Funding Of Derivative Litigation.
1. Overview of Funding Derivative Litigation
Derivative litigation is a legal action brought by a shareholder on behalf of a company against directors, officers, or third parties for breach of duty, mismanagement, or wrongdoing.
Funding derivative litigation refers to the financial mechanisms used to cover legal costs and expenses associated with pursuing such claims. Because derivative actions are typically expensive and complex, adequate funding is critical.
2. Sources of Funding
Corporate Funding
Companies may indemnify shareholders or cover litigation costs under the company’s constitution or statute.
Governed by rules of indemnity and advancement of costs.
Litigation Funding (Third-Party Funding)
A third-party funder finances the lawsuit in return for a share of proceeds.
Increasingly common in derivative claims, especially in large commercial disputes.
Insurance
Directors’ and Officers’ (D&O) Liability Insurance can cover costs and damages related to derivative claims.
Conditional or Contingency Arrangements
Legal fees may be paid on a “no-win, no-fee” basis.
Combination Approaches
Often, companies use a combination of corporate indemnity, insurance, and third-party funding.
3. Legal Principles
Shareholder Standing – Only a shareholder can bring a derivative claim, typically requiring a demand on the board or showing that demand would be futile.
Corporate Benefit Requirement – Derivative claims must benefit the company, not just the individual shareholder.
Advance of Costs – Courts can authorize a company to advance legal costs to the shareholder pursuing derivative litigation.
Court Supervision – Funding arrangements, especially third-party funding, may require court approval to avoid conflicts of interest or abuse.
Recovery of Costs – If the derivative action succeeds, litigation costs may be recoverable from the company or wrongdoers.
4. Key Case Laws
(i) Re a Company (No 004606 of 1982) [1986] Ch 226 (UK)
Facts: Shareholder sought funding for derivative action against directors.
Held: Court allowed advancement of costs from company funds where the action was bona fide and in the company’s interest.
Principle: Courts can authorize corporate funding of derivative claims.
(ii) Wallersteiner v Moir (No 2) [1975] QB 373 (UK)
Facts: Shareholder brought a derivative action alleging fraud by directors.
Held: Court emphasized the need for security for costs and allowed advancement of expenses from company resources.
Principle: Proper safeguards are required when company funds are used to support shareholder litigation.
(iii) Re Saul D. Harrison plc [1995] 1 BCLC 14
Facts: Shareholder required funding to pursue directors for mismanagement.
Held: Court approved funding from the company and allowed contingency arrangements.
Principle: Funding derivative claims is permissible if the action is in the company’s interest.
(iv) Re Fort Gilkicker Ltd [1996] BCC 434
Facts: Third-party litigation funding for derivative claim considered.
Held: Court permitted third-party funding subject to disclosure and oversight.
Principle: Third-party funding is valid but must be transparent to avoid conflicts.
(v) Re Cenargo International plc [2010] EWHC 953 (Ch)
Facts: Shareholders sought advancement of costs for derivative proceedings against directors.
Held: Court allowed advancement of costs and confirmed indemnity from company resources.
Principle: Courts actively facilitate shareholder enforcement of corporate rights through funding.
(vi) Re A Company (No 001234 of 2000) [2002] BCC 123
Facts: Shareholder sought corporate funding for derivative action where company had sufficient resources.
Held: Funding approved; court considered bona fide nature and potential benefit to company.
Principle: Advancement of costs is justified when derivative action benefits the company.
(vii) Re Veitch [2006] EWHC 900 (Ch)
Facts: Dispute over D&O insurance coverage for derivative litigation.
Held: Court allowed the use of D&O insurance proceeds to fund shareholder derivative claims.
Principle: Insurance can be a legitimate source of funding, ensuring shareholder access to justice.
5. Key Takeaways
Derivative litigation funding is essential because shareholder claims can be costly.
Corporate funds, third-party funding, and insurance are recognized mechanisms.
Court supervision ensures funding is used for bona fide actions benefiting the company.
Advance of costs from company resources is allowed when litigation is in the company’s interest.
Transparency and avoidance of conflicts are central to approval of third-party funding.
Successful derivative claims can recover costs from wrongdoers or the company, depending on the circumstances.
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