Cinematic Finance Ltd v Ryder & Ors

A derivative claim is an exception to the rule that a company must pursue its own cause of action. The statutory procedure in Chapter 1 of Part 11 of the Companies Act 2006 does not abolish that fundamental principle. A shareholder who controls the company will therefore be permitted to pursue a derivative claim only in very exceptional circumstances. Control is a highly significant factor, even though it is not one of the mandatory refusal grounds in section 263(2). A controlling shareholder should not use a derivative claim to avoid the insolvency regime. Where the company is insolvent and liquidation or administration is appropriate, the decision whether to pursue claims belongs to the insolvency office-holder.

The claimant applied for permission to continue a derivative claim on behalf of 17 investment companies against their former directors and a limited liability partnership. The application proceeded to the substantive second stage under section 261(3) of the Companies Act 2006, after Lewison J had directed under section 261(2) that it should not be dismissed summarily.

The claimant controlled all or substantially all of the shares in the companies and could procure the appointment of directors who could cause the companies to sue directly. It argued that control was only one factor under section 263 and did not bar a derivative claim. The defendants argued that the procedure was inappropriate and that insolvency proceedings provided the proper route.

1. The application for permission to continue the derivative claim was dismissed.

2. The general rule is that a cause of action vested in a company must be pursued by the company. A derivative claim is an exception for circumstances in which the company cannot or will not bring proceedings against the alleged wrongdoer. This principle, reflected in Prudential Assurance Company Ltd v Newman Industries Ltd (No 2) [1982] 1 Ch 204 and the rule in Foss v Harbottle (1843) 2 Hare 461, remains applicable under Part 11.

3. The court’s discretion under section 261(4) must be exercised consistently with that established principle. The Act comprehensively regulates derivative claims, but it does not indicate any intention to reverse the fundamental distinction between a company and its shareholders. A shareholder controlling the company may exceptionally bring a derivative claim, but permission should be granted only in very exceptional circumstances.

4. No such circumstances existed. The claimant knew that it controlled the companies and could have obtained their books, appointed directors and caused the companies to sue. Its reliance on the absence of records therefore did not establish that the companies could not or would not enforce their rights.

5. The claimant’s evidence indicated that the companies were insolvent. If liquidation or administration were commenced, the liquidator or administrator would decide whether the claims should be pursued. Derivative proceedings should not normally be brought for a company in liquidation or administration. The controlling shareholder could not use the derivative procedure to circumvent the insolvency regime.