UK: BP Alaska Derivative Claim

Originally published in BLG’s Directors’ and Officers’ Liability Review, Winter 2006

The derivative action filed in October in the Alaska State Court against directors and officers of BP Plc ("BP") and its US subsidiaries (the "BP Action") may develop into an important precedent. Although only in its infancy, the case raises significant issues for UK companies doing business in the US, notably in connection with the reforms in the new Companies Act.

The claimants in the BP Action include the City of London Pension Fund, as well as other claimants purporting to sue derivatively on behalf of BP and certain of its US subsidiaries. The allegations focus on the corrosion problems in the pipelines at Prudhoe Bay, the Texas refinery explosion, and the investigations into alleged price fixing in the propane market. It is contended that the conduct of the executives damaged BP’s reputation, left BP exposed to costly lawsuits, penalties and fines, increased its operating costs, and diminished its assets and value. The claimants demand unspecified damages as well as corporate governance reforms to say nothing of fees for their legal counsel, who is none other than the redoubtable Bill Lerach.

Traditionally, derivative actions have been rare in the UK. The courts have honoured the principle of "majority rule" and effectively limited such derivative actions to very narrow exceptions: notably, "fraud on the minority". In contrast, derivative actions in the US are commonly deployed by claimant law firms, often alongside securities class action lawsuits. Furthermore, most US state securities laws provide that the fees of the lawyers prosecuting such actions will be paid by the company.

That said, both state and federal US courts have been reluctant to allow derivative actions involving foreign companies not established under US company law to proceed. This is because US courts usually recognise the "internal affairs" doctrine. This doctrine provides that the applicable law for examining the duties of its directors and officers is the law of the state of registration or incorporation. BP, as an English registered company, would normally fall within this rule. Under this doctrine, the US courts consider whether the law of incorporation allows for derivative actions on the basis of the pleaded case. A leading case is Batcholder v Kawamoto, a 1998 decision of the 9th Circuit Court of Appeal, when a US owner of ADRs in Honda, a Japanese company, sought derivative relief. The Court of Appeal upheld the dismissal of the action, on the basis (amongst others) that Japanese law did not recognise derivative actions under the circumstances as pleaded.

Similarly, the Maryland Court of Appeal recently upheld the dismissal of a derivative action in Tomran Inc. v Passano et al (6 February 2006) against the directors of Allied Irish Bank for their alleged negligence in connection with a $700 million trading loss incurred by a US subsidiary. Allied Irish Bank is registered in Ireland. The Court, after hearing expert evidence about the criteria for derivative actions under Irish law, dismissed the case because: (1) mere beneficial ownership of shares through an ADR was not sufficient to constitute membership under Irish law; and (2) the pleaded case did not fall into any of the exceptions to the general principle of "majority rule".

Under the new Companies Act the position is different. Once brought into force in 2007, members of a company will be able to launch a new statutory derivative action in respect of a broad class of wrongs, including "negligence, default, breach of duty or breach of trust by a director". Purchase and ownership of a single share in a company will entitle the shareholder to bring a claim in the name of that company even if he was not a shareholder at the time of the acts or omissions about which the complaint is made.

It is certainly true that in the parliamentary debate around the introduction of the new statutory derivative claim, fears were expressed that it would result in "open season" on frivolous claims against directors brought by interest groups, hedge funds and lobbyists. It is also the case that to meet such concerns a number of safeguards were built into the new statutory procedure¹. To what extent these safeguards will come into play in the BP Action is uncertain.

What is of particular interest is that it seems that legislative changes introduced by the Companies Act were anticipated by the lawyers who filed the BP Action. The Complaint (which was filed before the Companies Act received Royal Assent) states that English law "permits or will permit this action to be maintained" [our emphasis]. What the US courts make of this plea given the state of flux of English law remains to be seen.

For instance, a potential battleground may turn out to be whether and to what extent the new statutory derivative claim can have extra-territorial effect. Section 266 of the Act provides that a derivative claim "may only be brought with the leave of the Court". Section 1166 defines "court" as the High Court of England and Wales, or the Scottish Court of Sessions, or the High Court in Northern Ireland. These provisions are suggestive of a parliamentary intent that the new action should not be invoked in any foreign courts. Whether these sections have the effect of preventing derivative actions against UK companies in the US courts remains to be seen. There certainly seems to be precedent for this. In one recent decision of New York Second District Court in a case called Local 302 et al v Blanard et al, the Court dismissed a derivative action against executives of Canadian-incorporated Nortel because, under the Canadian Business Corporations Act, derivative actions could only be commenced in certain specific Canadian courts.

Whatever the outcome, the derivative claim brought against BP in Alaska will be studied closely.

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