The High Court has refused permission for a derivative claim to be continued against a bank (as an alleged shadow director), brought by the shareholders of an AIM-listed company which had been transferred to the bank’s loan management unit: Ryan & Anor v HSBC UK Bank Plc & Anor  EWHC 1066 (Ch).
This is an example of permission to continue a derivative action being refused at the second permission stage mandated by the Companies Act 2006 (the Act), and is a helpful illustration of the factors the court will consider when determining whether to grant permission at a substantive hearing. For a recent case in which permission was refused at the first stage, under section 261 of the Act, you can read our analysis of the ClientEarth litigation against the directors of Shell here.
In summary, the bank had made various loans to the company, which subsequently faced cash flow difficulties and was transferred to the bank’s loan management unit. Thereafter, the company’s AIM listing was suspended and it went into administration, due to (on the claimants’ case) the bank’s “overarching plan” to take control of the business and run it for the bank’s own benefit. The claimants were shareholders in the company and asserted that the bank had acted as a shadow director of the company, allowing them to bring a derivative action against the bank under the Act.
The claimants were successful in obtaining permission to continue their claim at the first stage, meaning the court considered there was a prima facie case sufficient that it was not bound to dismiss the claim at the outset. However, permission at the second stage was refused on the basis that no person concerned with promoting the success of the company would seek to continue the claim: the court found that the claim was “weak” and “the only rational decision” would be to refuse permission. The allegation that the bank acted as a shadow director was also found to be “lacking essential core facts”.
The claimants owned or controlled approximately 46% of the second defendant (MCPLC), an AIM-listed company which formed part of a group of companies in a residential development business. The first defendant (the Bank) provided banking facilities to MCPLC.
From January 2015 onwards, the Bank’s loans were in default, and a personal loan was advanced to the claimants to be put into the business. Later that year, MCPLC was transferred into the Bank’s loan management unit and by 2021 had ceased trading. The judgment describes the Bank as MCPLC’s only substantial creditor, being owed more than £20m by MCPLC, in addition to the personal loan owed by the claimants.
The claimants blamed the Bank for the failure of the business and sought permission under section 261 of the Act to bring derivative proceedings on behalf of MCPLC against the Bank. In addition to the derivative claim, the claimants commenced personal claims against the Bank.
MCPLC was restored to the register of companies (having previously been dissolved after the insolvency process concluded) on the claimants’ application for the purposes of the litigation, and the claimants asserted that they would meet any costs arising as a result of the derivative claims being brought (whilst noting that those costs would be incurred in the personal claims in any event).
Under section 260(1) of the Act, derivative claims can only be brought by members of a company who are seeking relief on the company’s behalf. In this case, there was no dispute that the claimants were both members of MCPLC.
Section 260(3) provides that the cause of action in a derivative claim must arise from an act involving negligence, default or a breach of duty by a director of that company. The Act specifies that this includes former directors and shadow directors (section 260(5)). The claimants sought to satisfy this requirement by seeking a declaration that the Bank acted as a shadow director of MCPLC once the company was transferred to the Bank’s loan management unit on the basis that, from that point, the Bank took increasing control over the company’s use of its assets, choice of management and business activities.
Once a derivative claim has been brought, the claimant must apply for the court’s permission to continue it. This is broken down into two stages.
The first stage is based on the documents filed by the claimant: the court must refuse permission to bring a derivative claim if the documents do not demonstrate a prima facie case for granting permission. The claimants in this case passed the first stage, and their application for permission was not refused.
If a claimant succeeds at the first hurdle, then permission to continue the derivative claim is assessed at a more substantive hearing, at which the potential defendant may play a role, based on the factors set out in section 263 of the Act. The High Court in the present case provided a helpful summary of the authorities on these factors, breaking them down into two further stages, which require the court to place itself in the position of a hypothetical director.
1. Section 263(2)
First, permission must be refused if: (i) the director’s actions have been authorised or ratified (which was not applicable in the present case); or (ii) a person acting in accordance with the directors’ duty contained in section 172 of the Act – the duty to promote the success of the company – would not seek to continue the claim.
The court described the second of these factors as a “mandatory refusal”, and cited Iesini v Westrip Holdings Ltd  EWHC 2526 (Ch), concluding that the court must refuse permission on this basis if it is satisfied that no hypothetical director acting properly could continue the claim. Per Iesini, if some directors would continue the claim, and some would not, then the court must move on to consider the next set of factors. The court also noted that it was unusual to refuse permission on this initial, mandatory basis.
2. Section 263(3)
Second, there are a set of factors contained in section 263(3) of the Act which must be taken into account by the court when determining whether to grant permission.
Notably, one factor is the importance that the same hypothetical director, who acts in accordance with the duty to promote the success of the company, would attach to continuing the claim.
The other factors include whether:
- the claimant is acting in good faith in seeking to continue the claim;
- the underlying act of the director is likely to be ratified or authorised;
- the company has decided not to pursue the claim; and
- the member could pursue the cause of action in their own right instead.
The most relevant in the present case was the first: assuming some directors would choose to continue this claim against the Bank, how much importance would those directors attach to the claim?
The High Court refused to grant permission on the section 263(2) factors, concluding that “no person concerned to promote the success of MCPLC would seek to continue this proposed claim”. This was ultimately based on a preliminary assessment of the merits of the claim, with the key reasons being:
- The anecdotal evidence relied upon by the claimants to support their allegation that the Bank was driven by an ulterior motive would be borne in mind by the notional director, but the notional director would have an open mind, and would be encouraged to focus on the actual circumstances of the case.
- The claimants’ assertion of the Bank’s illegitimate intentions ignored the more likely possibility that the Bank was merely protecting its own risk, whilst wanting to support the business as far as it could. The notional director would have this in mind, as well as the temptation of making such assertions.
- The notional director would recognise the inconsistency of the Bank’s alleged behaviour with the actual outcome: the Bank had been left with irrecoverable debt, as the only remaining substantial creditor. Indeed, the court noted that as a creditor, the Bank was entitled to look to its own interests.
The court noted that the parties held differing views on the nature of the merits test which should be applied, and whilst those differences did not impact the court’s decision, it criticised the claimants’ submissions that a weaker case may be strengthened by a large potential recovery.
The court then went on to consider the section 263(3) factors, in the event that it was incorrect in respect of section 263(2), and determined that the poor merits of the claim would also lead to low importance being attached to the claim by a hypothetical director.
As for the claimants’ suggestion that they should be granted permission on the basis that a notional director of MCPLC would be bound to bring the claim as MCPLC had nothing to lose in the circumstances, this was rejected. The court pointed out that the section 263(3) factors required there to be some positive reason for a director to seek to continue proceedings.
Lastly, the court addressed the remaining statutory factors briefly, noting that there was no suggestion of bad faith against the claimants, they would not properly have an alternative remedy for the claims, and there was no relevance in the company not having decided to pursue the claim itself (given it had no directors).
The Bank as a shadow director
The Bank disputed this allegation, submitting that it was entitled to impose conditions on its support of MCPLC without becoming a shadow director, and that the claimants’ allegations were based on an unjustified assumption that everything was done at the bidding of the Bank.
The court referred to the conclusions of Lewison J in Ultraframe (UK) Ltd v Fielding  EWHC 1638 (Ch) that strong positions of influence taken by creditors over debtors do not equate to shadow directorships: “a creditor […] is entitled to protect [its] own interests as a creditor without necessarily becoming a shadow director”.
It declined to conclude that the Bank had acted as a shadow director, stressing that the allegation by the claimants “lacked essential core facts”.
The claimants’ funding promise
The claimants had not provided any evidence of their assets to support their promise to fund the derivative claim. This was justified, said the claimants, on the grounds that any such evidence would have a collateral benefit to the Bank in the personal claims because (the court presumed) it would give the Bank an unfair advantage in any settlement discussions or enforcement proceedings. However, the Bank argued that if the claimants’ promise was to be relevant, then it needed to be substantiated by evidence, relying on Hughes v Burley  EWHC 104 (Ch).
The court declined to determine this issue, on the basis that: (i) permission was being refused on the merits; and (ii) MCPLC had no assets capable of being depleted by the litigation in any event.