Claims Against Directors

Shareholders suffer if a director does not act in their best interests. But, there are ways that the shareholders can protect themselves – including bringing claims against directors. There are ways to make the company rather than the shareholders responsible for taking action. We specialise in finding the solutions to put the company back on track. Our skills include specialist legal knowledge, practicality and we are good tacticians.

Claims against directors to consider

The problem for most shareholders is that a company can only decide to take action if the board of directors approves it. If the board is in the wrong, then they will not take action against themselves. The shareholders can then step in.

There are a variety of routes to consider. The best route will depend upon the facts. The choices include:

  • Dismissal of the director;
  • A claim against the director – known as derivative actions;
  • Unfair prejudice claims;
  • Winding up petitions; and
  • Declarations.

Dismissal of a company director

There is a procedure under the Companies Act for the dismissal of a director. The problem is it requires more than 50% of the shareholders to vote in favour. The threshold can be increased within articles or a shareholders’ agreement.

You need to review the director’s service agreement. This may permit the company to dismiss the director as an employee if for example found negligent or dishonest. If dismissed as an employee, the agreement may also provide for the director’s forced resignation from the board. Powers of attorney are useful to give effect to the forced resignation provision.

Derivative action taken by shareholders against directors

A derivative claim is commenced by the shareholders on behalf of the company. The Court does have to give permission for the claim to continue to trial and when considering whether to grant permission the court will take into account whether:

  1. The claim is for the company’s benefit – often shown if the director has profited at the company’s expense or caused it loss;
  2. The petitioning shareholder has the support of others;
  3. A director acting reasonably would pursue the claim.

Like any court claim – evidence is crucial.

Uses of a derivative claim

A derivative claim can be considered where the board of directors have abused their position in some way. An individual director may have breached duties owed to the company.

Or, the director may be negligent or dishonest. Situations where the director diverts company clients to another company in which he has an interest would be a fairly typical case of dishonesty.

Indirect claim against the board

The derivative action is seen as indirect claim against a director(s) because the shareholder claims on behalf of the company. The company usually seeks damages from the director, or an account of profits for any gain made.

A useful point for shareholders is that there is no obligation to show the director in default has benefited. A shareholder claiming against a director under the derivative claim route merely has to show that the company has suffered loss.

Using a derivative action to broker settlement

Derivative claims are fairly rare in practice. However, the threat can be effective. If the director is ordered to pay damages he will also have to pay the legal costs of the shareholder(s) bringing the claim against the director(s) and the legal costs of the company. These can escalate if not capped or controlled.

We can work to defend claims against directors as they will always need a robust initial response.

Unfair prejudice claims

The unfair prejudice route is one of the most common claims. It is brought by a minority shareholder, against a majority shareholder. Rationale being the majority shareholder is commonly in control of the board and thus the company’s decision making. If successful, the Court will order a purchase order which obliges the majority to purchase the minority’s shares at an agreed value which is usually fair value following a valuer’s determination.

Winding up petition against the company

A shareholder can apply to court for an order for the company’s winding up. This is a drastic route, but one that can be used to gain leverage to strike a deal. The court will consider whether it is just and equitable for the company to be wound up. The court will not make an order unless a winding up is the only solution.

If the company is deadlocked, then the court may order a winding up. The petitioning shareholder will have to show that they have not majorly contributed to the company’s deadlock as if this is the case then the Court will look unfavourably at the winding up petition.

A director in default will be keen to avoid winding up if the company is a lifestyle business and used to fund personal endeavours.

Declarations

A shareholder can apply to court for a declaration as to facts. For example, a director may have removed another from office without power or consent. The court can confirm that the removal was void and had no effect, i.e. reinstate the removed director.

Claims against directors commenced by shareholders

Directors owe duties to the company and others they serve. The duties are codified under statute with common law examples supporting.

Examples of how a claim against a director can arise

Typical claims revolve around:

  • Directors diverting company clients to another company in which they have an interest;
  • Directors proposing a payment plan for themselves that undermines the shareholders’ position to receive dividends – for example a director increasing base pay to reduce profits otherwise available for distribution as a dividend to the company’s shareholders;
  • Directors acting in conflict when making company decisions – an example being ordering the company to purchase an asset from a director for an inflated value;
  • A director failing to account for fees received from a client or customer properly due to the company for its services or goods rendered;
  • A director taking an opportunity offered to the company in his personal name regardless of whether the company wished to pursue the opportunity;
  • Directors using the company’s funds for personal expenditure for example holidays and cars;
  • Directors paying a dividend to one shareholder (i.e. themselves) and not another despite holding the same class of shares with equal income rights.

The list is non exhaustive. New facts do arise. Directors also have a general duty to account to the company for profits or fees received outside of the business if the profits or fees could have been received by the company. This is of course unless corporate documentation confirms otherwise.

How to resolve a claim against a director

In practice, most disputes do not end up with a full trial. This is because we can usually find a workable solution.  All will depend on the circumstances. We do offer creative solutions that can be attractive to all parties – tax is also a key consideration and one we can advise on. The Court will look to see whether sensible settlement offers have been advanced when considering claims against directors. If not, then it will only work to a party’s disadvantage upon the Court considering costs.

Solutions to resolve claims against a direct can include

Letters before action

A letter before action sets out the basis of the claim against a director. Letters before action are required under court protocol rules. However, a well drafted letter before action can open a path to settlement to a claim against a director.

Working out an exit strategy to avoid a claim against a director

Phasing an exit – whereby the director leaves over a period of time.  Shares can be acquired over a period of time to help with cash flow.  It is possible under the director’s service agreement to agree a termination date well into the future. There are in practice many possibilities depending upon the circumstances.

Winding up the company

Agreeing to wind up the company.  Drastic – but can be a good threat.

Mediation to avoid a claim against a director

Mediation works in a surprisingly large number of cases.

Restructure of the business

Splitting up the business assets by a spin off, demerger, or reorganisation.

  • Our dispute was incredibly sensitive. Gannons appreciated this, but nevertheless got us the result we wanted.

  • We needed a firm to provide us with clear and strategic advice. Gannons dealt with the immediate matter, and then provided advice to avoid future issues. No hesitation in recommending the firm.