The new way: has the advancement of shareholder activism consigned traditional shareholder remedies to history?

In the immediate aftermath of the global financial crisis, commentators correctly anticipated an increase in shareholder class actions in the US where activist shareholders have been prevalent since the 1980s. In England and Wales, it was thought that the same aims would be met through increased utilisation of Group Litigation Orders (GLO) and an uptake of the new UK Companies Act 2006 mechanism for shareholder derivative action in England and Wales.

However, several years on, and with global economies still in recovery, the predicted UK increase in shareholder class actions has been displaced by an increase in shareholder activism. Does this mean that tradition has been consigned to history?

Arguably today’s activist shareholders fill a governance void, seeking to improve company boards and to encourage company focus on value creation rather than stripping assets, as well as spurring other investors to engage as they try to garner their support.¹

Support for this form of activism has been widespread, including from government and industry leaders:

The UK Investor Forum, established by the investment industry in October 2014 in response to a recommendation of the Kay Review,² seeks to improve collective engagement with the aim of promoting cultural change and enhancing increased shareholder stewardship, which accords with the UK Stewardship Code for institutional investors. Under that Code, formerly passive institutional shareholders who are signatories to it must apply its principles and guidance on a ‘comply or explain’ basis. As a result, they should be willing to act collectively with other investors where appropriate, they must actively consider when they will intervene, and they may seek to effect change regarding issues such as company strategy, management, long-term growth, M&A activity, and the appointment, remuneration and removal of directors.

In December 2014, the UK National Association of Pension Funds encouraged shareholders to ‘rise to the challenge of the UK Stewardship Code’ and suggested that members should vote together to remove the chairman of any company consistently ignoring shareholder recommendations and/or objections, for example in relation to executive remuneration.³

In February 2015, Vanguard, one of the world’s largest fund managers, wrote to the independent directors of its largest portfolio holdings to request the establishment of ‘shareholder liaison committees’,⁴ which the fund manager considered would promote communication between shareholders and company boards, enabling shareholders to anticipate problems and ‘nip them in the bud’.⁵

Thus, shareholder activism usually focuses on the prevention, rather than cure, of potential executive misdemeanours and/or mismanagement of the company.

Strategies employed include: privately addressing concerns to the board; actively engaging with fellow shareholders to influence decisions at general meetings; raising audit concerns; seeking disclosure; and requisitioning general meetings.

In the context of increased global regulatory enforcement and the need for companies to ensure that their regulatory compliance systems and controls are effectively implemented, the value of increased monitoring of board activity by shareholders is clear.

As a mechanism for prevention or early intervention, shareholder activism also has the potential to be a less costly step for shareholders than engaging in formal adversarial proceedings.

However, the cost to a company of adopting a defensive position against an activist shareholder can be substantial, thereby potentially damaging company value and shareholder interests. Sothebys reported that the battle and subsequent reconciliation with its activist shareholder, Third Point, cost the auction group US$20.1m in the first nine months of 2014 (half its net income for that period), a process which culminated in Third Point being given three board seats.⁶

In light of the apparent push for increased shareholder activism and the positive results it mostly brings, the question arises: is there still a place for the traditional shareholder remedies?

It is really a question of timing. The value of activism (for both company and shareholders) lies in its early deployment to stop proposed activities or encourage others. Once any perceived harm has been done (or is about to be done regardless of shareholder objections), the only option for shareholders who do not simply wish to sell and cut their losses may be to look for a remedy in litigation. For example, where there is negligent misrepresentation on the part of the board, it is to be expected that shareholders will still choose to seek redress in court.

Under the Companies Act 2006, shareholders may seek to bring a derivative action against the board on behalf of the company, for breach of the duties owed by the directors to the company. The key distinction under English law, as compared with the regime in the US, is that such a claim, although initiated by shareholders, is brought in the name of the company and on its behalf. This means that the company will also be the recipient of any damages award. In contrast, US securities class actions present shareholders with an opportunity to recover substantial damages for their own account.

Derivative claims can only be brought with the prior permission of the Court and, even then, in limited circumstances. Under section 263(2) (a) of the UK Companies Act 2006, the Court must refuse permission to continue with a derivative action where it considers a notional director acting to promote the success of the company would not seek to continue it. In Mission Capital plc and another,⁷ the court refused permission for shareholders to continue with the claim because it deemed that such a hypothetical director would not seek to continue the claim as they would be unlikely to attach much importance to it, and the alleged damage suffered was speculative.

An alternative remedy under the Companies Act 2006 is for shareholders to petition the court for relief under section 994, where they can demonstrate that the company is being run in a manner unfairly prejudicial to them, or an actual or proposed act or omission would prejudice their interest.

In practice, this tends to be a minority shareholder remedy; majority shareholders are not barred from bringing such petitions, but they will not successfully demonstrate to the Court that any prejudice is unfair where (by their majority) the prejudicial state of affairs could be easily rectified.

As with any litigation, costs are a key consideration. When contrasted with the position in the US, the lack of shareholders seeking collective redress by way of derivative action in England and Wales is easily explained. Not only will shareholders bringing such a claim under English law not retain the damages award for themselves, they must also fund the litigation, unless they can obtain a court order for a costs indemity from the company.

Under English rules on costs, shareholders also run the risk of an adverse costs order against them should they fail to achieve a successful outcome at trial, meaning they may have to contribute substantially to the defendants’ costs (to the extent they have not obtained ATE insurance to cover all or part of this potential liability). In contrast, parties in the US generally meet their own costs.

For those companies with dual listings in the UK and the US, there is the added risk that, in certain circumstances, shareholders on both sides of the Atlantic may launch an action, meaning they must contend with parallel class action / group litigation in two jurisdictions. Indeed, the supermarket Tesco is currently facing just such a challenge.

Neither shareholder activism nor the more traditional shareholder remedies offer a panacea for the shareholder. Each has their own benefits and the option chosen by shareholders will likely depend upon the nature and timing of their complaint, the desired outcome, and the level of support from other shareholders.

Indeed, it may be appropriate to deploy both methods to ensure that companies continue to pay attention to their shareholders and act in a constructive and fruitful manner.

At the very least, shareholders need to be aware of the tools in their armoury, and companies must remain firmly on their toes.