultees for the Scottish interest supported a non-exhaustive list of matters which the court should be required to consider. We agree that this would be helpful and that it is consistent with our aim of seeking to clarify and make the law in this area more accessible. Such a list could then be developed in the future to take account, where appropriate, of developments in company law in both jurisdictions.

(8) that in considering whether to grant leave, the court should take account of all the relevant circumstances, without limit, and in particular, should take account of certain prescribed matters (clause 1: new section 458B, subsection (10)).

51. We now consider the specific matters of which we recommend the court should take account in considering whether to grant leave.

Applicants good faith

52. We agree with the Law Commissions discussion of the matter of the applicants good faith: this should be a matter to be taken account of by the court.(52) Consultees for the Scottish interest expressed a consistent view that the applicants good faith should be a material consideration, but should not a pre-requisite in deciding whether to grant leave. They also expressed a consistent view that it was not possible satisfactorily to define the concept of good faith. We agree, and do not consider that the concept needs to be defined: it is a concept with which the Scottish courts are very familiar. Accordingly, as respects Scotland, we recommend:

(9) that the good faith of the applicant should be a specific matter to be taken account of by the court, but it should not be a pre-requisite; and that the concept of good faith should not be defined (clause 1: new section 458B, subsection (10)).

53. We agree with the Law Commission that the court should take into account the interests of the company, and in doing so, should have regard to the views of directors on commercial matters.(53)The concept of the interests of the company has been applied fully by the Scottish courts in the context of the shareholders common law right of action - it is an inextricable part, eg, of ascertaining whether a purported ratification results from wrongdoer control of a majority of votes, etc.(54)

54. We agree that it is not appropriate to require the applicant to prove that the action is in the interests of the company in order to obtain leave. We agree also that if the court is satisfied that the action is not in the interests of the company, it should refuse leave - this matter is discussed further below in the context of the circumstances in which the court should be required to refuse leave.(55)Accordingly, as respects Scotland, we recommend:

(10) that the interests of the company should be a specific matter to be taken account of by the court, and in doing so, the court should have regard to the views of directors on commercial matters (clause 1: new section 458B, subsection (10)).

Authorisation and ratification

55. As for England and Wales,(56)under Scots law, if the directors conduct has been effectively ratified by the company (or if the companys claim against the director or third party - as appropriate - has been effectively waived), this will be a complete bar to an action by an individual shareholder or a minority of shareholders. There is clear authority that ratification (and similarly waiver) will not be effective if obtained by an interested majority or if the relevant majority was unfairly obtained. (57)

56. We agree with the Law Commission(58)that ratification (and waiver) should continue to be effective in the cases where they are effective at present to bar an action by a minority shareholder - where there has been effective ratification or waiver; but that otherwise the fact that the directors conduct is ratifiable, or has purportedly been ratified, or that the company may waive its claim or has purportedly waived its claim against the director or the third party, as the case may be, should be only factors of which the court should take account. So, for example, the fact that the directors conduct is ratifiable or indeed has purportedly been ratified in itself will not prevent a member from having title to raise an action under the new statutory provision for Scotland: rather, the court will take account of this in considering whether to grant leave. On the other hand, however, if the court is satisfied that there has been effective ratification (in the absence of wrongdoer control, etc) or waiver, then it should be required to refuse leave.(59)Accordingly, as respects Scotland, we recommend:(60)

(11) that the fact that the directors conduct has purportedly been, or may be, approved by the company in general meeting or that the companys claim against the director or the third party, as appropriate, has purportedly been, or may be, so waived by the company should be a specific matter to be taken account of by the court (clause 1: new section 458B, subsection (10)).

57. The Law Commission discuss that it is open to a majority of members to resolve that no action should be taken in respect of a directors conduct, and that such a resolution, if made in good faith and what they consider to be for the benefit of the company, will bind the minority.(61)This is the case too under Scots law. In our view, in some cases such a resolution would amount to waiver, but in others it might not, eg, because the wording of the resolution might not amount to abandonment of a right. It may also be that it cannot be relied on - the party seeking to rely on it may not have conducted his affairs on the basis that the company had abandoned its right.(62) We agree that in both cases the fact that there has been such a resolution should be relevant and that this is a specific matter of which the court should take account in considering whether to grant leave.(63) Accordingly, as respects Scotland, we recommend:

(12) that the fact that the company in general meeting has resolved not to raise proceedings in respect of a directors conduct, against the director or third party, as appropriate, should be a specific matter to be taken account of by the court (clause 1: new section 458B, subsection (10)).

Views of independent organ

58. The concept of the views of an "independent organ" as applied under English law is discussed fully by the Law Commission.(64)As the Law Commission explain, even if there has been no approval (or purported approval) of the wrong, the court may be informed of commercial reasons why the shareholders (or a group of shareholders), or even the directors or a committee of directors, consider that the action should not proceed. The term "independent organ" is used to describe a group of persons within the company whose views would be taken into account for these purposes. These are persons whose votes would not be disregarded on the grounds that they had been (or would be) "cast with a view to supporting the defendants rather than securing benefit to the company, or [that] the situation of the person whose vote is considered is such that there is a substantial risk of that happening".(65)

59. To date, this concept of an "independent organ" as such does not appear to have been established under Scots law. It seems more likely that this would be a general matter which would be considered by the court in ascertaining whether or not the action was in the interests of the company.(66) Consultation response for the Scottish interest on this point was mixed. Some consultees considered that the wishes of an "independent organ" should be conclusive. Others expressed concern that this would lead to the issue being pre-judged by the court. On balance, however, we think it is the case that Scottish courts would generally look at the matter - to assist them in ascertaining whether or not the action was in the interests of the company. We agree with the Law Commission(67) that the views of an "independent organ" should not be conclusive on the issue of whether or not leave should be granted. We also agree, however, that such views should be a factor to be taken account of by the court. Accordingly, as respects Scotland, we recommend:

(13) that the views (if any) of an independent organ that for commercial reasons the action should or should not be raised should be a specific matter to be taken account of by the court, but the views of the independent organ should not be conclusive on the issue of whether or not leave should be granted (clause 1: new section 458B, subsection (10)).

60. We agree with the Law Commission that the final matter which should be included in the list of matters of which the court should take account is the availability of other remedies.(68) Accordingly, as respects Scotland, we recommend:

(14) that the availability of alternative remedies should be a specific matter to be taken account of by the court, but that their availability should not necessarily be conclusive on the issue of whether or not leave should be granted (clause 1: new section 458B, subsection (10)).

61. We have explained above that we agree with the Law Commission that it would be unsatisfactory to require the court to apply fixed or definitive criteria for the granting of leave: rather, the court, as now, should take account of all relevant considerations. Consistent with the aim of seeking to clarify and make the law more accessible, however, there should be a list of certain specific matters falling within this head.(69)

62. We also indicated, however, that we considered it appropriate for there to be a requirement for the court to refuse leave in certain circumstances: on this, too, our policy is the same as that of the Law Commission.

63. The circumstances concerned are where the courts at present do not permit an action - the effect, therefore, being to deny title to sue. In short, the circumstances are where the court is satisfied that:

- there has been effective ratification by the company in general meeting of the directors conduct, or effective waiver by the company in general meeting of its claim against the director or the third party, as appropriate.(70)

(15) that the court should refuse leave if satisfied that:

(i) the action is not in the interests of the company; or

(ii) there has been effective ratification by the company of the directors conduct or effective waiver by the company of its claim against the director or third party, as appropriate (clause 1: new section 458B, subsections (6) and (9)(b)).

The manner in which the Secretary of States enabling powers should be set out in the legislation

65. We have explained above our view that the requirements as to the matters of which the court should take account in considering the granting of leave and the criteria to be applied in relation to the refusal of leave should be set out by the Secretary of State by statutory instrument.(72)

66. We have given careful consideration to what should be the scope of the enabling power, and how that enabling power could properly be framed. It is not our intention that the Secretary of State should exercise his power in a manner which would stray into matters of procedure or which would derogate from the traditional power of the court to decide what is relevant within a framework of law laid down by Parliament.

67. To constrain the power, however, either positively, eg by specifying categories of criteria or matters which may be prescribed, or negatively by excluding certain categories, is not, in our view, an option. Either approach has potential for giving rise to significant problems in the future. In our view, at the very least, either approach would give rise to the possibility of at least doubtful vires and might result in there being no or inadequate vires to keep in step with developing case law and developments under English law in an area where it is desirable to be able to do so. We have explained above our view, and that of the Law Commission, that in substance this is an area where there should be consistency, as far as possible, in terms of policy between the jurisdictions.(73)This underlying policy aim was overwhelmingly supported on consultation.

68. We consider it essential, therefore, that the enabling power is not so constrained. We also consider it essential, however, that there is an adequate safeguard built into the legislation to ensure that the Secretary of State does not so stray into matters which should be left to the courts. In our view, the appropriate safeguard is a requirement for the Secretary of State in exercising his power to consult with the Lord President of the Court of Session. The Lord President is content with such a requirement of consultation with him, and the Department of Trade and Industry is similarly content with this approach.

(16) that

(a) express power should be conferred by statute on the Secretary of State to prescribe

(i) the matters (including the specific matters) of which the court must take account in reaching a decision as to whether to grant leave, and at any other stage in the action (clause 1: new section 458B, subsection (10)); and

(ii) the criteria, any of which if shown to arise, should result in the court being required to refuse leave (clause 1: new section 458B, subsections (6) and (9)(b));

(b) before exercising this power, the Secretary of State should be required to consult with the Lord President of the Court of Session; and that the Secretary of States power should not be constrained otherwise than by this requirement of consultation (clause 1: new section 458B, subsections (9) and (10));

(c) the court should take account of all relevant circumstances and such circumstances should, as at present, include the following matters

- whether the action is in the interests of the company, taking account of the views of the companys directors on commercial matters,

- whether the directors conduct as a result of which the cause of action is alleged to arise may be approved by the company and (if it may be) whether it has purportedly been so approved,

- whether the cause of action may be or has purportedly been waived by the company,

- whether the company in general meeting has resolved not to raise proceedings in respect of the direcors conduct against the director or the third party, as appropriate,

- the opinion (if any) of an independent organ that for commercial reasons the action should or should not be pursued,

- whether an alternative remedy is available; and

(d) the criteria which should be prescribed, as at present, are:

- that the action is not in the interests of the company,

- that there has been effective ratification by the company of the directors conduct,

- that there has been effective waiver by the company of its claim against the director or third party, as appropriate.

70. The Law Commission consider a number of other issues in Part 6 of the Report in respect of the new derivative action recommended for English law. It is appropriate to discuss these also for Scotland.

Indemnity orders in relation to expenses

71. The issue of costs indemnity orders relates to the derivative action under English law.(74)A similar issue, however, arises for Scotland. Under Scots law, as we have explained, the right of a shareholder to raise an action to protect the companys interests in respect of a directors breach of duty is not derived from the company. This has significant financial implications for applicants and potential applicants. Under Scots law, the court does not have a common law power to make an award of expenses against a person who is not a party to the cause unless he is the dominus litis or legal representative of the party.(75)The basis on which the action may be raised, and its purpose, is to protect the interests of the company and to obtain a remedy for the company. In our view, therefore, it is only right that the court should have power to grant an application by the shareholder for an indemnity out of the companys assets in respect of expenses incurred, or to be incurred, by him in relation to the action. This should not be confined to judicial expenses. The court should be able to make an award covering any and all expenses. Accordingly, as respects Scotland, we recommend:

(17) that the court should have power to grant an application by the shareholder for an indemnity, out of the companys assets, in respect of expenses incurred or to be incurred by the member in relation to the action: this should not be confined to judicial expenses, but should be able to extend to all expenses incurred in relation to the action (clause 1: new section 458B, subsection (8)).

Courts power to appoint an independent expert

72. The Law Commission do not consider that the court should have a special power to appoint an independent expert to investigate and advise on the action.(76)The consultation response for the Scottish interest was divided on this point. On balance, we agree with the views of the Law Commission.

Ability of member to seek remedy for himself under new statutory provision for Scotland

73. The Law Commission have concluded that it should not be open to the court in a derivative action to make an order granting a personal benefit to a shareholder bringing that action, such as an order that the defendant wrongdoers buy the applicants shares.(77) We agree that it would be inappropriate for a member raising an action under the new statutory provision we recommend for Scotland to be able to seek a remedy for himself in that action. We have explained above that, under Scots law at present, a member has a separate right of action to protect his own interests and to seek a remedy on his own behalf.(78)The new statutory provision recommended for Scotland is drawn explicitly to make clear that this right of action is preserved and not affected by the replacement of the existing common law right to raise an action to protect the interests of the company and to seek a remedy for the company by a new statutory right of action to do so.(79)

Multiple actions

74. By multiple actions, in this context, we mean to refer to the discussion in the Report of whether a shareholder in a parent company should be able to bring an action under the new statutory provision for Scotland on behalf of a subsidiary or associated company within the group. The Law Commission conclude that there should be no express provision dealing with such actions.(80) The consultation response for the Scottish interest was divided on this point. On balance, we agree with the views expressed by the Law Commission.

Other matters

75. Another matter discussed by the Law Commission in Part 6 of the Report is not, in our view, relevant as respects Scotland. The Law Commission discuss the question of the substitution of new plaintiffs to deal with conflict of interest situations making the initial plaintiff unsuitable to be a representative plaintiff.(81) This matter is not relevant for Scotland given the different background, namely that the members right of action in Scotland is a direct right, and not derived from the company. He is not a "representative" applicant.

76. Other matters discussed by the Law Commission would constitute matters which, for Scotland, would appropriately be the subject of rules of court. Examples of such matters are whether it should be possible for a shareholder pursuer to be sisted into an action raised by the company but which the company fails to pursue diligently (in circumstances where this failure in itself is a breach of duty by the directors),(82)the sisting of an action on the ground that another action in respect of the same breach of duty is pending(83)and what are generally described as case management matters, eg, the power of the court to adjourn;(84) whether the company should be called as party to the action;(85) and discontinuance or compromise of actions.(86)As respects Scotland, the appropriate consultation would be carried out in the context of the relevant rules of court being drafted. Accordingly, we do not consider that these are matters on which it is appropriate for us to comment in this Appendix.

Summary of our recommendations as respects Scotland

(1) the right of a shareholder to raise an action to protect the interests of his company and to obtain a remedy on its behalf should be put on a clear statutory basis; (clause 1: new section 458B)

(2) that a shareholder should be entitled to raise an action under the new statutory provision for Scotland if the cause of it arises as a result of an actual or threatened act or omission involving

(a) negligence, default, breach of duty or breach of trust by a director of the company, or

(b) a director putting himself in a position where his personal interests conflict with his duties to the company; (clause 1: new section 458B, subsection (1)) and

(3) that

(a) the action might be against the director or some other person, or both; (clause 1: new section 458B, subsection (2)) and

(b) for the purposes of the new statutory provision, "director" should include a shadow director; (clause 1: new section 458B, subsection (9)(a))

(4) that the right of action under the new statutory provision for Scotland should be available only to members of the company; (clause 1: new section 458B, subsection (1))

(6) that, unless on cause shown the court orders otherwise, the applicant should be required to give the company notice of his intention to raise the action 28 days before the action is raised; and that the notice should specify the grounds of action and state that, if the company does not bring proceedings in respect of the cause of action, the applicant intends to raise the action; (clause 1: new section 458B, subsections (3) to (5))

(7) that leave of the court should be required to raise an action under the new statutory provision for Scotland; (clause 1: new section 458B, subsection (1))

(15) that the court should refuse leave if satisfied that:

(i) the action is not in the interests of the company; or

(ii) there has been effective ratification by the company of the directors conduct or effective waiver by the company of its claim against the director or third party, as appropriate; (clause 1: new section 458B, subsections (6) and (9)(b))

(16) that

(a) express power should be conferred by statute on the Secretary of State to prescribe

(i) the matters (including the specific matters) of which the court must take account in reaching a decision as to whether to grant leave, and at any other stage in the action; (clause 1: new section 458B, subsection (10)) and

(ii) the criteria, any of which if shown to arise, should result in the court being required to refuse leave; (clause 1: section 458B, subsections (6) and (9)(b))

(b) before exercising this power, the Secretary of State should be required to consult with the Lord President of the Court of Session; and that the Secretary of States power should not constrained otherwise than by this requirement of consultation; (clause 1: new section 458B, subsections (9) and (10))

(c) the court should take account of all relevant circumstances and such circumstances should, as at present, include the following matters

- whether the action is in the interests of the company, taking account of the views of the companys directors on commercial matters,

- whether the directors conduct as a result of which the cause of action is alleged to arise may be approved by the company and (if it may be) whether it has purportedly been so approved,

- whether the cause of action may be or has purportedly been waived by the company,

- whether the company in general meeting has resolved not to raise proceedings in respect of the directors conduct against the director or third party, as appropriate,

- the opinion (if any) of an independent organ that for commercial reasons the action should or should not be pursued,

- whether an alternative remedy is available; and

- that the action is not in the interests of the company,

- that there has been effective ratification by the company of the directors conduct,

- that there has been effective waiver by the company of its claim against the director or third party, as appropriate;

(3) See for example Smith v Glasgow and South Western Railway (1897) 4 SLT 327, Cameron v Glenmorangie Distillery Co Ltd (1896) 23 R 1092 and Lochaber District Committee v Invergarry and Fort Augustus Railway Co 1913 1 SLT 361.

(4) Section 14 of the Companies Act 1985. See Part 2 of Consultation Paper No 142.

(5)Cameron v Glenmorangie Distillery Co Ltd

(7) See Lee v Crawford (1890) 17 R 1094, Hannay v Muir (1898) 1 F 306, Harris v A Harris Ltd 1936 SC 183 and Olivers Trustees v W G Walker & Sons (Edinburgh) Ltd 1948 SLT 140.

(8) Hannay v Muir (1898) 1 F 306, Brown v Stewart (1898) 1 F 316. See also Currie v Cowdenbeath Football Club Ltd 1992 SLT 407.

(10) Orr v Glasgow, Airdrie and Monklands Junction Railway Co (1860) 3 Macq 799, Brown v Stewart (1898) 1 F 316.

(11) See for example A Mackenzie "The problem of enforcement of directors duties in Scotland" 1981 SLT (News) 257; A A Paterson, "The derivative action in Scotland" 1982 SLT (News) 205.

(12) The Law Commissions parallel recommendation is set out at paras 6.15 and 8.10 of the Report.

(14) See the recommendations set out at paras 6.49, 8.11(1) and (2), and the discussion at paras 6.24-6.48 of the Report.

(15)See para 6.24 of the Report - the overall issue being discussed at paras 6.24-6.37.

(20) See Thomson and Others v Clydesdale Bank Ltd 1893 20 R (HL) 59, the Lord Chancellor and Lord Watson at 61 and Lord Shand at 62; Style Financial Services Ltd v Bank of Scotland 1997 S.C.L.R. (OH) 633.

(22) See paras 6.38-6.41 and the recommendation set out at paras 6.49 and 8.11(1) of the Report.

(23) See the discussion at para 6.47 and the recommendation set out at paras 6.49 and 8.11(1) of the Report.

(26) See paras 6.25-6.26 and the discussion there of Movitex Ltd v Bulfield [1988] BCLC 104 and para 6.48 and the related recommendations set out in paras 6.49 and 8.11(2)(i) of the Report.

(28) The recommendations are set out paras 6.49 and 8.11(1) and (2) of the Report.

(30) See the recommendation set out paras 6.50 and 8.11(3) and the discussion at para 6.50.

(32) See the recommendation set out paras 6.55 and 8.11(4) and the discussion at paras 6.51-6.55.

(36) (1898) 1F 316: in particular the references to Foss v Harbottle and Orr cit supra.

(37) See, eg, Lee v Crawford (1890) 17 R 1094; Hannay v Muir (1898) 1 F 306; and Harris v A Harris Ltd 1936 SC 183.

(42) See, Maxwell, the Practice of the Court of Session (1980) pp 147-150; Macphail, Sheriff Court Practice (1988) para 4-28.

(45) See the recommendations set out at paras 6.59 and 8.11(5), the related discussion at para 6.58 of the Report and rule 50.4 in Appendix B.

(49) The Law Commission discuss the issue of leave in the procedural context of English law at paras 6.66-6.69 of the report: see also rule 50.6 in Appendix B.

(50) See the discussion at para 6.73 of the report. We do consider, however, that there should be certain fixed or definitive criteria for the refusal of leave - see paragraphs 61-64 below for a discussion of this matter.

(51) The parallel recommendation by the Law Commission is set out at paras 6.73 and 8.11(8)- (11): see also the related discussion at paras 6.70-6.74 and rule 50.7(1) in Appendix B.

(52) See the discussion at paras 6.75-6.76, the recommendation set out at paras 6.76 and 8.11(10)(i) of the Report and rule 50.7(2) in Appendix B.

(53) See the discussion at paras 6.77-6.79, recommendation set out at paras 6.79 and 8.11(10)(ii) of the Report and rule 50.7(2) in Appendix B.

(54) See, eg, Lee v Crawford 1890 17 R 1094; Harris v A Harris Ltd 1936 SC 183; 1936 SLT 227.

(57) See, eg, Lee v Crawford (1890) 17 R 1094 ; Hannay v Muir (1898) 1 F 306; and Harris v A Harris Ltd 1936 SC 183.

(58) The Law Commissions recommendation is set out at paras 6.86 and 8.11(10)(iii) of the Report: see also para 6.87, n 125 and rule 50.7(2) of Appendix B.

(60) We include waiver expressely in our recommendation because for Scotland the relevant matters will be set out in subordinate legislation, and not to include it might lead to difficulties of interpretation. The policy of the Law Commissions is the same; see the discussion at notes 123 and 125 to paras 6.86 and 6.87 of the Report.

(61) See para 6.87 of the Report, and in particular the discussion at n 125 of Taylor v National Union of Mineworkers (Derbyshire Area) [1985] BCLC 237 and of the position under English law generally.

(62) See the discussion of the law of waiver in Armia Ltd v Daejan Developments 1979 SC (HL) 56; 1979 SLT.

(63) The position where it amounts to effective waiver is discussed at paras 63-64 below.

(65) See para 6.88 of the Report and the discussion there of Smith v Croft (No 2) [1988] Ch 144.

(67) See the recommendation set out at paras 6.90 and 8.11(10)(v) of the Report and rule 50.7(2) in Appendix B.

(68) See the discussion at paras 6.91-6.92, the related recommendation set out at paras 6.91 and 8.11(10)(vi) of the Report and rule 50.7(2) in Appendix B.

(70) See paras 32 and 56-57 above and the related discussion at paras 6.77-6.79 and 6.80-6.87 of the Report.

(71) The relevant recommendation by the Law Commission in respect of these matters is incorporated in the recommendations set out at paras 6.79, 6.86 and 8.11(9) and (10) of the Report: see also of rules 50.7 and 50.8 in Appendix B.

(75) Meekison v Uniroyal Engelbert Tyres Ltd

(79) See clause 1, new section 458B, subsection (12) set out in Appendix A to the Report.

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You are here: BAILII >> Databases >> The Law Commission >> SHAREHOLDERS REMEDIES [1997] EWLC 246(APPENDIX D) (24 October 1997) URL: http://www.bailii.org/ew/other/EWLC/1997/246(APPENDIX_D).html Cite as: [1997] EWLC 246(APPENDIX D)