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  • Writer's pictureGavin Jayapal

Derivative actions: Exploring the common law and statutory framework in Malaysia (Part 1 of 2)

Derivative actions: Exploring the common law and statutory framework in Malaysia




A company is a legal entity though; it is not an organic being. It is breathed into life by virtue of statute. A company's “intentions” are, in essence, a reflection of the intentions of its directors.


The conundrum


If a company's directors decide to pursue a course of conduct that is harmful to the company, where lies its (company's) respite?


How is a company that has been (or is being) wronged to set matters right when its controlling mind is bent on the inverse?


The derivative action


Enter the derivative action. The derivative action has been described as a “procedural ingenuity designed to serve the interests of justice.”


 A derivative action sees a shareholder taking on the mantle of a company and suing the wrongdoers (be they fellow shareholders, directors or third parties causing harm to the company).


To beetle, or not to beetle


📷


To give flesh to this somewhat technical legal creation, consider a fictitious example.

Metarhizium Pte Ltd (Metarhizium) deals solely in palm oil. A pest to palm oil plants would be the majestic Rhinoceros Beetle (Oryctes rhinoceros). Despite being a scourge, the number of Rhinoceros Beetles has dwindled due to deforestation and they are listed as Critically Endangered under the IUCN's Red List.


Legislation has been passed to protect the Rhinoceros Beetle. The Oryctes Rehabilitation and Recovery Act 2014 (“the ORRA 2014”) makes it an offence to seek-out and/or destroy the beetles, with fines of up to RM1 million being meted out. 


Destructive intent


Despite this bit of legislation, the directors of Metarhizium see only profit. They intend to eradicate the Rhinoceros Beetle by any means available. They purchase multi-million dollar gasses and equipment, all in a bid to decimate.


 The costs incurred by the directors in their anti-arthropod campaign cause huge losses to Metarhizium. In addition, the Government's environmental investigation unit has taken a great interest in the company's affairs, thereby putting it at risk of being heavily fined.


A shareholder's panic


A shareholder of Metarhizium, John (20% shareholding), has been kept blissfully unaware of the situation brewing.


One fine day, John receives a letter from the environmental investigation unit, demanding that he appear before a tribunal to answer questions.


John is thrown into a panic. He dials Smith, who is the 80% shareholder in Metarhizium.

Smith nonchalantly tells John that he is well-aware of the directors' plans and that he fully supports it.


Having had a terrifying run-in with the genus Scolopendra in his formative years, Smith has developed and nurtured an abject horror for everything that crawls. He intends the extinction of the Rhinoceros beetles to be his legacy.


The derivative action: John's fight-back


In such a scenario, what is John to do?


He is not on the directorial board of Metarhizium and is a minority shareholder. He cannot pass the necessary resolutions to sack the directors and to correct the course of the company.


Metarhizium is certainly headed for trouble. Its directors, with the collusion of Smith, have already caused the following harm to the company:

  • Losses from the purchase of equipment and gasses;

  • Placed the company at risk of a fine;

  • Caused the company to flout numerous sections of the ORRA 2014;

  • Diverted the course of the business;

  • Placed the interests of a shareholder (Smith) ahead of the company's.

In such a situation, the derivative action will come to John's aid. The derivative action will enable John to take on the mantle of Metarhizium and to sue its directors and Smith for causing untold harm to the company.


The legal framework of a derivative action- Statutory or common law?


In the Malaysian context, the derivative action can take on 2 forms namely, the common law or statutory derivative action.


For the purposes of this article, I intend to focus on the common law derivative action. Part 2 shall deal with the statutory regime.


The common law derivative action



The right to bring a common law derivative action is enshrined in S. 181A(3) of the Companies Act 1965 (CA 1965), which states as follows:


181A  Proceedings on behalf of a company.
(3) 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.

The right is founded on the English case of Foss v Harbottle (1843) 67 ER 189. Here, the Court set-down the 'proper plaintiff' rule, wherein the Court will generally not interfere with the internal workings of a company where the majority of its shareholders have ratified its decision.


However, there are exceptions to the rule laid down in Foss v Harbottle. Where these exceptions kick-in, the common law derivative action would be a suitable course of action. These actions were refined in Edwards v Halliwell [1950] 2 All ER 1064 (CA) as follows:

(1)Ultra vires acts: 'in cases where the acts complained of are wholly ultra vires the company or association the rule has no application because there is no question of the transaction being confirmed by any majority'.
(2)Fraud on the minority: 'where what has been done amounts to what is generally called in these cases as a fraud on the minority and the wrongdoers are themselves in control of the company, the rule is relaxed in favour of the aggrieved minority who are allowed to bring what is known as a minority shareholders' action on behalf of themselves and all others'.
(3)Special majorities: 'an individual member [is not] prevented from suing if the matter … [is] one which could validly be done or sanctioned, not by a simple majority of the members … but only by some special majority'.
(4)Personal rights: Where 'the personal and individual rights of members of [the plaintiffs] have been invaded', the rule 'has no application at all'.
(5)When the justice of the case requires it, though this has been doubted by the English Court of Appeal in Prudential Assurance Co Ltd v Newman Industries (No 2).

The position in the UK, Australia, Canada and Hong Kong


The common law derivative action has been abolished in the UK (Bridge v Daley [2015] EWHC 2121 (Ch)). Australia has followed suit (S. 236(3) of the Corporations Act 2001; Viscariello v Macks [2014] SASC 1891).


However, in the UK, multiple derivative actions (which will be a topic for future dissection) may still be brought under the common law (Universal Project Management Services v Fort Gilkicker [2013]  Ch 551; affirmed in Bhullar v Bhullar [2015] All ER (D) 130 (Jul)).


For other common law jurisdictions such as Canada (see below), Singapore (Sinwa SS (HK) v Morten Innhaug [2010] 4 SLR 1) and Hong Kong (Waddington v Chan Chun Hoo [2009] 4 HKC 381), common law derivative actions are viable options. Until specifically repealed by legislation, the same will still be available for use.


The Malaysian context


The Companies Act 2016 has abrogated the right to initiate a common law derivative action.


The remainder of this article is purely an academic exercise.


How does one go about initiating a derivative action?


Leave- Unnecessary for common law derivative actions


To maintain a common law derivative action, leave of Court is not necessary (Abdul Rahim Bin Aki v Krubong Industrial Park (1995) 3 MLJ 417 (CA); University Students' Council of the University of Western Ontario v Association of Student Councils (Canada) 15 BLR (3d) 286). 


This is reinforced by the Federal Court in Koh Jui Hiong v Ki Tak Sang [2014] 3 MLJ 10:

[19] Leave to commence a derivative action is not part of the procedure under the general law (see Oates and Consolidated Capital Servies Pty Ltd and ors (2009) 257 ALR 558, where it was held by the New South Wales Court of Appeal per Campbell JA (Spigelman CJ and Allsop P concurring) thatWallersteiner v Moir (No 2) [1975] QB 373 is not authority for leave to commence a derivative action ever having been part of the procedure under the general law, and Roberts v Gill & Co and others [2010] 4 All ER 367, where the Supreme Court of England agreed with Campbell JA that 'there is no requirement under the general law relating to derivative actions for leave to be obtained before a plaintiff commences such an action').
[20] There is however a requirement for leave to bring a statutory derivative action. 

Specific issues that must be canvassed in the pleadings


Although leave is not necessary, there are specific issues that must be expressly pleaded in the Statement of Claim supporting a common law derivative action.


This has been outlined very conveniently by Gopal Sri Ram JCA (as His Lordship was then known) in Abdul Rahim Bin Aki v Krubong Industrial Park (1995) 3 MLJ 417 (CA):

We now turn to consider the one exception with which this case is concerned. It is the derivative action; an ingenious procedural device created by courts of equity; by which the rule of judicial non-interference is overcome. It is based upon the premise that the company which has been wronged is unable to sue because the wrongdoers are themselves in control of its decision-making organs and will not, for that reason, permit an action to be brought in its name. In these circumstances, a minority shareholder may bring an action on behalf of himself and all the other shareholders of the company, other than the defendants. The wrongdoers must be cited as defendants. So too must the company. The title to the action must reflect that the suit is being brought in a representative capacity. The statement of claim or other pleading filed in support of the originating process must disclose that it is a derivative action and recite the facts that make it so. Further, there must be an express statement in the pleading that the action is being brought for the benefit of the company named as a defendant. An action that does not meet these requirements is liable to be struck out as being frivolous and vexatious.

From the above, the following salient issues MUST be canvassed in one's pleading:

  • The Plaintiff is a minority shareholder;

  • The wrongdoers are to be cited as Defendants;

  • The company must be cited as a Defendant;

  • The intitulement must reflect that the suit is brought in a representative capacity;

  • The statement of claim must disclose that it is brought as a derivative action;

  • The facts must disclose that the suit is a derivative action;

  • There must be an express statement that the suit is brought for the benefit of the company.

Should these issues not be pleaded in full, a claim that purports to be a derivative action is at serious risk of being struck-out.


To ensure that there is full compliance with the above requirements, it is prudent practice to ensure that the Writ of Summons also contains a suitable endorsement. It should expressly state that the suit is brought in a representative capacity, for the benefit of the company. 


Why should one opt for a common law derivative action?


A common law derivative action, until and unless it is repealed, is a viable option for a wronged shareholder. However, why ought one opt for it?


A few benefits of a common law derivative action would be: 

  • Speed- There is no need to give notice

  • No requirement to obtain leave- There exists a high threshold for leave (Celcom v Mohd Shuaib Ishak [2011] 3 MLJ 636);

  • Ability to direct proceedings- The wronged shareholder is able to instruct his own set of solicitors to act accordingly

However, there are drawbacks:

  • The action must be commenced by a minority shareholder- The statutory scheme allows for the suit to be brought by a majority shareholder (Ong Keng Huat v Fortune Frontier [2015] 11 MLJ 604);

  • The exceptions to the rule in Foss v Harbottle are stringent- Should a party not fall into the exceptions, the claim may be struck-out;

  • The pleadings must be exacting- Failing on any one of the requirements propounded by Gopal Sri Ram JCA may cause the suit to be dismissed.

Application


From the factual scenario outlined above, should John intend to quickly address the problem brewing at Metarhizium, he must consider instructing his solicitors to file an urgent common law derivative action into Court, naming the directors, Smith and Metarhizium as defendants.

John will have to plead that the actions of the directors and Smith are causing serious, irreparable harm to Metarhizium.


The common law derivative action may ameliorate the level of culpability on the part of John for any breach of the ORRA 2014 that may be found at a later stage (i.e., he may come off as having tried to save the company from the predatory talons of the directors and Smith).


Conclusion

In concluding, it is apparent that the common law derivative action requires an unwavering eye for detail. Overlooking any single legal requirement may cause the action to be struck-out.


In the time that it takes to correct the mistake, irreparable harm and damage may have already been caused to the company. It is of the imperative that both the client and their solicitors work closely to ensure that the pleadings are complete.


This article is also made available at my Linked in page and may be accessed here.

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