Mr Brian Harris (“Mr Harris”) is a member of the limited liability partnership Microfusion 2003-2 LLP (“the LLP”). He wishes to bring a derivative claim which he says would be for the benefit of the LLP against Future Films (Management Services) Limited and Future Films (Partnership Services) Limited (collectively “Future Films”) in respect of what Mr Harris says were breaches of duty committed by those companies as “Designated Members” of the LLP to the detriment of the LLP. He alleges that the LLP is entitled to damages or equitable compensation from Future Films amounting to more than £5 million.

The intended claims arise under three heads. He applied to the High Court, pursuant to standard procedure, for permission to continue the claims against Future Films on the LLP’s behalf. The application came before HH Judge Pelling QC, sitting as a judge of the High Court, on 24 March 2015 and by his judgment and order made on the following day, 25 March 2015, the judge granted permission to proceed with two of the intended claims but refused permission to proceed with a third. (The neutral citation for the judge’s judgment is [2015] EWHC 1116 (Ch)).

Mr Harris appeals against the order refusing permission to continue the third claim and Future Films appeals against the grant of permission in respect of the other two grounds. The judge refused permission to appeal but permission was granted in respect of both appeals by Lewison LJ by orders of 21 May 2015.

Behind the issues arising in this litigation lies voluminous commercial documentation about which it is not necessary to give more than a very brief outline. The context is a film financing scheme into which wealthy individuals were invited to invest, primarily in order to obtain certain taxation advantages from investment in the British film industry. In this case, in common with similar schemes, investment was invited to enable production of a particular film, ultimately called “Chasing Liberty”. There are 32 individual investor members of the LLP and the two Future Films companies, Future Films, who are parties to these appeals, are appointed as the “Designated Members” of the LLP.

Under the partnership deed (to the version of 28 November 2013 of which we were directed), clause 3.1 provides as follows:

The draft Particulars of Claim presented to the judge alleges that Future Films had and have control over the day to day management of the LLP and that they owed and owe fiduciary duties which were particularised in paragraph 4 of the draft as follows (in the draft the LLP is called “ the C” and Future Films “the Ds”):

The allegation is that Future Films committed breaches of these obligations in respect of three matters. These have been called in the proceedings “the LMI fee issue”, “the Alcon fee issue” and “the rebate of minimum guaranteed amount issue”. The judge granted permission to proceed with the second and third of these claims, but not the first.

Taking the LMI fee issue first, here it is alleged that LM Investments Limited (i.e. “LMI”), a company owned by the same person(s) who controlled the promotion of the film, had the apparent role of carrying through various parts of the film financing scheme. It is alleged that, at the instigation of Future Films, it received a fee from the LLP of £3.39 million for its general administrative services. The promotional literature had said that,

The second issue, the Alcon fee issue, arises out of Future Films being said to have procured the payment by the LLP of a fee of £2.5 million to Alcon Entertainment LLC for marketing services. It is alleged that there was no good commercial reason for the LLP to pay for such services, as it contracted for the provision of the same services by a company called Daughter Productions LLC (“DPL”) on the same day. It is alleged that the purposes of the arrangements with Alcon was explained in various different ways by the individual controlling Future Films. In an e-mail of 4 August 2003 the fee was (it is said) broken down into three parts, “an EP fee”, “a financing fee” and “commission”. It is said that HM Revenue and Customs rejected this explanation, saying that Alcon was the real maker of the film and the fee was not for better performance but part of the costs of the production arrangements. In the circumstances, it is alleged in the draft pleading that the payment was a breach of fiduciary duty as follows:

The third matter of which complaint is made is the “rebate of minimum guaranteed amount issue”. In this case it is said that the LLP entered into two agreements on 30 September 2003, with separate companies Trademark (First Daughter) Limited and Etic Films SRO (a Czech company) to make the film proposed to be produced by the LLP. Each was paid a sum of money. It was a term of each agreement that the difference between the sums paid over and the actual costs of production would be held by each company on trust for the LLP. The draft pleading alleges that on 7 June 2004 the LLP, acting by Future Films, agreed that a surplus of more than £1 million would be paid over to DPL as a rebate of money (“the Minimum Guaranteed Amounts”) otherwise due to the LLP.

Again, it is alleged that there was no real commercial reason for the surplus to be paid away in this way and that the stated consideration was merely illusory. It is alleged that the arrangement constituted a breach of duty by Future Films and, as with the Alcon fee, it is alleged as follows:

As already mentioned Mr Harris wishes to pursue these three claims on behalf of the LLP in a derivative action. His right to do so in respect of each is challenged by Future Films and each have appeals before us in respect of those claims in which their respective contentions were rejected by the judge. Thus, Mr Harris has to persuade us that the three claims are the proper subject of such an action and Future Films have to persuade us otherwise. The rival cases were presented with skill and cogency by Mr Harper QC for Mr Harris and by Miss Anderson QC for Future Films.

It has been common ground throughout that Chapter 1 of Part 11 of the Companies Act 2006 providing for a statutory derivative remedy, does not apply to limited liability partnerships. It is also not challenged that the common law derivative remedy has survived the enactment of the statutory remedy: see the decision of Briggs J (as he then was) in Universal Project Management Services Ltd. v Fort Gilkicker Ltd. & ors.[2013] Ch. 551.

The question for us is whether the proposed claims or any of them can properly be brought by Mr Harris as a member of the LLP because they fall within an exception to the rule in Foss v Harbottle(1843) 2 Hare 461. That is the rule of law by which only the company against whom a wrong is said to have been committed can bring proceedings in respect of that wrong; an individual member of the company cannot normally do so. There are four exceptions succinctly stated by Templeman J (as he then was) in Daniels v Daniels[1978] 1 WLR 406 at 408G-H as follows:

The legal debate before us has been as to the ambit of the fourth exception. I have to say a little more about the authorities on this subject. However, the judge summarised what he took to be the law from the recent analysis of David Richards J (as he then was) in Abouraya v Sigmund[2014] EWHC 277 (Ch). In that case, David Richards J said this (at paragraph 18 of the judgment):

Judge Pelling in the present case said,

Having reached that conclusion on the law, the judge’s decision on the LMI fee issue was this:

With regard to the Alcon fee issue, the judge recited the allegation in paragraph 15 of the draft pleading, which I have quoted above, alleging that the claimant could not see on what basis Future Films could honestly believe that Alcon was entitled to the fee paid. He then said (at paragraph 30):

The judge reached a like conclusion with regard to the rebate of minimum guaranteed amount issue, in the light of the similar statement in paragraph 21 of the pleading that the claimant could not see the basis of any honest belief in any benefit to the LLP in what was done. He said this (at paragraph 33):

Before us Mr Harper said that he had not intended to convey to the judge (and he did not, therefore, submit to us) that the plea in respect of the Alcon fee issue or that in respect of the rebate of minimum guaranteed amount issue were allegations of “deliberate and dishonest breach of duty”. He did not, therefore, seek to uphold the judge’s decision with regard to those two proposed claims on the basis decided by the judge.

Mr Harper’s submission, in outline, was that the summary of the ambit of the fourth exception to the rule in Foss v Harbottle was too narrowly stated by both David Richards J in the Abouraya case (supra) and by the judge in the present case. He argued that the requirement of “fraud” for the purpose of the exception was satisfied “where the proposed claim involves an allegation of breach of fiduciary duty and/or an abuse/misuse of power” (skeleton argument paragraph 40). He maintained that David Richards J had been wrong to find that a breach of duty (whether fiduciary or otherwise) would only amount to “fraud” if it was alleged that the person in breach of the duty had benefitted by it. This he said was contrary to the decisions of Briggs J in the Fort Gilkicker case and that of Megarry V-C in Estmanco (Kilner House) Ltd v GLC [1982] 1 WLR 2. Thus, it was submitted that all three proposed claims fell within the fourth exception.

Miss Anderson QC for Future Films argued that the judge’s conclusion on the law was correct but that he had erred in the application of it with regard to the Alcon fee issue and the rebate of guaranteed minimum amounts claims. As indicated above, Mr Harper did not seek to uphold those two claims on the basis found by the judge. He sought to defend them on the basis of his wider submission as to the ambit of the fourth exception.

Mr Harper’s submission rested primarily upon the Estmanco case, which he sought to support with certain dicta in Fort Gilkicker. I think it is useful, however, first, to consider the conclusion to which Templeman J came in Daniels v Daniels, after conducting a thorough review of earlier authority.

It will be recalled that in that case two directors were accused of selling land owned by the company at a gross undervalue to one director who was the wife of the other. The defendants sought to strike out the claim on the basis that there was no pleaded allegation of fraud. The application to strike out failed. After, as I say, a full review of the cases, in which Templeman J described this exception as “a restricted exception to the rule in Foss v Harbottle” (at p.413G) he said this:

Estmanco was a very unusual case. The Greater London Council owned a block of flats in which, in mid-1980, it began to sell off the flats on long leases. Later in the same year it set up a management company to manage the block. There was a share capital of £3000 divided into 60 shares of £50 each. Initially, all the shares were held by the Council but as flats were sold off on the long leases one share was transferred to each purchaser. It was envisaged that in due course the shares so transferred would be voting shares, but in the interim all voting rights were held by the Council. The three directors were council employees. In 1981 the company entered into an agreement with the Council by which it was provided (inter alia) that the council would use its best endeavours to dispose of the remaining flats on long leases. Later in the year control of the Council passed to a political party that was opposed to the sale of Council properties. Twelve flats had been sold and in the case of 35 others agreements (subject to contract) had been entered with prospective purchasers who had paid deposits. The three directors brought proceedings to enforce the contract with the Council, but the Council took steps to convene a meeting of the company at which it used its voting powers to instruct the directors to discontinue the action. The applicant, a purchaser of one of the flats, sought to be substituted as plaintiff.

Counsel for the applicant relied for his client’s standing to continue the proceedings upon the same “fraud on the minority” exception to the rule in Foss v Harbottle as is relied upon by Mr Harris in this case. Megarry V-C said this (at p. 12C-G):

In an earlier passage, the Vice-Chancellor made clear that “I do not think that it can simply be said that there is an exception from the rule whenever the justice of the case requires it” (p.10H). He continued,

I quote this last passage because it seemed to me that at times Mr Harper sought to justify the width of the exception for which he contended by a simple touchstone of “justice” in the particular case. In my judgment, the passage just quoted from the judgment of Megarry V-C precludes such an approach.

I think that it is clear that Estmanco was a case where the majority was seeking to use the alleged breach of duty to further its own ends and in that sense to gain a personal benefit, albeit political rather than financial, and therefore was (allegedly) using its majority voting power to commit a “fraud on the minority”. To that extent it is on all fours with Daniels v Daniels.

Mr Harper’s submission was also advanced on the basis of certain passages in the judgment of Briggs J in the Fort Gilkicker case. The first passages were in the section of the judgment in which the judge was considering whether the procedural device of the multiple derivative action had survived the enactment of the statutory remedy under the Companies Act 2006. He was examining, it seems to me, the justification for the exceptions to the rule in Foss v Harbottle rather than their boundaries. In this context, he said this (at paragraph 19):

I do not think that either of these cases (Estmanco or Gilkicker) supports Mr Harper’s wider proposition that the exception to the rule in Foss v Harbottle is “opened up” in cases, short of deliberate and dishonest breach of duty, in the absence of personal benefit to the party allegedly in breach of duty. For my part, having reviewed the authorities, with the helpful assistance of counsel, I consider that the extent of the relevant exception to the rule is indeed as stated by David Richards J in Abouraya.

While the authorities to which I refer are all authorities at first instance, they are decisions of judges with the deepest of knowledge of our company law and I would not be inclined to depart from them except for very good reason. I can find no good reason to do so.

On the contrary, it seems to me that Miss Anderson was correct to say that principle supported her submission as to the extent of the exception. Essentially, people are free to join as members of corporate entities upon whatever terms they choose, formulated in articles of association, partnership deeds for LLPs or shareholders’ agreements. They are bound by such arrangements and if majority rule is provided for, the minority is bound by the wishes of the majority. The majority can choose to excuse breaches of duty by directors, provided that the majority have not used their voting powers to confer benefits upon themselves in breach of duty and are not using the self-same powers to prevent the company from recovering the loss caused to it, in effect expropriating the minority in the process. The constraints imposed by equity make an exception to the rule in Foss v Harbottle in cases where the controlling members are precluded from ratifying the relevant breach by exercise of their majority votes. Thus, the “fraud on the minority” exception prevents directors from improperly benefitting themselves at the expense of the company.

Mr Harper accepted that in the cases in which the judge granted permission to proceed there was no allegation of deliberate and dishonest breach of duty and no personal benefit to Future Films could be alleged. Accordingly, as it seems to me, on the formulation of the law as stated in Abouraya, the judge should not have given permission to proceed.

So far as the LMI fee claim is concerned, equally there is no allegation of deliberate and dishonest breach of duty. The only question is whether there is sufficient allegation of “benefit” to Future Films themselves to fall within the exception to the rule in Foss v Harbottle as I perceive its extent to be.

The relevant allegations in the draft pleading are as follows. As appears from paragraph 2(4) to (7), it is alleged that the LLP was promoted to potential investors by Future Films Limited (defined as “FFL”). FFL and Future Films are (and were at all material times) members of the Group of Companies headed by Future Capital Global Holdings Limited (“Global” and “the Group”) respectively. A Mr Levy in addition to being a member of the LLP is said to be a director of Future Films (as defined in this judgment), and Global. Mr Levy is said to be the ultimate beneficial owner of the Group. It is then said that, at material dates, Mr Levy was a director of LMI. Then, in paragraph 7(3) b of the draft it is alleged that Future Films did not disclose to the LLP that they were in a position of actual or perceived conflict in view of the “connection” (inverted commas as in the draft pleading itself) between Future Films and LMI “see paragraph 2(4) to (7) above” (again inverted commas as in the draft).

For my part, I do not find that that is a sufficient averment of “benefit” to Future Films themselves to satisfy the requirements of the exception to the Foss v Harbottle rule, as stated in Abouraya. As Miss Anderson submitted, it is a long way from the type of benefits alleged to have been obtained by the allegedly defaulting directors in any of the authorities to which we were taken. I agree with the judge’s decision on this issue in paragraph 26 of his judgment which I have already quoted above.

As final points, I should mention, first, that it was contended on behalf of Future Films that the proposed claims against them by the LLP would, in any event be statute barred by the Limitation Act 1980. Thus, as a matter of the court’s discretion, permission to proceed should be refused. Further, Future Films also relied upon an exculpation and indemnity provision in clause 13.1 of the partnership deed, which it was said would relieve them from the material breaches of duty. Mr Harper for Mr Harris argued that the claims in this case would be taken outside the time bar under the 1980 Act by either section 21 or section 32(1)(b) or both, covering cases of fraud or fraudulent breach of trust and cases of concealment from a claimant of relevant facts. So far as the exoneration clause was concerned, Mr Harper argued that the breaches of duty alleged would fall within the description of “fraud, wilful misconduct, bad faith or reckless disregard for…obligations and duties” which fall expressly outside the cover of the clause.

In the light of the view that I have taken, that the proposed claims do not properly fall within the relevant exception to the rule in Foss v Harbottle, it is not necessary to say more about those issues.

For these reasons, I would dismiss Mr Harris’s appeal and would allow the appeal of Future Films.

I agree.

I also agree.