Indemnity Costs in Derivative Claims – Briefing Note

Case law has moved on recently from the accepted position where a shareholder pursuing a derivative claim on behalf of a company is indemnified for legal fees by the company, whether successful or not. At Charles Russell Speechlys, recent experience in the case of Re Arnbrow Ltd; Re Westridge Estates Ltd; Leslie v Ball and others [2023] EWHC 1771 (Ch) has shown that the granting of an indemnity is by no means a certainty.  

In ordinary circumstances, where a wrong is committed against a company, the company itself will bring that claim, with the decision to do so vesting in the board of directors or alternatively the shareholders if dissatisfied by the board.¹

However, if the alleged wrongdoers are directors who hold the majority of the shares, they will not in practice vote to issue proceedings against themselves. 

Further, where a majority of shareholders have approved an action, a minority shareholder is precluded from bringing a complaint in relation to it.

As a result, those who suspect wrongdoing to the company by those who control its affairs will struggle to bring any claim, creating the potential for injustice. 

As such, the law has developed the means by which an interested party, typically a minority shareholder, may obtain the Court’s permission to bring a claim on behalf of the company. These are known as derivative claims and were initially a common law concept but now codified under the Companies Act 2006 (s260), and subject to, inter alia, the provisions of Civil Procedure Rule 19.14 and Practice Direction 19A. 

Where a Court permits a derivative claim to continue, it may order that the relevant company indemnifies the individual claimant for its costs, such that the company pays the costs of the claim brought.

In this note, we will set out the broad requirements to bring a derivative claim, and some of the relevant factors for then receiving an indemnity for costs.

Actions that may be brought as derivative claims

Only certain actions may be brought as statutory derivative claims. There must be an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a statutory, shadow, or former director of the company, including breaches of directors’ duties under the Companies Act. In certain circumstances, third parties may be brought into derivative claims, for example accessories in connection with a relevant breach. 

The Court’s permission

Generally, there must be some other limit on the bringing of a derivative claim, particularly given that this may result in the use of not insubstantial company assets to fund the litigation. As such, the court’s leave is required, and scrutiny is applied.

At the stage of issuing a derivative claim, the Court does not need to give permission. However, thereafter, for the Claim to continue and for any other step to be taken in proceedings, the Court’s permission is required, by way of a two-stage process. 

At the first stage, the applicant must present a prima facie case to the Court, to be considered on the basis of the applicant’s evidence alone, without requiring evidence from the defendant. The Court must dismiss the application at this stage if not satisfied that the applicant has a prima facie case.

At the second stage, before the substantive action begins, the Court may require evidence to be provided by the defendants to the action.

The Court will scrutinise the claim and refuse permission if either of the following conditions are met:

1. Continuing the claim is contrary to the success of the company, or, more specifically, a person acting in accordance with the directors’ statutory duties would not believe in good faith that the decision would promote the success of the company, having regard to factors including its long term consequences, impact on employees, community and environment, the need to foster business relationships and act fairly between members, and the desirability of maintaining a reputation for high standards of business conduct.
2. The proposed act or omission was authorised or ratified by the company, with the Court having power to adjourn the decision whilst the company decides whether to ratify. It is worth noting here that certain acts which are ultra vires, unlawful, fraudulent, or prejudicial to creditors cannot be ratified.²

In addition to considering those conditions, the Court will take account of the following non-exhaustive criteria when exercising its discretion as to whether the claim should continue. 

• Whether the member is acting in good faith.
• The importance that a person acting in accordance with the duty to promote the success of the company under section 172 of the CA 2006 would accord to the proposed claim.
• Whether a proposed or past act or omission would be likely to be authorised o ratified.
• Whether the company has decided not to pursue the claim.
• Whether a member has a cause of action that they may pursue in their own right rather than on behalf of the company.
• The views of the members of the company who have no personal direct or indirect interest in the matter.

The Court may also grant:

• Permission subject to conditions (for example, that the member may not discontinue or compromise the claim without the permission of the Court (Civil Procedure Rule (CPR) 19.20).
• Limited permission to continue (for example, until the disclosure stage when the merits have become clearer.)

(Stainer v Lee [2010] EWHC 1539 at paragraphs 48 and 55.) 

Indemnification for costs by the company in derivative claims

The court may, but is not required to, make an order that the company pays the costs of the litigation once permission is granted. This is a pre-emptive indemnity, distinct from costs orders usually made at the conclusion of an application or trial.

There are several purposes for this, which are indicative of the Court’s reasoning for granting that indemnity. First, a minority shareholder should not be deterred from bringing proper complaints on behalf of the company upon which they themselves stand to benefit from only indirectly. I.e., the costs pressure of bringing litigation should not unfairly fall to those who are not acting solely for their own benefit, though of course there is a great degree of costs risk for those costs incurred up to issue and permission (which can be substantial). Second, the minority shareholder is acting as an agent on behalf of the company, regardless of any indirect interest in its outcome, and so the company should arguably pay its costs.

The impact of a pre-emptive indemnity is potentially dire, in that the Company could face potentially significant bills of costs and the litigation is effectively de-risked for the derivative claimant. It is not, however, an “all or nothing” decision. The Court has wide discretion to order the indemnity on certain conditions or in-stages, for example, that the indemnity itself may be re-assessed or conditional on further pleadings and evidence, ordered only up to a certain stage in the proceedings to then be revisited, or otherwise limited in some way based on the individual case before the courts. The major distinction is between a “pay as you go” indemnity whereby bills of costs are presented to and paid by the company throughout the course of proceedings, and an indemnity which is limited or capped up to certain stages of the litigation i.e., disclosure or pleadings, then re-assessed based on the merits and application of the criteria again. In the latter case, the indemnity gives the claimant the right to call on the company to meet costs to which the claimant is exposed – not on a “pay as you go” basis, but after a court order as to who will bear costs.  

In Wallersteiner v Moir (No 2) [1975] QB 373, the Court of Appeal held that it would normally be appropriate to award an indemnity where three criteria are satisfied:

• The claim is one that would have been reasonable for the board of directors to have pursued.
• The claimant member has no interest in the outcome other than in their capacity as a shareholder of the company.
• All benefit of the action will accrue to the company.

It is worth noting that Wallersteiner is one of very few Court of Appeal decisions on indemnity costs, and it remains a leading case even where the regime is now codified by statute and the CPR.

These conditions are similar to those that are relevant to the court’s exercise of its discretion to permit the derivative claim to be brought, and so it is deemed by some to be the usual order for a grant of permission to be accompanied by a costs indemnity. However, this is not always the case.

A further leading case, Bhullar v Bhullar [2015] EWHC 1943 (Ch) cautions that any pre-emptive costs order must be considered carefully given the resultant imbalance between the parties, especially in those disputes which are ultimately between different factions of members.

The impact of Re Arnbrow Ltd; Re Westridge Estates Ltd; Leslie v Ball and others [2023] EWHC 1771 (Ch)

These proceedings concerned a family business with a history of landholdings in the UK. Central to that dispute were parcels of land and the asserted value thereof. 

At the time litigation commenced, the shares of the ultimate beneficial owner of that land were split effectively into three equal portions between siblings.

Years later, one sibling, brought a claim, ostensibly seeking to interrogate the historic affairs of the family business and its transactions, including the former sale of the parcels of land, which were facilitated via a sale first to companies owned the two other siblings and then an onward transaction to another unconnected company. In short, the assertion was that the land was sold out of the family business at significant undervalue before being sold again at true or greater value, to the detriment of the family business by virtue of that undervalue. There were two sets of proceedings; a double-derivative claim whereby the Claimants would bring the claim on behalf of the Topco through its subsidiary (that subsidiary being the direct owner of the land in question), coupled with an unfair prejudice petition seeking, inter alia, the purchase of her shares, with the value inflated to account for the asserted undervalue.

In May 2022, the Court granted permission to continue the claims. The claimants went on to seek an order that they be indemnified by the companies both in respect of the costs which they had incurred and those which would be incurred in pursuing the claim on their behalf, and also in respect of any adverse costs order that might be made against them at the end of proceedings. 

The other parties did not resist the permission but reserved their position on the indemnity application. 

When it came to be heard, the indemnity application was opposed on the basis that the allegations could have been brought within one set of proceedings instead of derivative claim with a simultaneous unfair prejudice petition. Therefore, costs would be incurred progressing identical allegations across both matters, some of which were for the sole benefit the individual sibling rather than the holding company (considering that the defendants would be its remaining shareholders), and the matters being inextricable due to the remedy sought in the petition, which required determination of the asserted undervalue to decide on the value of the shares to be purchased if prejudice was made out. 

After detailed consideration, the judge concluded that there was ‘a complete overlap, or at least almost complete overlap, between the allegations in the derivative claim and in the petition’. The application for pre-emptive indemnities was dismissed accordingly. 

His reasoning was as follows:

"I cannot see why an entirely independent board of directors, faced with litigation between shareholders in which one was seeking an order for a buy out on the basis of allegations in a derivative claim, would regard it as being in the company's best interests to offer an advance indemnity to that shareholder. It seems to me that their proper, perhaps hard-nosed, commercial response to a request for such would be that as the shareholder was pursuing the same allegations for his own direct benefit, and was able to fund the same from his own resources, then they would await the event and see what happened at trial, and see what to do then. In particular, I do not see why, in these circumstances, they would offer an advance indemnity even if he lost hands down at trial in pursuing those allegations, just because he was also pursuing them for the company's benefit as well."

In short – no company directors would offer to fund litigation itself which would stand to benefit just one shareholder, particularly so where that shareholder was able to fund the litigation themselves and await the outcome of trial, including costs, though he could not feel a high degree of assurance that this would be the case. 

1Foss v Harbottle 67 E.R. 189; Prudential Assurance Co Ltd v Newman Industries Ltd [1982] Ch. 204
²The Court can also grant permission in alternative circumstances where the claim has already been brought by the company itself or someone else in an effort to frustrate the process.