I. Introduction

Corporate Governance is essential to ensure all stakeholder that are affecting or affected by companies’ activities are gained their rights properly. To reach that goal, a set of corporate governance tools are set such as shareholders voting, Non-Executive Directors (NEDs), one-on-one approach, takeover, and enforcing director liability through a derivative claim. Under Company Act 2006 derivative claim is defined as an action brought by a member of a company in respect of a cause of action vested in the company and seeking relief on behalf on the company. Arguably, Derivative Claim has a role in the company however it does not work effectively. This writing will try to examine that statement through two part. The first part will highlight agency problems and why corporate governance is needed and the second part will cover some problems with derivative claims under the Company Act 2006 and the possible corporate governance tools to complete it. Then the third part will conclude the discussion.

II. Corporate Governance and Agency Problem
A heated discussion of the importance of corporate governance had arisen since the Berle and Means coined the separation and dispersion of ownership and control in a modern company. Corporate governance will be needed to solve what we called to as “agency problems” which is defined as problems that arise as consequences of relationship between two (or more) parties in the company. Prentice argues agency problems  primarily focus on an attempt to align shareholders-directors relationship in which the shareholders should ensure the director always make the best decision for shareholders profit maximization instead of director interest. Different with Prentice, Kraakman et al point out broader agency problems. Kraakman not only focus on shareholders-director problems but also with the relationship between the company and wider stakeholders such as minority shareholders, employer, creditor, and consumer. The contractual relationship between company and other stakeholders makes the company owes disclosure for them.

Kraakman’s approach in addressing agency problems arguably more desirable today especially since the fall of several big companies in the early of 2000. The collapse of Enron in the United States and Maxwell and Polly showed that a weak corporate governance system in a company was not only affecting the companies themselves but also another stakeholder. In Enron scandal, for example, up to 4,500 employees lost their jobs as well as of their pension fund. In responding Enron, United Kingdom initiated changes its corporate governance system which one of it is the codification of derivative claim in UK Company Act 2006.

III. Derivative Claim as Corporate Governance Tool

The suit is called “derivative” because the shareholders are allowed to bring a dispute on behalf of the company or the shareholders assert his rights “derivatively”. This term arisen as a response to Foss v Harbottle rules of ‘proper claimant’ and ‘majority rules.’ Under those rules, shareholders were prohibited to bring a claim on behalf of the company because a company is an independent legal entity and therefore only the company itself that can bring proceedings to redress the wrong. Lord Denning in Wallersteiner v Moir commented that Foss v Harbottle principles cannot answer a problem when the wrongdoer is insider who controls the company, for example the director itself. Therefore there is an exception of Foss v Harbottle rules which in 2006 is codified on Company Act 2006.

This new statute arguably gives more easiness to minority shareholders in bringing derivative claim on behalf of the company because they are no longer necessary to show that the wrongdoing directors are ‘in control of the company’ which often become a hard things for minority shareholders. However, Hudson argue that there is still improvement made in term of minority shareholders protection as a response to BHS collapse in 2015. The proposal is to expand the rights of minority shareholders under section 260 (3) to not only under the scope of negligence, default, breach of duty and breach of trust, but also to object some significant transaction that would harm the company and any stakeholder related to the company. This proposal sounds interesting however one that should be noted is, given too much discretion to minority shareholders might be create unstable decision maker in the company.

Further, with regard to derivative claim, two principal functions are coined by scholars namely deterrence and compensation functions. Kraakman and Reisberg argued  derivative claim has deterrence effect  whereas the directors will be overshadowed by the threat to be suited to the court. Banta argued, instead of being more careful, such threat may make the director will be more risk-averse and maybe make the company loss its opportunity to reach big business transaction. Aside from that, the fear to be litigated also makes the director spends more money to hire experts and store documents that consequently cost the company more. It can be argued that the deterrence effects cannot be looked at two extreme responses, whether the director will be more careful or be more risk-averse. Arguably, there will be the degree of response which can be managed with another corporate governance tools, for example, a one-on-one meeting between shareholders and the director.

Reisberg also mentioned that derivative claim as a tool to ensure the company gets good compensation when the director harms the company. However, he also emphasized that the importance of calculating the expected recovery with litigation cost. Sometimes the costs of litigation might exceed the expected recovery gained by the company. In Prudential Assurance Co Ltd v Newman Industries, Newman directors were alleged causing loss £45,000 as a result of their actions. However, in contrast, the spendable costs for the litigation was more than £750,000. This amount should be borne by Newman Industries as based on decision in Wallersteiner v Moir (No.2) (1975) the plaintiff shareholder is entitled to get indemnity. In this case, the company has been killed by the kindness of its shareholders.

Aside, from that the there is still a debate on cost-analysis on whether the compensation is worth with the and non-material cost that might be burden by the company. Publication of litigation may affect the reputation of the company and likely deter further investment and decrease customer trust. It also will destruct daily management of the company because the director and manager of the company will focus to overcome litigation the which arguably are the biggest lost for the company.Moreover, some scholar also criticize the capability of the court to evaluate business decision made by the director. Business decisions standing between the attempts to countering risk and confronting uncertainty. Aside from that, the circumstances surrounded business decision made previously arguably cannot easily be reconstructed in courtrooms years later , therefore, it is deemed only the experienced professional in business can evaluate it. This argument might be fit with today’s context, especially when the number of derivative claim in the UK is just a few. As the reported by Armour during 1999 to 2006, there was only 25 derivative claims in the UK which is not to be used by the court in adjudicating the derivative claim.

However, if look effectiveness of corporate governance through precedence, Ferris at al argument on derivative claims in the US can be a reference. After examining derivative claims during 1982 to 1999 in the United States (US), Ferris at al found that the derivative claim helps company in filling their new composition of the board of directors. It is also proven in improving greater outside representation and minimize boards composition which consequently provides superior corporate governance.
Although it is still questionable whether the positive impact of derivative claim can also happen in the UK, it is clear that UK needs more precedent to test the effectiveness of derivative claim on its corporate governance regime. As stated by Riley, derivative claim precedents are needed to clarify not only the scope of future managerial mismanagement but give clearer the contractual relationship between managers and shareholders.

IV. Conclusion
Before the enactment of Company Act 2006, derivative claim laid with the exception of Foss v Harbottle principle on ‘proper claimant’ and ‘majority rule’ which prohibited minority shareholders to bring an action on behalf of the company. However, after the enactment of Company Act 2006, minority shareholders are allowed and get more leeway to bring the derivative claim. The derivative claim has two primary roles namely deterrence and compensation role. However, these functions does not work effectively to overcome agency problems. In relation to deterrence effect, derivative claim cannot directly create a balance responses of the deterrence effect. Arguably, the shareholders should apply another corporate governance for example one-on-one meeting. Further in relation to compensation effect, there is an issue on material and non-material costs that might exceed the recovery.

BIBLIOGRAPHY

Authorities
1. Company Act 2006
2. Foss v Harbottle (1843) 2 Hare 461, 67 ER 189
3. Waddington Ltd v Chan Choo Hoo Thomas [2009] 2 BCLC 82
4. Prudential Assurance Co Ltd v Newman Industries [1982] 1 Ch 204, 234
5. Wallersteiner v Moir (No2) [1975] QB

Book
1. Prentice D.D , ‘Some Aspects of the Corporate Governance Debate’ in D.D Prentice and 2. P.R.J Holland (ed), Contemporary Issues in Corporate Governance, 1993, Clareendon Press
3. Solomon J, Corporate Governance and Accountability, 4th edn, John Wiley & Sons Ltd, 2013
Worthington S and Sealy L, Sealy and Worthington’s Cases and Materials in Company Law, 10th edn, OUP 2013

Journals

1. Armour J, Black B and the others, ‘Private Enforcement of Corporate Law: An Empirical Comparison of the UK and the US’ (2009) 6 J of Empirical Legal Studies 687.
2. Banta P, ‘The New Indiana Business Corporation Law: “Reckless” Statute or New Standard?’ [1987] Colum. Bus. L . 233
3. Brian R Cheffins, ‘Reforming the Derivative Action: The Canadian Experience and British Prospects’ [1997] Company Financial and Insolvency Law Review 227
4. Gooh SH, ‘Multiple Derivative Action and Common Law Derivative Acion Revisited: A Tale of Two Jurisdiction’ [2010] Journal of Corporate Law Studies 2010
   Hudson A, ‘BHS and The Reform of Company Law’ [2016] Company Lawyer
5. Kraakman R, Armour J and others, ‘Agency Problems, Legal Strategies, and Enforcement’ (The Harvard John M. Olin Discussion Paper Series) <http://www.law.harvard.edu/programs/olin_center/ > accessed 11 December 2016
6. Reisberg A, ‘Shareholders’ Remedies: The Choice of Objectives and the Social Meaning of Derivative Action’ (2005) 6 European Business Organization Law Review 227
7. Riley C, ‘Contracting out of Company Law – Section 459 of the Companies Act 1985 and the Role of the Court (1992) 55 (6) Modern Law Review 782

Blog
1. Consequences of Enron Scandal’ <http://www.global-ethic-now.de/gen-eng/0d_weltethos-und-wirtschaft/0d-01-globale-wirtschaft/0d-01-203-enron-folgen.php> accessed 10 November 2016