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Published online by Cambridge University Press: 19 April 2002
This article challenges the commonly expressed view that shareholders wishing to bring a derivative action on behalf of the company must have “clean hands” ie that there must be nothing in the shareholders behaviourwhich renders it unjust to allow the derivative action to proceed. While minority shareholders’ misbehaviour might well have consequences for themselves, such as requiring the repayment of dividends known to have been paid unlawfully, those actions ought, in the normal course of events, to be irrelevant for the purpose of deciding whether to allow a derivative action to proceed. This article suggests some circumstances in which a minority shareholder’s situation or actions may affect the decision to allow a derivative action brought by that particular shareholder to proceed, but these do not spring from the clean hands doctrine, but rather from the particular factual circumstances of the case or from an entirely proper desire on the court’s part to use the derivative action only where it is necessary to achieve justice for the company
I am grateful to Dan Prentice and Roger Smith for their comments on an earlier draft. Any errors remain entirely my own.
1 Foss v. Harbollle (1843) 2 Hare 461; Prudential Assurance Co. Ltd. v. Newman Industries Ltd. (No. 2) [1982] Ch. 204, 210.
2 See Gower, , Principles of Modern Company Law, 6th edn., by Davies, Paul (London 1997), p. 668Google Scholar; Gore-Browne on Companies, 44th edn., vol. 2, para. 28.8; Law Commission Consultation Paper No. 142, Shareholder Remedies, para. 5.18.
3 Nurcombe v. Nurcombe [1985] 1 W.L.R. 370, 378 per Browne-Wilkinson L.J.
4 The phrase was first used in Fitzroy v. Gwillim (1786) 1 T.R. 153, 154 per Lord Mansfield, although there it was regarded as equivalent to the maxim “he who seeks equity must do equity”, a principle which is now regarded as distinct, relating to future rather than past conduct (cf. the clean hands doctrine). The first case in which the clean hands doctrine is recognised as a distinct maxim in its own right is Dering v. Earl of Winchelsea (1787) 1 Cox. Eq. Cas. 318. However, the origins of the clean hands concept can be seen in earlier cases, e.g., Jones v. Lenthal (1669) 1 Cas. in Ch. 154; Small v. Brackley (1707) 2 Vern. 602.
5 See, e.g., Z. Chafee, , “Coming into equity with clean hands” (1947) 47 Mich. L.R. 877Google Scholar. It seems likely that since this maxim was first enunciated other equitable doctrines have developed to deal with many of the issues which would otherwise fall within the clean hands principle, such as equitable estoppel, laches, acquiescence etc. The ambit of the clean hands doctrine proper is therefore likely to have been reduced over time. Indeed, the House of Lords in Tinsley v. Milligan [1994] 1 A.C. 340 seem to regard it as equivalent only to the idea that a claimant who has been guilty of fraudulent or illegal conduct will forego assistance, a narrower view that adopted earlier in the century (e.g. Towers v. African Tug Co. [1904] 1 Ch. 558 which regarded acquiescence by the claimant as within the clean hands concept). The exact extent of the maxim is irrelevant for the purposes of this article since it is the role of this maxim however defined which will be discussed.
6 E.g., Duchess of Argyll v. Duke of Argyll [1967] Ch. 302; Griffiths v. Griffiths [1973] 3 All E.R. 1155; NZ Netherlands Society “Oranje” Inc. v. Kuys [1973] 2 All E.R. 1222; J. Willis & Son v. Willis [1986] 1 E.G.L.R. 62; Tinsley v. Milligan [1994] 1 A.C. 340.
7 Loosley v. National Union of Teachers [1988] I.R.L.R. 157, 162 per Sir Denys Buckley.
8 E.g. Gascoigne v. Gascoigne [1918] 1 K.B. 223.
9 E.g. Re Emery's Investment Trusts [1959] Ch. 410.
10 Tinker v. Tinker [1970] 1 All E.R. 540, 541 per Lord Denning.
11 Towers v. African Tug Co. [1904] 1 Ch. 558, 572 per Cozens-Hardy L.J. (although see n. 19 and associated text); Re Flitcroft's Case (1882) 21 Ch. D. 519, 534-535 per Brett L.J.
12 Van Gestel v. Cann [1987] Times, 7 August per May L.J.
13 North West Transportation v. Beatty (1887) 12 App. Cas. 589.
14 [1904] 1 Ch. 558.
15 [1985] 1 W.L.R. 370.
16 [1904] 1 Ch. 558, 567 per Vaughan Williams L.J.
17 Ibid.
18 [1985] 1 W.L.R. 370, 378 per Browne-Wilkinson L.J.
19 It was common, as occurred in Towers, for the action of the shareholders on behalf of the company to be described as “an action … by a shareholder suing on behalf of himself and all other shareholders against the company as defendants” ([1904] 1 Ch. 558, 571, per Cozens-Hardy L.J). There seems to have been some confusion even at the time regarding the nature of this claim. For example, in Moseley v. Koffeyfontein Mines Ltd. [1911] 1 Ch. 73, reported seven years after Towers, the principle in Towers was relied on by counsel in relation to a personal claim by a shareholder and all three Court of Appeal judges in that case went out of their way to distinguish Moseley and Towers on that basis, see, e.g., [1911] 1 Ch. 73, 78 per Cozens Hardy L.J.
20 See, e.g., Foss v. Harbottle (1861) 2 Hare 461, 491-492 per Sir James Wigram V.-C.
21 [1904] 1 Ch. 558, 566 per Vaughan Williams L.J. Post-Wallersteiner v. Moir (No. 2) [1975] Q.B. 373, of course, the substance of a derivative action is regarded as identical to that of a claim by the company on its own behalf, albeit that the form is different.
22 Ibid., at p. 572 per Cozens-Hardy L.J.
23 [1975] Q.B. 373, 391.
24 This has important consequences, so that, for example, shareholders can bring derivative actions in relation to wrongs which were done to the company before they became members (see, e.g., Seaton v. Grant (1867) L.R. 2 Ch. App. 459), something which is obviously not possible in relation to a personal action.
25 [1985] 1 W.L.R. 370, 378 per Browne-Wilkinson L.J.
26 Law Com. No. 246, Shareholders Remedies, part 6.
27 See DTI, Modern Company Law for a Competitive Economy: Developing the Framework (March, 2000) paras. 4.131-2 and DTI, Modern Company Law for a Competitive Economy: Final Report (June 2001) para. 7.46.
28 Cf. Law Commission Consultation Paper No. 142, Shareholder Remedies, para. 5.18.
29 Law Com. No. 246, Shareholders Remedies, paras. 6.73-6.74.
30 This broad discretion is certainly wide enough to allow the court to continue to apply the clean hands principle developed in Towers and Nurcombe in the way in which it has, inappropriately it is suggested, been applied to date. There is certainly no suggestion in the Law Commission's Report that the courts should not take the concept of clean hands into account when deciding whether to allow a derivative action to proceed.
31 Law Com. No. 246, Shareholders Remedies, paras. 6.75-6.76. The Law Commission's Report does not, however, suggest that good faith should be a prerequisite.
32 Ibid., para. 6.76.
33 This is not made explicit in the text. However, another of the Law Commission's stated factors recommends the court to have regard to the “interests of the company” (see n. 44 and associated text). If “bad faith” is only intended to cover situations in which the shareholder is acting contrary to the interests of the company, i.e. bad faith between the shareholder and the company, then the provision would presumably be otiose. It seems likely, therefore, that the good faith factor is intended to have broader application and to encompass issues of bad faith which exist between the shareholder and wrongdoer.
34 Prudential Assurance Co. Ltd. v. Newman Industries (No. 2) [1982] Ch. 204; Johnson v. Gore Wood & Co. [2001] 2 W.L.R. 72.
35 For example, in relation to illegal dividend payments, the court has no difficulty in allowing the claims against the directors to proceed even where some of the shareholders have received the payments in full knowledge of the illegality of those payments: Moxham v. Grant [1900] 1 Q.B. 88.
36 See e.g., Smith v. Croft (No. 2) [1988] Ch. 144, 170 per Knox J.; Nurcombe v. Nurcombe [1985] 1 W.L.R. 370.
37 Not only is the idea of denying someone an otherwise valid claim solely on the basis of an improper motive contrary to other, arguably analogous, areas of company law (see e.g., Bryanston Finance Ltd. v. De Vries (No. 2) [1976] Ch. 63, 75 per Buckley L.J.) but motive is also a concept which it is notoriously difficult for courts to ascertain, often being mixed and difficult to prove. The Law Commission has avoided the suggestion that an ulterior motive should of itself necessarily be sufficient (via the concept of bad faith) for the court to deny a derivative action: Law Com. No. 246, Shareholders Remedies, paras. 6.75-6.76.
38 In an insolvent company a similar situation can arise regarding the motive for presenting a winding up petition. See e.g., Re Crigglestone Coal Co. Ltd. [1906] 2 Ch. 327; F. Oditah, “Winding up recalcitrant debtors” (1995) L.M.C.L.Q. 107, 123-130.
39 [1988] Ch. 144.
40 This is a view which has subsequently been endorsed by the Law Commission (Law Com. No. 246, Shareholders Remedies, paras. 6.88-6.90), albeit that the recommendation of the Law Commission is that the views of the independent organ should not be regarded as conclusive, but merely one of the factors to be taken into account by the courts. See also DTI, Modern Company Law for a Competitive Economy: Final Report (June 2001) paras. 7.46-7.51.
41 Independence, for these purposes is measured by whether the shareholders would vote for the defendant directors in order to support them rather than for the benefit of the company: Smith v. Croft (No. 2) [1988] Ch. 144, 186 per Knox J.
42 [1995] 1 B.C.L.C. 243.
43 See n. 37.
44 [1995] 1 B.C.L.C. 243, 256 per Peter Gibson L.J. This principle seems to have been explicitly recognised by the Law Commission (Law Com. No. 246, Shareholders Remedies, paras. 6.77–6.79) which has suggested that the court should take account of the interests of the company when deciding whether to allow a derivative action to go ahead.
45 [1985] 1 W.L.R. 370, 377 per Lawton L.J.
46 By comparison, the suggestion in Bairslow v. Queens Moat Houses plc (CA), [2001] EWCA Civ 712, [2001] 2 B.C.L.C. 531 was that, in the context of unlawful dividend payments, even innocent shareholders could be liable to repay those dividends to the company. It was suggested that all shareholders (including therefore innocent shareholders) would receive an unmerited windfall if the amounts of the unlawful dividends which the shareholders had received in the past were then restored to the company by the directors and were again distributed, this time lawfully, by way of dividend. No view was reached on the merits of this issue in Bairstow, but this argument does not seem strong. There is little or no case law support for such an argument. The few words put forward from Cotton L.J.'s judgment in Re Flitcroft's Case (1882) 21 Ch. D. 519 in support of this claim by counsel in Bairstow are poor support, being contrary to the express views of the other two judges in Re Flitcroft's Case and arguably not able to support the meaning suggested in any case, see, e.g., Segenhoe v. Akins (1990) 1 A.C.S.R. 691. In addition, in other areas of company law windfall payments to shareholders are clearly regarded as acceptable, e.g., Regal (Hastings) Ltd. v. Gulliver [1967] 2 A.C. 134n. A better argument to reclaim the payments made to the innocent shareholders may be a restitutionary claim, subject to the change of position defence.
47 Russell v. Wakefield Waterworks Co. (1875) L.R. 20 Eq. 474; Rolled Steel Products (Holdings) Ltd. v. British Steel Corporation [1986] Ch. 246, 297-298 per Slade L.J.; Precision Dippings Ltd. v. Precision Dippings Marketing Ltd. [1986] Ch. 447; for a recent example, see Allied Carpets Group pic v. Nethercott [2001] B.C.C. 81.
48 E.g., Moxham v. Grant [1900] 1 Q.B. 88; Precision Dippings Ltd. v. Precision Dippings Marketing Ltd. [1986] Ch. 447; Hilton International Ltd. v. Hilton [1989] 1 N.Z.L.R. 442; Aveling Barford Ltd. v. Perion Ltd. [1989] B.C.L.C. 626.
49 E.g., Re Denham & Co. (1883) 25 Ch. D. 752.
50 Section 277(1) of the Companies Act 1985, which operates in parallel with the common law provisions (s. 277(2) and see Precision Dippings Ltd. v. Precision Dippings Marketing Ltd. [1986] Ch. 447).
51 [1900] 1 Q.B. 88.
52 Of course, the fact that a shareholder generally owes no duty to act in the best interests of the company leaves them free to make such a promise.
53 This is unlikely to prevent a subsequent shareholder, or indeed a liquidator in the event of the company being wound up, being allowed to bring a claim on the company's behalf in relation to that wrong at a later date because, although there is no direct authority on this point, it seems likely that a decision not to sue is not extinctive of the company's claim. A more extreme, but less likely, possibility would be for the court to regard the company as having taken a valid decision to ratify the transaction via the principle discussed in Multinational Gas and Petrochemical Co. v. Multinational Gas and Petrochemical Services Ltd. [1983] Ch. 258, 280 per May L.J, that “the unanimous decision of all the shareholders in a solvent company about anything that the company under its memorandum of association has power to do shall be a decision of the company”. This analysis is of no assistance where the company is in liquidation or where, as in Towers, the directors are attempting to do something (such as pay an illegal dividend) which the company has no power to do, but may be applicable in a Nurcombe-type situation. The views of the wrongdoing majority shareholder (not to bring a derivative action) are already known and therefore the views of the minority shareholder are the remaining piece of the jigsaw in determining the company's position for this purpose. If this does occur then it is likely that the ratification will be regarded as extinctive of the company's claim so that no future shareholder, or liquidator, would be able to re-open this issue (see J. Payne, “A Re-examination of Ratification” [1999] C.L.J. 604, 616-617).
54 Browne-Wilkinson L.J. preferred to view the case as one of acquiescence rather than election but does not seem to have believed that this affected the principles to be applied (at p. 378).
55 [1985] 1 W.L.R. 370, 380 per Sir Denys Buckley.
56 Re Saul D. Harrison & Sons plc [1995] 1 B.C.L.C. 14, 18 per Hoffmann L.J.; Re Charnley Davies Ltd. (No. 2) [1990] B.C.L.C. 760.
57 Re London School of Electronics [1986] Ch. 211. However, the cleanliness of the hands of the plaintiff will undoubtedly have a part to play in determining whether the activities complained of are, in fact, unfair, and also on the remedy which the court awards at the end of the day.
