The Minority Shareholder’s Sword to Pierce the Majority’s Twin Shields of Corporate Personality and Majority Rule
Part A. Introduction
A derivative action is an action brought by a shareholder based on a cause of action that the company has, rather than a cause of action belonging to the shareholder. The common law allows a minority shareholder to bring this action on behalf of the company in situations where the company does not take action because the wrongdoer controls the company and is able to prevent the company from taking any action.
The new statutory derivative action, under sections 181A to 181E of the Companies Act 1965 (“the Act”), allows a complainant to apply for leave of the Court to bring an action on behalf of the company. This new action, which came into effect on 15 August 2007 under the Companies (Amendment) Act 2007, allows a shareholder to sidestep the restrictions of the common law derivative action.
The common law rule in Foss v Harbottle (1843) 67 ER 189 states that if a company suffers a wrong then, because it is a separate legal entity from its shareholders, prima facie it is the company that should bring an action. Such a rule allowed a shareholder to bring an action on behalf of the company if two elements could be proven. First, that the wrong is one that cannot be validly ratified by the majority as there has been a fraud on the minority, and second, that the perpetrators of the fraud were in control of the company.
The new statutory derivative action bypasses the narrow Foss v Harbottle rule. However, it is clear that the right to bring a common law derivative action continues to be maintained here in Malaysia (see section 181A(3) of the Act).
The new sections 181A to 181E of the Act are very similar to the statutory derivative action provisions of the Singapore Companies Act, which were in turn modelled after the provisions of the Canadian Business Corporations Act.
Part B. Applicable to Pre-Amendment Wrongdoings?
Before delving into the provisions of the statutory derivative action, it is submitted that the new provisions can apply to wrongdoings or events which occurred before the coming into force of the amendments, i.e. before 15 August 2007. This may be the case where a member of the company seeks leave to bring an action but the issue is not so clear in respect of other parties seeking leave to bring a statutory derivative action.
It can be strongly argued that the new sections 181A to 181E of the Act merely set out a new procedural form for the common law derivative action, and therefore these provisions are applicable retrospectively to pre-amendment wrongdoings. In the Federal Court decision of Lee Chow Meng v Public Prosecutor [1978] 2 MLJ 36, it was recognised that a statute dealing with procedure has retrospective effect, that is, it applies to proceedings begun before and after the commencement of the statute, unless a contrary intention is expressed or clearly implied. The statutory recognition of the common law right to bring proceedings on behalf of the company is stressed in section 181A(3) of the Act.
Although the Australian provisions on statutory derivative actions are quite dissimilar to the Malaysian provisions, the Australian cases of Advent Investors Pty Ltd and Others v Goldhirsch and Others [2001] 37 ACSR 529 (“Advent Investors”) and Karam & Ors v ANZ Banking Group Ltd & Anor (2000) 34 ACSR 545 (“Karam”) held that the new provisions merely set out a new procedure to bring proceedings on behalf of a company and therefore could apply retrospectively to pre-amendment events. It must be noted that the issues in these two cases primarily involved claimants in each case, who had brought a common law derivative action, arguing that they need not seek leave to bring an action when the new provisions of the Corporations Act came into effect i.e. that the new provisions on seeking leave to bring a statutory derivative action were prospective. The new provisions had displaced the common law derivative action and the Courts held that the provisions were retrospective and that leave was required.
One issue that must be highlighted however, is that while the statutory derivative action may be a procedural streamlining of the common law derivative action brought by a member of a company, the statutory derivative action goes further than that in granting standing to a director and even a former member of a company to bring an action. Such parties were never recognised as having the locus standi to bring a derivative action. It could be argued that a retrospective application of sections 181A to 181E of the Act should not apply to such parties.
In both Advent Investors and Karam, the issue of whether the provisions applied retrospectively arose in cases involving shareholders bringing a derivative action. It is not clear how the issue on retrospectivity will play out if for instance, a director seeks leave under section 181B of the Act, in respect of wrongdoings prior to the amendments to the Act.
Or perhaps a simpler answer can be that there is no reference to events or wrongdoing in the new provisions, and section 181A of the Act merely allows a complainant to bring an action on behalf of a company. The company, on behalf of which the action is being brought, always had the right to sue for pre-amendment wrongs. The difficult untanglement of the new provisions could have been avoided if the Companies (Amendment) Act 2007 had contained some transitional or saving provisions.
Part C. Who Can Apply for Leave to Bring a Statutory Derivative Action?
Section 181B of the Act requires a ‘complainant’ to seek leave of the Court to bring a derivative action in the name of the company. Unlike the common law derivative action which is confined to only members of the company, section 181A(4) of the Act allows a wider standing for a complainant to bring an application for leave from the Court.
A complainant is defined as (1) a member, or a person entitled to be registered as a member, of a company; (2) a former member of a company if the application relates to circumstances in which the member ceased to be a member; (3) any director; or (4) the Registrar for certain types of company.
Part D. Requirements for Leave
(i) Notice
The first requirement in applying for leave of the Court is that the complainant must give thirty days notice in writing to the directors of his intention to apply for leave under section 181A of the Act. The purpose of this compulsory notice is to first give the company the opportunity, through its board of directors, to consider its rights and course of action.
One criticism of this requirement of notice is that unlike in other jurisdictions, the Court is not given the discretion to allow for the dispensation of such a notice. In cases where urgent injunctive relief is required, for instance where there is a wrongful dissipation of the company’s assets by the directors, the compulsory 30-day notice to be given to the wrongdoers themselves prior to applying for leave would discourage a complainant from utilising the remedy of a statutory derivative action.
(ii) Good Faith
After the 30-day notice, a complainant can make an application by originating summons for leave of the Court (as required by section 181B of the Act). There are two requirements which the Court shall take into account when deciding whether or not to grant leave. The first is whether the complainant is acting in good faith.
The Singapore Court of Appeal has held in Pang Yong Hock and another v PKS Contracts Services Pte Ltd [2004] 3 SLR 1 (“Pang Yang Hock”) that “the best way of demonstrating good faith is to show a legitimate claim which the directors are unreasonably reluctant to pursue with the appropriate vigour or at all.” This echoes what was held in the Canadian case of Re Richardson Greenshields of Canada Ltd and Kalmacoff et al (1995) 123 DLR (4th) 628 in that “there [were] legitimate legal questions raised here that call for judicial resolution.”
The Singapore Court of Appeal in Pang Yang Hock also approved the case of Agus Irawan v Toh Teck Chye & Ors [2002] 2 SLR 198 (“Agus Irawan”) which suggested that the burden would be on the opponent to show that the applicant did not act in good faith. The Singapore Court of Appeal had also noted that hostility between factions involved is normally present in such applications and is therefore generally insufficient evidence of lack of good faith on the part of the applicant.
(iii) Prima Facie in the Best Interest of Company
The second requirement which must be demonstrated is that it appears prima facie to be in the best interest of the company that the application for leave be granted. As observed in Agus Irawan, this requirement of good faith overlaps with the requirement that the claim must be in the interests of the company.
Agus Irawan had interpreted the almost identical Singapore provision to mean that the claim must have a reasonable semblance of merit – not that it was bound to succeed or likely to succeed, but that if proved, the company will stand to gain substantially in money or money’s worth.
The Court may also weigh the availability of an alternative remedy, such as the winding up of the company. In Pang Yang Hock, where there was an impasse in the management of the company and the company was not performing well financially, the appropriate solution in that case was to wind up the company.
Part E. Leave to Discontinue, Compromise or Settle Proceedings
Section 181C of the Act provides that proceedings brought, intervened in or defended under section 181A may be settled only with leave of the Court. This provision recognises the danger that such an action may be brought for the sole purpose of and in the hope of reaching some collusive settlement for the benefit of the complainant and the alleged wrongdoers. The interests of the other shareholders or the company may then be prejudiced if the action is settled. This provision allows the Court to reject the settlement of the action if it considers the terms unfair or unjust.
Part F. Ratification
Under common law, if a wrong has been effectively ratified by the shareholders of the company, this will be a complete bar to a derivative action. The company will not have any wrong to complaint about as an act authorised by its shareholders is an act of the company itself.
Section 181D of the Act does away with this problem by providing that the fact the alleged wrong to the company may be approved or ratified by the members is not by itself sufficient for a stay or dismissal of the action. Such approval or ratification may however be taken into account by the Court when determining whether to grant leave under section 181B of the Act and in the making of any orders under section 181E of the Act.
Part G. Powers of the Court
In granting leave, section 181E of the Act grants the Court wide ranging powers in making such orders as it thinks appropriate. Aside from authorising the complainant or some other person to control the conduct of the proceedings, some of the other orders the Court may grant include: -
(i) Giving Directions
Depending on the circumstances of the case, the Court is able to grant specific directions for the conduct of the proceedings. In the Singapore case of Teo Gek Luang v Ng Ai Tiong [1999] 1 SLR 434, the Court granted leave to the complainant subject to certain conditions. The Court exercised its discretion, under the similar Singapore provisions, to make an order that the complainant was not to commence action until 22 days had passed, and if the defendant-director paid the sums due to the company within 14 days of the order, the complainant was not to commence an action.
(ii) Access to Information
This provision allows a complainant to obtain evidence by accessing documents normally not available to him, for instance Board documents or management accounts.
(ii) Costs
Sections 181E(d) and (e) of the Act allows the Court to relieve the burden of costs on the complainant by allowing both a payment by the company of reasonable legal fees and disbursements incurred by the complainant, and also a wider order for indemnity for all the costs incurred.
The Court may be guided by the principle set out in Wallersteiner v Moir (No 2) [1975] QB 373, where Denning J (as he then was) suggested that where there is a reasonable case for the minority shareholder to bring an action at the expense at the company, then the shareholder should ordinarily have a right to an indemnity for his costs, whether or not the case is successful.
Part H. Conclusion
Based on the experience from the other jurisdictions, it is not anticipated that the new statutory derivative action will open the floodgates of shareholder litigation. Derivative litigation by its nature is altruistic in that the benefit of any remedy goes to the company. The plaintiff-shareholder will only benefit indirectly and even then, only on a pro-rata basis. The other shareholders not involved in the proceedings would free-ride on any successful litigation, without any of the risks.
Unlike in Canada and New Zealand, Malaysia’s provisions do not allow the Court to order for damages to be paid directly to the complainant. A shareholder will still be more attracted, where practicable, to the filing of an oppression petition under section 181 of the Act due to the prospect of obtaining personal relief against the oppression and not merely damages to be paid to the company.
However, the lack of statutory derivative litigation in other jurisdictions may also be an indication that it does serve as an effective deterrent on managerial misconduct by imposing the threat of liability. As one academic commented more than a decade ago, ‘the knowledge that one is being watched and that one must justify one’s actions improves the behaviour of most individuals.’
The introduction of the statutory derivative action increases the scope of shareholder intervention, while the leave requirements will ensure that there are safeguards against abuse of unjustified litigation. Allowing for increased shareholder activism will ensure that directors of companies will have to take into greater account shareholder rights and interests.
(This article is contributed by Lee Shih)
information given is relevant
Good for Monash University company law assignment.
But as students, online sources are generally not advised. But this article explains a lot. Good luck BTW2213 students.
I bet everyone is referring to this. =) Very useful.
I’m sure everyone would be referring to this article. Very useful. Thanks to the author!
The codification of the Derivative Action under the UK Companies Act 2006 seems to have done little to improve the remedies for minority shareholders after all.
The new rules are found in sections 260 to 264 of the 2006 Act. Claims can be made in respect of acts or omissions, negligence, default or breach of duty by a director or a third party. They may be brought by any member regardless of membership status at the time of the alleged breach. Indeed, claims can be brought by a person in respect of breaches alleged to have occurred before shares were purchased. The act provides notable changes in that in ratification under section 239, no vote by either the director or member whose conduct amounts to negligence, default, breach of duty or trust, or any member connected with him will count. Where the wrongdoing has been authorised or ratified, then the court can disregard it if it has been authorised or ratified by way of the votes of the accused directors. However MSs have not been given a carte blance to sue the majority in that considering whether to give permission to bring an action the court must take into account s263(3), in particular whether the shareholder is acting in good faith in seeking to continue the claim. It is a two stage test requiring the shareholder to obtain the court’s permission to continue a claim. Firstly the court must bring proceedings to an end if there is no prima facie case; and secondly the court has a discretion to refuse or grant leave to continue a claim, taking account of specified matters such as whether directors acting in accordance with their new duty to promote the success of the company would not seek to continue the claim; or the matter complained of has been authorised in advance or has been ratified subsequently.
The new provisions appear to offer more protection for shareholders. Part 11 of the Act gives shareholders for the first time a statutory right to sue directors in a derivative action even if the directors concerned have not benefited from their negligence. This is a significant change from the Common Law position Pavlides v Jensen.
However, concern raised that the changes to the derivative action regime could lead to increased tactical litigation against directors from activist shareholders have been unfounded . Thus, the CA 2006 does not formulate a substantive rule to replace the rule in Foss v Harbottle as hoped by some but rather a new procedure for bringing actions based on the existing rules according to the Attorney-General, Lord Goldsmith. He said, it is a fail-safe mechanism rather than a weapon of first resort and was at pains to make it clear that it is not expected there will be a significant increase in the number of derivative claims. Courts will continue to retain a wide discretion over whether a derivative claim may proceed. It is important to remember that damages are paid not to individual shareholders but to the company itself, and yet it is the shareholder, who brings the action, who may be required to bear heavy legal costs thus the practicalities of financing shareholder litigation will remain a major obstacle to MSs wishing to bring claims.
A dozen years ago, Professor Sealy predicted that, even if Parliament provided a statutory remedy, the courts would reinvent just as effective way of saying ‘go away’.
In view of the CA 2006 Act and recent case law this seems a remarkably accurate prediction. There is nothing in the new procedure that will convince a rational shareholder he should be better off litigating the case on behalf of the company rather than selling his shares. Regrettably, the common law position on costs of derivative claims has not changed significantly either and costs and fees rules need to be re-evaluated if any real change is to occur. The availability of alternative remedies for an aggrieved shareholder is an important factor in determining whether the court will grant permission to continue a derivative action. The court will look at the bigger picture of what is best for the company as well as what is best for the member. In cases where a company is controlled by wrongdoing directors who are also major shareholders it is likely that an action under S.994 will be more appropriate.
This means it may only be in limited cases that the new derivative action will be a useful tool for activist shareholders who want to apply pressure on directors. They will instead be directed towards an action under S.994. This means that any legal action will have to be personally financed by the member and the most likely remedy will be a buyout of shares at a fair value, which in the case of a very small minority shareholding may not be worth pursuing. Nevertheless, s459 plays an important role in balancing the rights of the MS against those of the majority. Without it, MSs would find their investments protected only by the magnanimity of the majority.