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The scope for hedge funds to use litigation, or the threat of litigation, against company directors has increased following recent changes to U.K. company law. With the implementation of new provisions of the 2006 Companies Act on 1st October, investors now have a statutory right to sue directors for “negligence, default and breach of duty.” Under existing common law, such claims (known as ‘derivative actions’) could only be brought in very limited circumstances as it was argued that company boards should not be under constant threat of claims from minority shareholders. Two significant changes in the new rules are that claims can now be brought even if a director did not act in bad faith (negligent is sufficient), and where a director did not personally profit from the alleged wrongdoing.

The scope for claims has also increased because the new law also introduces a new, wider duty for directors to “promote the success of the company for the benefit of the members as a whole,” – taking into account factors such as the “likely consequences of any decision in the long term.” It has been suggested that this could enable activist funds to block prospective takeovers on the basis that this failed to take into account a company’s long-term interests. Directors are now also under a duty to act “fairly as between members of the company.”

However, the new law also imposes significant hurdles for claims made under the derivative action method, including permission from the Court to proceed, which will be subject to the claimants establishing a prime facie case and providing evidence. In addition, as under the existing law, if a director has acted in good faith and exercised reasonable skill and care, a claim will be unlikely to succeed.

For more information, see the recent FSI briefing note: Derivative Actions and the Activist Shareholder.