Derivative actions – The Court of Appeal considers when permission will be granted to shareholders of non-UK claims to pursue a derivative claim

In Durnont Enterprises Ltd v Fazita Investment Ltd [2024] EWCA Civ 299, the Court of Appeal recently dismissed the appeal of a shareholder of a Cypriot-based company for permission to continue a derivative action against various defendants.

Background

The claimant, Durnont Enterprises Limited (Durnont), sought permission to continue a derivative action on behalf of an overseas company, Polish Real Estate Investment Limited (the Company).

The Company was incorporated in Cyprus and was a joint venture between its shareholders for the purpose of investing in property in Poland, including shopping centres. The shareholders were groups of Norwegian and Polish investors, including a Polish bank (the Bank).

Durnont was also a Cypriot company and it held 27.94% of the Company's shares, as a vehicle for Norwegian investors.

The relationship between the Company's shareholders was governed by a share and subscription agreement that was subject to English law (the SSA).  Durnont was a party to the SSA.  The SSA set out the terms on which the Bank would subscribe for both shares in the Company and convertible bonds issued by the Company. In particular, the Company and Durnont had a right of veto over both resolutions of the board and resolutions of the Company's members.

The Company held 100% of the investment certificates in a close-ended investment fund (the Fund) worth more than €100M, which then owned real-estate assets through subsidiary companies.

In 2014, the Bank agreed to sell its shares in the Company for significantly less than their market value. However, Durnont and the Company did not have any knowledge of this until November 2022 at the earliest.

In a turn of events, the Bank's bonds were redeemed and the investment certificates in the Fund and/or their proceeds had found their way into entities controlled by two of the Company's shareholders, Mr Wladyslaw Jaroszewicz and Mr Michael Jaroszewicz.

As a result, Durnont argued that Mr Wladyslaw Jaroszewicz and Mr Michael Jaroszewicz had misappropriated the investment certificates, and in turn had divested the Company of assets worth over €100M.

The first instance decision

In the first instance, the High Court held that it had jurisdiction to hear a derivative claim that was brought on behalf of a foreign company, given there were significant connections between the claims and the English jurisdiction. The High Court then granted permission (under CPR Part 19) for the claim to continue against various shareholders, and for the claim to be served against them pursuant to CPR Part 6.

However, the High Court did not sanction the derivative claims against three of the defendants, (being the Bank and two directors of the Company), on the basis that Durnont did not show a prima facie case against any of them, as there was no evidence that they were involved in the key events that appeared to have caused loss to the Company.

As such, Durnont sought to appeal the High Court's decision against the Bank and the two directors.

The Court of Appeal decision 

The Court of Appeal set out the legal framework for shareholders of overseas companies to bring a derivative claim.

Where a member of a company incorporated outside the United Kingdom makes a claim for the company to be given a remedy to which it is alleged to be entitled, the member must apply to the Court for permission to continue the claim. 

Under section 261 of the Companies Act 2006 (CA 2006) there is a two-stage approach to be followed by the Court when considering applications for permission to continue derivative claims. By section 261(2), the Court must dismiss the permission application at the first stage if it appears to it that the application and evidence do not disclose a prima facie case for giving permission. An application which is not dismissed at that point will proceed to a second stage at which, following a hearing, the Court may give permission, refuse it and dismiss the claim, or adjourn the application.

Where a member of a UK-incorporated company applies for permission to continue a derivative claim, section 263 of the 2006 Act applies. That requires the Court to refuse such an application in certain specified circumstances and otherwise to take particular matters into account when considering whether to give permission. In this case, the Court held that where you have an overseas company section 263 does not apply. Instead, the Court will apply common law principles requiring consideration as to whether the claimant can establish a prima facie case that the company is entitled to the relief claimed. 

In this case, the Court of Appeal upheld the first instance decision on the basis that there was no prima facie case that the Bank was liable for loss caused to the Company as a result of any breach of the SSA or the Company's Articles. Equally, the Court of Appeal held that there was no prima facie case to justify derivative claims against the two directors, as the claims against them were broad assertions and did not adequately identify or explain why they were alleged to have breached their fiduciary duties.

Take-away

This decision sets out the approach courts will take when deciding whether to grant permission for derivative actions to be brought by a member of an overseas company. 

The case is a reminder that to demonstrate a prima facie case (under common law principles) there is a higher hurdle than having a seriously arguable case and the Court will have regard to the totality of the evidence placed before it at the permission stage. 

This decision comes at a time when we are seeing an increase in derivative claims which has been driven in part by the rise of third-party funding over the past decade. The legal framework set out by the Court in this decision is likely to be a point of reference (and litigation) for further derivative action claims pursued by shareholders of overseas companies.