Notes on Member's Derivative Action (Section 181A Companies Act)

MEMBER’S DERIVATIVE ACTION Derivative action is a legal action brought by a person relying on a cause of action belonging to others. In company law, it refers to a legal action brought by a member of a company based on a cause of action belonging to the company (Aiman Nariman, p. 359). In other words, derivative action is initiated by a shareholder to enforce the company’s rights instead of the company itself. This action will be brought against person who had committed a wrong against the company. A company has the right to enforce a duty owed to it. Where such duty had been breached, the company is the one who has a cause of action to bring a legal action. This is known as the “proper plaintiff rule” developed by the case of Foss v. Harbottle (1843) 2 Hare 461; 67 ER 189. The rule specified that the company is the proper plaintiff to enforce duties owed to it. In the said case, two shareholders of the company brought an action against the company’s director and other persons alleging that the directors had misappropriated company’s property. The court held that the defendant’s conduct did not cause an injury to the plaintiff. It was an injury to the company as a whole and hence, the plaintiff could not maintain the action. This is because the company and the shareholders are two separate legal persons which have their own distinct rights. Hence, the company is the proper plaintiff to bring an action against the directors and other person. It can be seen that company shareholders do not have a locus standi to bring an action on behalf of the company due to the fact that the wrong was committed to the company not themselves. However, there are exceptions to this rule. In the case of Tan Guan Eng v. Ng Kweng Hee [1992] 1 MLJ 487, the court laid down the exceptions to this rule as follows:   

Where the act of the company is ultra vires to its object clause; A decision was passed by an simple majorities when it requires special majorities; Members’ personal rights are infringed;

 

Fraud on the minority; or Where justice is required in the case.

COMMON LAW DERIVATIVE ACTION A common law derivative action is brought under the exception to the proper plaintiff rule of fraud on the minority. The applicant is permitted to bring an action on behalf of the company since a fraud had been committed on the minority of the company. However, the applicant must fulfil three requirements before he can bring an action on behalf of the company. 1.

The wrongdoer must be in control of the company

Generally, control was presumed if the wrongdoer holds a majority share of the company with voting power. In such situation, the wrongdoer will be able to control the decision making process of the company by voting against any proposal to initiate proceedings against himself. However, a person without majority holding in the company may also have an actual control over the company. This can be seen in the case of Prudential Assurance Co Ltd v. Newman Industries Ltd & Ors (No. 2). In this case, two directors of Newman Industries had induced its shareholders to vote in favour of acquiring a property with a high price from a company which they were personally interested in. The court allowed the action against the directors because they have an actual control over the company even without being a majority shareholder since they may exercise their power to refuse any proposal to initiate proceedings for the company against themselves. The element of control is fulfilled even the directors do not hold a majority shareholding. 2. The wrongdoer obtained benefit at the company’s expense

The applicant must also prove that the wrongdoer had obtained benefit at the company’s expenses. If the majority shareholders or person having control of the company diverted company’s business or misappropriate company’s assets, there is fraud on the minority (Aiman Nariman, p. 364). A person having control of the company is deemed to commit fraud on the minority if they diverted the company’s business and misappropriate its assets. There are a few cases to illustrate where the court held that a fraud on minority has been committed since the person having control of the company had obtained personal benefit at the expense of the company. In the case of Daniels v. Daniels (1978) 2 All ER 89, two majority shareholders are also directors of the company. The directors sold the company’s asset below the market price to one of the company’s director. The court held that the minority shareholders may bring an action on behalf of the company since there is fraud on the minority. This is due to the fact that the directors, who are having control of the company, had obtained benefit at the expense of the company by selling and requiring the company’s asset below value. The directors used their power fraudulently to benefit themselves at the expense of the company and therefore, a fraud on minority had been committed. The minority shareholders may take an action on behalf of the company against the directors. In the case of Meenier v. Hooper’s Telegraph Works (1874) 9 Ch App 350, Hooper was the majority shareholders of the company. He had diverted a contract to lay cables in South Africa from the company to another company. The court held that the diversion of the contract is a fraud on minority because he had obtained benefit at the expense of the company by doing so. The minority shareholders may bring an action against Hooper on behalf of the company. 3. The wrongdoer prevents the company from enforcing its right

It is important to prove that the wrongdoer had prevented the company to enforce its rights. Only then, the minority may take up the action on behalf of the company. Generally, the majority shareholders will be able to control company’s decision to bring legal action against themselves by their voting power. It is sufficient to show that the wrongdoer has control and there is possibility that they will prevent proceedings being brought (Aiman Nariman, p. 366). In other words, the minority need not to prove that the wrongdoer had positively prevented the company to enforce its right. It is sufficient to show that the wrongdoer was in a position which enables him to prevent any proceedings being brought. This requirement will be easily fulfilled once the wrongdoer had been proven to have control over the company. However, in the case of Paidiah Genganaidu v. Lower Perak Syndicate Sdn Bhd (1974) 1 MLJ 220 held that exception to proper plaintiff rule does not apply if the decision not to bring a legal proceeding was made by majority of the shareholders independent of the wrongdoer. Such decision will be binding on the company as not to bring any actions against the wrongdoer.

STATUTORY DERIVATIVE ACTION Section 181A of the Companies (Amendment) Act 2007 introduced the statutory derivative action. Sec 181A (1) of the said Act provides that a complainant may bring, intervene in or defend an action on behalf of the company with the leave of the Court. “Complainant” under the provision is defined under Section 181A (4) which reads: For the purposes of this section and sections 181B and 181E, “complainant” means:a) a member of a company, or a person who is entitled to be registered as a member of a company;

b) a former member of a company if the application relates to the circumstances in which the member ceased to be a member; c) any director of a company; or d) the Registrar, in case of a declared company under Part IX. By virtue of this provision, these persons are entitled to be a complainant to bring, intervene in or defend an action on behalf of the company provided that they have obtained leave by the Court. Section 181A (2) of the Companies Act states that proceedings brought under this section shall be brought in the company’s name. The company’s rights will be litigated in the proceedings as opposed to the member’s personal rights and the company is a party to the litigation. While Section 181A introduced a statutory derivative action, it does not abolish common law derivative action. Section 181A (3) of the said Act in evident states that the right of any person to bring, intervene in, defend or discontinue any proceedings on behalf of a company at common law is not abrogated. 1) Leave of Court A proceeding on behalf of a company may only be initiated by the leave of the Court. Section 181B (2) of the Companies Act states that the complainant is required to give thirty days’ notice in writing to the directors of his intention to apply for the leave of Court. This requirement is laid down as to enable the company whether or not to commence the action whereby the directors can resolve to commence the action for the company after being served with the notice (Aiman Nariman, p.368). On the expiration of the notice, an application for leave of the Court shall be made by originating summons and no appearance need to be entered [Section 181B (1)].

Section 181B (4) of the Companies Act provides that in deciding whether or not leave shall be granted, the Court shall take into account whether:a) the complainant is acting in good faith; and b) it appears prima facie to be in the interest of the company that the application for leave be granted. Once leave has been granted, the complainant shall initiate proceedings in Court within thirty days from the grant of leave [Section 181B (3) Companies Act]. After leave is obtained, the actual merits of the case will be litigated in the actual hearing or proceedings (Aiman Nariman, p. 368). Such proceedings shall not be discontinued, compromised or settled except with the leave of the Court [Section 181C Companies Act]. 2) Effect of Ratification Section 181D of the Companies Act states that members’ ratification and approval of the conduct which is the subject matter of the proceedings does not prevent the complainant from bringing an action with the leave of Court. However, Section 181D (c) states that the ratification or approval may be taken into account by the Court in determining what order to make. 3) Powers of the Court Section 181E of the Companies Act empowers the Court to make orders as it thinks appropriate including an order to:a) authorise the complainant or other person to control the conduct of the

proceedings; b) give directions for the conduct of proceedings;

c) for any person to provide assistance and information to the complainant including

to allow inspection of the company’s books; d) require the company to pay the legal costs incurred by the complainant; or e) make any order about the costs of the complainant, the company or other person

including an order as to indemnification for costs.

DIFFERENCE BETWEEN DERIVATIVE ACTION AND OTHER MEMBERS’ REMEDIES 1) Cause of Action Derivative action is brought by member of a company relying on a cause of action belongs to the company. The member initiating the claim does not have a personal cause of action since the wrongdoer actually had committed a wrong against the company as opposed to the members. For example breach of director’s duty. In contrast, the other member’s remedies require the member to have personal locus standi to initiate a legal proceeding. In such cases, the members have their own cause of action since their rights as a member has been oppressed.

2) Remedies If a proceeding of a derivative action is successful, any remedies granted by the court will be granted to the company. For example, if the wrongful director has been ordered to pay compensation, such compensation will be paid to the company not to any individual

shareholders. This is because the directors had committed a wrong against the company. On the contrary, remedies granted for other member’s remedies will be given to an individual shareholder whose rights had been oppressed. 3) Rights litigated In a derivative action, the rights of the company are being litigated against the duties of the wrongful person owed to the company. As Section 181A (2) of the Companies Act provides proceedings of a derivative action shall be brought in the company’s name. In contrast, other member’s remedies allow a shareholder to bring a proceeding on their own name since their own distinct rights from the company are being litigated.