UK directors should beware the new Companies Act

The International Bar Association Conference held in Rome last month (May) on class actions saw the European legal profession listening in rapt silence to speakers from the US explaining the practical realities of class action funding and resolution. It was interesting to see the preponderance of heavyweight commercial law firms present.

There is a growing awareness of the likelihood of significant class actions in the commercial and listed companies sphere. While Clyde & Co‘s venture into a competition law class action over alleged price-fixing on replica football shirts has gained publicity, and there are claimant tort actions within the UK, my personal greatest point of interest is the new Companies Act.

I believe there will be a demand for claimant and defence work directly arising out of the new Companies Act, and the class action is made for such litigation.

While much of the heat generated by the Companies Act has been on the enlightened shareholder value duties now imposed on directors, little attention has been given to the high likelihood of claims against directors for negligence.

An angry shareholder upset about the way a company has been run was traditionally limited to derivative claims, which required directors to be misbehaving in a way that yielded personal benefit, or actual fraud, under the Foss v Harbottle (1843) exception.

But Section 260(3) of the act makes it clear that shareholders can now sue directors for negligence and breach of duty generally. Leave is required, but I expect to see many cases with well-founded merits.

Company directors necessarily make more mistakes than professionals such as accountants and solicitors. Business assumes they must take risk and professionals are paid to reduce it.

The limitation of derivative actions has historically prevented shareholders suing directors personally for mistakes that, if made in the professional services sphere, would lead to professional negligence actions.

With the take-up of directors’ and officers’ liability (D&O) insurance, there is within many companies a pot available for claims for serious business errors. Signing a long but loss-making contract, a reckless property purchase or a basket case acquisition all could involve negligence. If there is insurance, then litigation will follow.

Even ignoring D&O insurance, the remuneration now available to directors during the golden periods of business success means that listed company directors can retire as extremely wealthy people. Simply put, there is a class of company director in this country with substantial personal assets who may now be exposed to shareholders with axes to grind.

I think it goes without saying that the liberalisation will open up new fronts in warring private company setups too – unhappy minorities will have a new stick to use against a board they do not like.

Importantly, the right to claim runs with the shares, so it is irrelevant that a shareholder who perceives that company managers have blundered joins the company after the event. There is the possibility of parties buying into companies simply to bring such a claim, as with vulture funds.

While there has been discussion of the arrival of US class action firms in London, my own suspicion is that the English costs rule will prevent an outbreak of law firm funding of extremely complicated claims. The great US successes have come from taking court-sanctioned fees of up to 30 per cent on damages funds worth up to $2bn-$3bn (£1m-£1.5m).

But there will be meritorious claims to be explored, and class actions may well be the vehicle nevertheless. Two hundred investors contributing £5,000 each buys an immediate fighting fund of £1m.

My prediction? In 10 years there will be a new textbook alongside Jackson & Powell on professional negligence, devoted simply to claims against directors.