Landlord and tenant – Purchase of freehold – Derivative action – Claimant applying for permission to continue derivative action under section 260(3) of the Companies Act 2006 – Whether no person acting in accordance with duty to promote success of company would seek to continue claim – Application dismissed
A dispute arose concerning a block of flats at 89-93, York Street, London W1 comprising 11 flats. In 1998, the freeholder offered the opportunity to the leasehold owners to purchase the freehold. The leaseholders of four of the flats took that opportunity and the fifth defendant was incorporated for the purposes of owning and managing the freehold of the property. One share of £1 was allotted to each of the four flat owners. The claimants were the successors in title to one of the original shareholders/flat owners. The first and second defendants (a married couple) and the third and fourth defendants were successors in title to the other shareholders/flat owners. The first claimant and the first defendant were also directors of the fifth defendant.
In about October 2012, each of the leasehold owners of flats at the property, except the claimants and the defendants, served notices on the seventh defendant to purchase the freehold of the property. The purchase was completed in August 2013. Before completion, the first defendant, as a director, arranged for a 999-year extension of the leases held by him and his wife and by the third and fourth defendants for a consideration of £1 in each case. It was common ground that, at the time of the lease extensions, the fifth defendant did not have sufficient profits available for distribution and that all parties knew that to be the case. The lease extensions had been valued at £136,000 in all, resulting in a diminution in the value of the freehold had been diminished by that amount.
Once the freehold was sold, the raison d’etre of the fifth defendant fell away. It had about £20,000 in cash assets and no business to carry on. In the circumstances, the claimants applied for permission to bring a derivative action under section 260(3) of the Companies Act 2006. The complaint against the first defendant, as director of the fifth defendant, was his procurement of the grant of long lease extensions by the fifth defendant to the defendant shareholders for a nominal consideration at a time when it had no profits available for distribution. The complaint against the other defendants, as shareholders, arose from their knowledge of that situation. The claimants also sought an order that they be indemnified out of the assets of the fifth defendant in respect of their legal costs.
Held: The application was dismissed.
The claimants had more than a prima facie case but the court was not satisfied that this was an action which it should grant permission to proceed. In the context of section 263(2)(a) of the 2006 Act, and whether a person acting in accordance with section 172 (duty to promote success of the company) would not seek to continue the claim, the test was whether no such person would seek to continue the claim and, if some would and some would not, the matter had to be looked at under section 263(3)(b): Iesini v Westrip [2009] EWHC 2526 (Ch) considered.
The fifth defendant currently had about £20,000 and it had no property to manage or business to conduct. The claimants’ costs to date were about £156,000, the action had barely started and they were or would probably be looking to the fifth defendant for reimbursement in respect of those costs. A wholly successful outcome would yield £136,500 plus some interest and, probably, a favourable order for costs. A fairly optimistic estimate of recoverable costs was about 80% of the monies spent. Once the action was over, if any monies were left, they were likely to be distributed among the shareholders, with each receiving 25%. If the action failed or settled on a walk-away basis, it would be a complete disaster for the fifth defendant.
Any prudent director carrying out a normal risk/benefit analysis would not seek to continue this claim. In the circumstances of a company such as the fifth defendant, in the position it found itself, with few assets and no future prospects, the disadvantages and costs of losing far outweighed the benefits of winning, even if there was factored in a significantly greater chance winning than losing. Accordingly, the claimants did not pass the section 263(2) gateway. A consideration of the matters in section 263(3) led to the same conclusion. Given the inherent risks of litigation and the availability of the alternative remedy of an unfair prejudice petition, a prudent director would not attach great importance to continuing the litigation. With the costs being so high in relation to the potential reward and what might be done with the money, he or she would not be keen to pursue it.
Spencer Keen (instructed by Howard Kennedy LLP) appeared for the claimants; Simon Harding (instructed by direct access) appeared for the defendants.
Eileen O’Grady, barrister
Click here to read a transcript of Zavahir and another v Shankleman and others
