Derivative Actions Under UK Company Law

If you suspect a director has harmed your company but your board won’t take action, you’re not powerless. UK law offers a specific tool called a “derivative action” that lets a shareholder ask the court for permission to bring a claim on the company’s behalf.

It’s a serious step. Derivative actions are tightly controlled by the courts, and most disputes are better resolved with simpler measures. But in the right circumstances, this remedy can stop further damage and hold the right people to account.

In this guide, we’ll explain what a derivative action is, when it’s available under the Companies Act 2006, the steps involved, practical alternatives that often work faster (and cheaper), and the governance documents that help you avoid reaching this point in the first place.

What Is A Derivative Action (And When Would A Small Company Use One)?

A derivative action is a court claim brought by a shareholder on behalf of the company to address a wrong done to the company - usually wrongdoing by a director (for example, breach of duty, negligence or default). Because the company is the proper claimant, the shareholder must first get the court’s permission to proceed. If permission is granted, the claim continues in the company’s name.

Why this matters for small companies: in closely held businesses, a controlling director or majority shareholder can block the board from suing, even where there’s a clear problem. The derivative action mechanism is designed to prevent that stalemate if it’s genuinely in the company’s interests for the claim to go ahead.

Typical scenarios where owners consider a derivative action include:

• Alleged breaches of directors’ duties (e.g. failing to promote the success of the company, conflicts of interest, misuse of company property)
• Transactions at an undervalue to connected parties, without proper approval
• Serious lapses in oversight leading to losses the board refuses to investigate
• Attempts to ratify clear wrongdoing where minority shareholders are squeezed out of the decision

Remember: any recovery (damages, compensation, property) goes to the company, not to the shareholder personally. This is about protecting the business, not a personal payout.

When Can A Shareholder Bring A Derivative Claim Under The Companies Act 2006?

The Companies Act 2006 sets out the framework for derivative claims. In simple terms, you can ask the court for permission to bring a claim if there’s a case to answer that a director (or another person, but connected to a director’s duty) has committed a wrong against the company. The court will run a two-stage filter to ensure only appropriate cases proceed.

The Underlying Wrong

Common director duties that come up in derivative claims include:

• Duty to promote the success of the company for the benefit of its members as a whole
• Duty to exercise reasonable care, skill and diligence
• Duty to avoid conflicts of interest and not to accept benefits from third parties
• Duty to declare interests in proposed transactions

If the alleged conduct is capable of being ratified by an informed, independent shareholder vote, the court will look closely at whether a derivative action is appropriate. However, in many small companies, the practical ability to obtain a genuinely independent vote can be limited, especially if the alleged wrongdoer controls the voting.

Mandatory Refusal And Discretionary Factors

The court must refuse permission if, for example, a hypothetical independent board would not continue the claim, or the act is already validly authorised or ratified. Where refusal is not mandatory, the court then looks at discretionary factors, such as:

• Whether the shareholder is acting in good faith
• The importance that an independent board would attach to the claim
• Whether the company could pursue the claim itself
• Whether the alleged act is likely to be ratified
• Whether the claim is in the best interests of the company (cost/benefit)

In practice, the permission stage is the biggest hurdle. The court will expect clear, focused evidence and a realistic plan for the litigation.

Step-By-Step: How A Derivative Action Works (Permission Stages And Evidence)

If you’re considering this route, it helps to know the typical path. Here’s a high-level process you can expect.

1) Gather Evidence And Consider Alternatives

Start by assembling the facts: board minutes, emails, contracts, accounts, and any approvals (or lack of them). You’ll also want to think about quicker solutions, like a formal complaint to the board, an independent investigation, or a targeted letter before action.

2) Put The Board On Notice

Before running to court, it’s sensible to ask the board to address the issue. That might mean requesting a meeting, proposing an independent review, or asking for a formal vote on next steps. Proper governance here matters - recording matters through board resolutions or general meeting resolutions reduces later disputes about what was considered.

3) File The Claim And Permission Application

A derivative claim begins with a claim form filed in the company’s name, together with an application for permission. You’ll need a witness statement setting out the alleged wrong, why it’s in the company’s interests to proceed, and why alternatives won’t work. The claim is initially considered on the papers.

4) The Permission Stages

• Paper stage: The judge decides whether there’s a prima facie case to proceed. If not, permission is refused without a full hearing.
• Oral hearing: If the paper stage is passed, there’s an inter partes hearing where both sides can be heard. The court then decides whether to grant permission (with or without conditions).

Conditions might include how the claim will be funded, how decisions will be made during litigation, or limits on settlement without the court’s approval.

5) Case Management And Conduct Of The Claim

If permission is granted, the shareholder effectively takes carriage of the litigation for the company, but important decisions may still require court oversight. Settling or discontinuing usually needs the court’s approval to ensure the company’s interests remain front and centre.

Practical Alternatives To A Derivative Action (Resolve It Without Court)

Most small companies resolve disputes before they escalate to a derivative action. Consider these practical pathways first.

Request An Independent Board Decision

Ask the board to refer the matter to an independent sub-committee or external lawyer for a report. If a disinterested group decides the company should pursue a claim (or settlement), that often resolves the need for any shareholder-led process. Formalising the decision with a directors’ resolution gives you a clear record.

Use Your Shareholder Rights

Depending on your voting power and the company’s constitution, you may be able to call a meeting or propose resolutions. Some decisions require special resolutions, while others can be handled by ordinary resolutions. Check your Articles of Association and any Shareholders Agreement to see what levers you already have.

Tighten Governance And Conflicts Processes

Many disputes stem from poor processes around related-party dealings and disclosure. Introducing a clear, practical Conflict of Interest Policy and documenting approvals properly can defuse suspicion and prevent repeat issues.

Targeted Claims And Negotiated Exit

Sometimes targeted action (for example, enforcing contractual rights or seeking an injunction) is faster and cheaper than a derivative claim. In some cases, a negotiated share transfer or buyout is the cleanest solution - especially where trust has broken down and co‑founders want to part ways.

Address The Root Causes

If the dispute relates to unapproved decisions that arguably breach the constitution, it may be appropriate to challenge a breach of Articles rather than pursue a full derivative action. Start with the narrowest, most proportionate step that protects the business.

Documents And Governance That Reduce The Need For Derivative Claims

Good paperwork won’t stop every dispute, but it gives you fair processes, clear rules and faster remedies - which often means you never need to consider a derivative action.

1) Articles Of Association And Shareholders Agreement

Make sure your constitution fits how you actually run the company. A modern set of Articles and a tailored Shareholders Agreement can provide:

• Clear voting thresholds and reserved matters
• Conflict-management procedures and related-party approval processes
• Information rights for minority shareholders
• Dispute resolution pathways and buyout mechanisms

If your current constitution is outdated or unclear, get an Articles of Association review to reduce ambiguity and future friction.

2) Board Procedures And Record-Keeping

Well-run boards put approvals and rationales on the record. Consistent meeting packs, declarations of interest and properly drafted minutes matter. When questions arise, those records (and formal board resolutions) help establish that decisions were made for proper purposes and with appropriate care.

3) Conflicts And Related-Party Transactions

Have a simple, practical framework to flag, assess and approve conflicts. A readable Conflict of Interest Policy and standing board agenda item for interests/disclosures keep everyone honest and aligned.

4) Shareholder Decisions And Ratification

Some decisions are for shareholders, not directors. Understanding when you need ordinary versus special resolutions reduces the risk of challenges later. If the company genuinely wishes to ratify a decision, the process needs to be transparent and independent of the alleged wrongdoer.

5) Director Protections And Limits

Directors often seek access and cost protections when acting in good faith, via a Deed of Access and Indemnity. These have statutory limits - you cannot indemnify a director against liability for their own negligence, default, breach of duty or breach of trust - but they can cover certain costs and access to records. If you’re putting these in place, make sure any deed (for example, a Deed of Access & Indemnity) reflects the company’s risk profile and legal boundaries.

Costs, Risks And Remedies To Expect

Derivative actions are strategic tools, but they’re not quick or cheap. Before you press “go”, weigh the following.

Costs And Funding

• Legal costs can be significant, especially across the permission stages and potential trial.
• The court can impose conditions about who pays what and when. In some cases, the company may ultimately bear costs if the claim benefits it, but this is not guaranteed.
• Adverse costs risk applies - if you lose, you may be ordered to pay a proportion of the other side’s costs.

Time And Management Distraction

Litigation takes management time and can distract from day-to-day operations. Be realistic about internal capacity and the potential impact on relationships within a small team.

Remedies The Court Can Grant

Because the claim belongs to the company, remedies are designed to protect the company’s interests. These can include:

• Damages or equitable compensation paid to the company
• Orders to set aside or unwind transactions
• Injunctions restraining further breaches
• Declarations and directions on corporate conduct

Risks Of Ratification Or Parallel Processes

In some cases, the board or shareholders may attempt to ratify conduct in parallel. The court will look at whether any ratification is genuine and independent. If not, it may carry little weight. Equally, if an independent board would not pursue the claim, permission may be refused.

Reputation And Confidentiality

Claims can become public and may affect staff, customers and investors. Before issuing, consider whether a negotiated solution or confidential investigation would protect value better than litigation.

Pre-Action Protocol And Proportionate Steps

Courts expect parties to try proportionate steps first: correspondence, information exchange, and reasonable attempts to settle. Well‑structured pre‑action letters (such as a focused letter before action) can prompt movement without issuing a claim.

Frequently Asked Questions About Derivative Actions

Is A Derivative Action The Same As An Unfair Prejudice Petition?

No. An unfair prejudice petition (often used by minority shareholders) focuses on conduct unfair to you as a shareholder. A derivative action focuses on a wrong done to the company. In some cases, both routes may be considered, but they serve different purposes and remedies.

Do I Need A Certain Percentage Of Shares To Bring A Claim?

No specific minimum shareholding is required for a derivative claim. However, the court will assess your good faith and whether an independent board would pursue the claim. The smaller your stake, the more you’ll want to show the claim benefits the company overall. Understanding your broader shareholder rights can help you plan your approach.

Can We Approve Or “Fix” A Director’s Breach After The Fact?

Some acts can be authorised or ratified by shareholders, but not all - and never where the process is tainted by the wrongdoer’s vote or where the law prohibits indemnification or ratification. If ratification is being considered, ensure the process is independent, transparent and compliant with your constitution and the law.

What If The Articles Are Being Ignored?

If decisions are being taken outside your constitution, challenge that directly. It’s often faster to correct a breach of Articles than to mount a full derivative action about the same conduct.

Should We Update Our Constitution First?

If the issue stems from unclear voting thresholds or missing conflict rules, prioritise governance fixes. Updating your Articles of Association and implementing a practical conflicts policy can prevent repeat problems while you assess any claims.

How To Decide Your Next Step

Here’s a simple decision framework you can use:

• Is there clear evidence of a wrong done to the company (not just a commercial disagreement)?
• Would an independent board likely pursue a claim, based on costs, prospects and impact?
• Have proportionate steps been tried - independent review, formal board process, targeted correspondence and negotiations?
• Are governance fixes available now to prevent ongoing harm (e.g. approvals, policy changes, resolution to unwind a transaction)?
• If litigation is still needed, is a derivative action the most suitable vehicle - or is there a narrower claim available?

If you’re unsure at any point, get tailored advice. The right early step - even a single well‑pitched board paper or pre‑action letter - can change the trajectory and avoid heavy litigation.

Key Takeaways

• A derivative action lets a shareholder ask the court for permission to sue on the company’s behalf where wrongdoing has harmed the business and the board won’t act.
• The court applies a strict permission test and will ask whether an independent board would pursue the claim and whether it’s in the company’s best interests.
• Start with proportionate steps: put the board on notice, document decisions with proper resolutions, and consider a targeted letter before action or negotiated exit.
• Strong governance reduces risk: up‑to‑date Articles of Association, a tailored Shareholders Agreement, and a clear Conflict of Interest Policy help prevent disputes or resolve them without court.
• Claims are costly and time‑consuming. Remedies benefit the company (not the individual shareholder), so weigh the business case and consider alternatives first.
• If litigation is unavoidable, plan your evidence and funding carefully and be ready for the court’s permission process and potential conditions.

If you’d like help assessing a potential derivative action, updating your governance documents, or preparing board and shareholder resolutions, you can reach us at 08081347754 or team@sprintlaw.co.uk for a free, no‑obligations chat.