Permission Denied: The Court of Appeal clarifies the threshold for derivative claims and the scope of directors’ indemnity

The Proposed Derivative Claim

Mr Dekel, a shareholder of Clerkenwell Lifestyle Limited (“CLL BVI”), sought leave under section 184C of the BVI Business Companies Act to bring derivative proceedings in England and Wales in the name of and on behalf of CLL BVI arising out of the management and financing of a real estate project operated by CLL BVI through its UK subsidiary, Clerkenwell Lifestyle (UK) Limited. The proposed derivative claim alleged breaches of fiduciary duties, negligence and improper conduct in the structuring, budgeting, financing and managing of the project. The intended defendants were the de jure directors of CLL BVI, two creditors, the property manager (“RE Capital”), and Mr Leech who was the CEO and a co-founder of RE Capital and who Mr Dekel alleged was liable as a shadow director of CLL BVI.

At first instance, the judge dismissed Mr Dekel’s application on the basis that the claims were inadequately pleaded and that there was insufficient evidence for the claims of fraud, dishonesty or breach of care to have any reasonable prospect of success based on the information and material before him. The most that could be said was that there had been some commercial misjudgment about certain aspects of the project. A subsequent application by Mr Dekel to vary or revoke the dismissal of the leave application on the basis that he was now prepared to indemnify CLL BVI against loss arising from the derivative claim was also dismissed by the judge.

The threshold for derivative claims

On appeal, Mr Dekel argued that the learned judge had impermissibly embarked on a mini trial by approaching the application as if he were determining the merits of the proposed claim.

Following Basab Inc v Accufit Investments Inc, the Court of Appeal held, that although at the leave stage the court is not required to conduct a trial of the proposed claims, the court is equally not bound to accept allegations at face value simply because they are pleaded.  An application for leave to bring a derivative claim fell somewhere between a strike out application and a full trial, and required the judge to conduct an evaluative assessment of the material before him in order to determine whether the claim had a realistic prospect of success. This exercise required him to consider whether the allegations advanced were supported by sufficient evidence.

The Court could find no error in the exercise carried out by the judge or his conclusion that the proposed heads of claim lacked merit. A belated offer by Mr Dekel to indemnify the company against any adverse costs liability arising from the proposed derivative claim did not cure the deficiencies in his case.

Directors Indemnity

The Court of Appeal affirmed the judge’s decision that the indemnity provided to directors under article 14 of CLL BVI’s Articles of Association operated as a complete defence to the directors against the proposed negligence claims.

Article 14 was in near identical terms to section 132 of the BVI Business Companies Act (the “BCA”). The Court held that there was nothing in the language of Article 14 or section 132 which supported Mr Dekel’s restrictive argument that the indemnity was confined to claims brought by third parties against the directors and could not operate as a defence to a claim brought by the company against its own directors.

In arriving at that decision, the Court found that the analysis of the Court of Appeal in Guernsey in Emerald Bay Worldwide Limited v Barclays Wealth Directors (Guernsey) Limited, though not binding on this Court, was persuasive. The case involved the interpretation of a similar indemnity provision in the articles of a BVI company and section 132 of the BVI BCA. The court there considered the plain and ordinary meaning of the language used and the commercial purpose of such indemnities, and concluded that the indemnity was not confined to third-party claims.

The Court of Appeal in Mr Dekel’s case affirmed that the section 132 and Article 14 were drafted in broad and unqualified terms thereby providing protection against the financial consequences of litigation to a director who had acted honestly and in good faith and in what he believed to be the best interests of the company. In light of the judge’s finding in the court below that the claims of dishonesty and bad faith were inadequately pleaded and remote, the judge was entitled to find that the negligence claim could not survive as the indemnity under Article 14 provided a complete defence.

Shadow Director

The Court dismissed Mr Dekel’s arguments that the definition of a ‘director’ under section 2 of the BVI Business Companies Act (the “BCA”) was broad enough to encompass shadow directors; that there was an overlap between de facto directors and shadow directors; and that in any event, shadow directors was now a well-established feature of company law throughout common law jurisdictions. The Court of Appeal held that the definition of a ‘director’ under the BCA, unlike the Insolvency Act, expressly did not include shadow directors and that the absence of the term in one statute and not the other was a powerful indicator that the omission was deliberate rather than inadvertent.

Conclusion

This judgment underscores the importance of substantiating the allegations pleaded in the proposed derivative claim when approaching the Court for permission to bring derivative proceedings, particularly where allegations of fraud, dishonesty and bad faith are pleaded which the courts have made clear are serious allegations requiring sound evidential basis.

The judgment is particularly helpful in its exposition on the breadth of the protection afforded by the indemnity to directors under company’s constitutional documents and section 132 of the BCA. Prior to this decision, there was no local authority on the point. It is now clear that the indemnity extends to all claims brought against the directors, by whomever, and that it is capable of providing a complete defence against negligence claims to a director who has acted honestly, in good faith and in the best interests of the company.

The successful defendant was represented by Ryan James Turner of Maitland Chambers instructed by Tamara Cameron of Appleby (BVI) Limited.