Derivative actions: Exploring the common law and statutory framework in Malaysia (Part 2 of 2) [The Statutory Derivative Action]
The death of the common law derivative action
The common law derivative action is NO LONGER available in Malaysia.
347(3) of the Companies Act 2016 expressly 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 abrogated.”
Common law derivative actions filed before the Bill is gazetted will not be caught out. However, practitioners must take care when drafting and not be at the receiving end of an unnecessary application to strike-out (consider Kingdom Seekers Ventures v Dato' Sri Chong Ket Pen [2015] MLJU 390 as a cautionary tale).
Practitioners must also take note of Section 620, which specifies that any rights, privileges, obligations and liabilities accrued or incurred before the Bill comes into force shall NOT be affected. For these matters, the Companies Act 1965 is still valid and binding.
The statutory derivative action- Framework
Utilising the same example as before, I propose to set-out a short piece as to how the framework for statutory derivative actions will be, given the changes brought about by the Bill.
It will be useful to first compare the provisions:
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From the above, it is apparent that there are 2 major changes:-
The right to institute a common law derivative action IS ABROGATED;
The Bill does not specify the manner in which leave to institute a statutory derivative action is to be sought (i.e., the Companies Act 1965 specified that an originating summons would have to be taken out. The Bill does not)
Similar, but for minor differences
The first change is easy enough; common law derivative actions are no longer available to litigants.
The second is slightly ambiguous; what it the proper mode to initiate an application for leave?
To solve this, one may make reference to Singapore. Section 216A (2) of the Companies Act 1967 (Revised in 2006) utilises similar terminology:
“...a complainant may apply to the Court for leave to bring an action or arbitration in the name and on behalf of the company or intervene in an action or arbitration to which the company is a party for the purpose of prosecuting, defending or discontinuing the action or arbitration on behalf of the company.”
In Lew Kiat Beng v Hiap Seng Co [2012] 1 SLR 488, the Plaintiff sought leave to initiate a statutory derivative action via an Originating Summons. Neither party disputed the procedure utilised and the Court did not pass any remark and/or adverse comments against the procedure adopted.
This is a clear indication that at the leave stage, the proper procedure to use would be to file an originating summons, together with an affidavit in support. The originating summons should be moved under Sections 347 and 348.
A bipartite process- Notice followed by leave
30-days' notice
Before any statutory derivative action may be commenced, it is vital that 30-days' notice is provided to the directors of the company (Section 181B(2) Companies Act 1965; Section 348(2) of the Bill).
The notice must specify the applicant's intention to apply for the leave of Court. It should also specify the section under which leave is being sought. Personal service on the directors is essential.
There is persuasive authority to suggest that a defective notice does not invalidate the claim as a whole (Bellman v Western Approaches [1981] 33 BCLR 45; Luft v Ball [2013] BCSC 574). The carpenter's adage of measure twice, cut once should be utilised here though; better to be circumspect in the preparation of the notice than to file an unnecessary application to amend.
The notice to the directors should specify the allegations against the wrongdoers and outline why a derivative action is necessary. The jurisprudence behind a notice is simple; a company should not be hampered by vexatious directors and/or shareholders.
Leave of Court
Once the 30 days are up and there has been no contest and/or opposition put forth by Metarhizium's directors, John may instruct his solicitors to file an Originating Summons application into Court, supported by an affidavit.
Both Section 181B(4) of the Companies Act 1965 and Section 348(3) of the Bill (in pari materia) specify the test which the Court shall take into account:
(4) 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 best interest of the company that the application for leave be granted.
What is good faith? What is prima facie in the best interests of the company?
The leading authority on the leave
Firstly, due consideration must be given to Section 181A(1) and (4) Companies Act 1965, which limits the class of persons that may apply for leave:
(1) A complainant may, with the leave of the Court, bring, intervene in or defend an action on behalf of the company.
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(4) 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 member of a company;
(b) a former member of a company if the application relates to 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.
Celcom v Mohd Shuaib Ishak [2011] 3 MLJ 636 (CA) is the leading authority on obtaining the leave of Court to commence a statutory derivative action. It has been expressly referred to and approved by the Federal Court in Koh Jui Hiong v Ki Tak Sang [2014] 3 MLJ 10.
It is essential that any litigator reads this case in its entirety before any action is even envisioned. For ease of reference, I have reproduced the salient portions below:
[8] It should be noted that the respondent had long ago ceased to be a member of the applicant (over six years). The intention of ss 181A–181E of the CA is to enable a member, present or past, to seek leave to bring an action in the name of the company to recover losses sustained by that company. As such, leave to bring a derivative action must not be given lightly (see Swansson v RA Pratt Properties Pty Ltd & Anor [2002] NSWSC 583). Thus, once leave is granted the defendants in this case cannot revisit the issue on the grant of leave. Granting leave is therefore final in that sense and not interlocutory in character. In this respect, the learned judge was wrong in stating cursorily that the matter before him was 'only an application for leave' and relying on the low threshold used under O 53 of the RHC (application for judicial review) ie to determine if an application for judicial review is not frivolous or vexations by relying on cases like Clear Water. The learned judge must as a matter of judicial prudence exercise a greater caution in satisfying himself that the requirements under s 181A of the CA are met. A low threshold of merely determining if there existed a prime facie case is therefore a wrong basis for granting the leave. There needs to be a strict interpretation of s 181A of the CA, and compliance to those statutory requirements (see Charlton v Baber (2003) 21 ACLC 1671).
[9] Section 181A of the CA should thus be restrictively applied. It curtails former members of a company from filing a derivative action under any circumstances. The qualification under sub-s (4)(b) requires proof by the respondent that there must be a direct causal nexus between the complaint and how he ceased to be a member.
[10] In this application the respondent seeks to impugn the decision of the directors of Celcom in entering the conditional SPA. In such a situation the question of his locus standi needs to be fully scrutinised and cannot be casually determined.
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[15] The second crucial requirement for the determination of the court in granting leave is the need for the respondent to show that he was acting in good faith in making this application ( s 181B(4)(a)). The onus of proof here is on the respondent on a balance of probabilities. The test of good faith is two-fold. One is an honest belief on the part of the respondent, and two, that this application is not brought up for a collateral purpose.
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[16] This second requirement will depend on the factual circumstance which comes before the court. This was stated by Palmer J in Swansson with these words:
Nevertheless, in my opinion, there are at least two interrelated factors to which the courts will always have regard in determining whether the good faith requirement of s 237(2)(b) is satisfied. The first is whether the applicant honestly believes that a good cause of action exists and has a reasonable prospect of success. Clearly, whether the applicant honestly holds this belief would not simply be a matter of bald assertion: the applicant may be disbelieved if no reasonable person in the circumstances could hold that belief. The second factor is whether the applicant is seeking to bring the derivative suit for such a collateral purpose as would amount to an abuse of process.
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[21] Next, we address the second limb of the lack of good faith submission that there was a strong basis to find that the respondent was actuated by an ulterior motive in making this application ie the collateral purpose argument. It was argued by the appellant's counsel that the learned judge had failed to sufficiently take into account that the respondent had commenced a personal action in the Kuala Lumpur High Court vide D6–22–1568 of 2007 ('D6 action') which is virtually identical to this derivative action and with identical reliefs sought. The respondent had sued the appellant as one of the defendants in that personal action, based on the same subject matter and same cause of action. Comparing these two actions, there appear to be an inconsistency in that in the D6 action the respondent is suing the appellant for damages whilst in this derivative action he is purportedly trying to recover damages on behalf of the appellant. It would seem to us that the respondent's stand is not coherent and this brings to the fore a suspicion on the true motive on his part in bringing this action. We therefore conclude that this action is suspect, and that the respondent does not really have the interest of the company at heart but is merely advancing his own interest. The law does not allow bringing a personal action against the company and then simultaneously to seek leave to bring a concurrent and inconsistent statutory derivative action against it on the same causes of action. In such a situation leave should not have been granted. Since it was apparent that the respondent was not acting in good faith, we hold that leave was wrongly granted.
[22] In Swansson it was held that the following approaches should be taken:
Nevertheless, in my opinion, there are at least two interrelated factors to which the courts will always have regard in determining whether the good faith requirement of s 237(2)(b) is satisfied. The first is whether the applicant honestly believes that a
3 MLJ 636 at 651
good cause of action exists and has a reasonable prospect of success. Clearly, whether the applicant honestly holds such a belief would not simply be a matter of bald assertion: the applicant may be disbelieved if no reasonable person in the circumstances could hold that belief. The second factor is whether the applicant is seeking to bring the derivative suit for such a collateral purpose as would amount to an abuse of process.
The applicant may, however, believe that the company has a good cause of action with a reasonable prospect of success but nevertheless may be intent on bringing the derivative action, not to prosecute it to a conclusion, but to use it as a means for obtaining some advantage for which the action is not designed or for some collateral advantage beyond what the law offers. If that is shown, the application and the derivative suit itself would be an abuse of the court's process: Williams v Spautz (1992) 174 CLR 509 at p 526; (1992) 107 ALR 635 at p 648. The applicant would fail the requirement of s 237(2)(b).
[23] In the circumstances of the two conflicting actions concurrently taken by the respondent, the learned judge should have alerted himself to the question of whether the respondent was acting in good faith. And, on the balance of probabilities, the onus of proof of which now falls on the Respondent, we are of a considered and firm view that respondent act is not bona fide and found him to have been guilty of an abuse of process.
[24] Also, action has been taken by Celcom to recover for an indemnity against some of the appellant's former directors viz Tan Sri Dato' Tajuddin Ramli, Dato' Bistamam Ramli and Dato' Lim Kheng Yew for causing the appellant to enter into the ARSA. These legal proceedings are for the recovery of the very loss which the respondent now wishes to claim on behalf of the appellant through this proposed derivative action. It is our finding that where there is a risk of double recovery, as is now apparent, then leave to bring a statutory derivative action like in this case, should not be granted (see Hengwell Development Pte Ltd v Thing Chiang Ching & Ors [2002] 4 SLR 902).
[25] In Johnson v Gore Wood & Co (a firm) [2001] 1 All ER 481, the House of Lords held that only a company can maintain an action to recover reflective losses and that a shareholder is precluded from doing so. Since the purported loss which the respondent is now claiming for, is a mere reflection of the loss of the appellant, then, in the words of Lord Bingham in Johnson 'the court must respect the principle of company autonomy, and ensure that the company's creditors are not prejudiced by the action of individual shareholders'. Against these principle and policy, it cannot now be argued as the respondent did, that this application for leave for a derivative action is taken up in the interest of the company (more of this later).
[28] We need to also mention that this proposed derivative action was filed six years after the event and that it would be obviously against the appellant's interest to pursue it. The test of the interest of the company can be found in the Singapore case of Pang Yong Hock and Another v PKS Contracts Services Pte Ltd [2004] SGCA 18 [2004] 3 SLR 1, in this passage:
Having established that an applicant is acting in good faith and that a claim appears genuine, the court must nevertheless weigh all the circumstances and decide whether the claim ought to be pursued. Whether the company stands 'to gain substantially in money or in money's worth' (per Choo JC in Agus Irawan) relates more to the issue of whether it is in the interests of the company to pursue the claim rather than whether the claim is meritorious or not. A $100 claim may be meritorious but it may not be expedient to commence an action for it. The company may have genuine commercial consideration for not wanting to pursue certain claims. Perhaps it does not want to damage a good, long-term, profitable relationship. It could also be that it does not wish to generate bad publicity for itself because of some important negotiations which are underway. (Emphasis added.)
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[29] This application, in effect, seeks to the unwinding of the entire MGO and we agree with the appellant's stand that it would now be a laborious, costly and complicated process. It would also have a disastrous effect on the Appellant's credibility and market reputation. It would further entail the return of every shares acquired by TM under the MGO back to all shareholders who chose to sell their shares over six years ago, which in turn would cause substantial hardships to all those shareholders especially those who have expended the monies received. Further, there have been changes in shareholders many times over. We agree with the appellant that the learned judge here had failed to appreciate that there was no reasonable commercial sense of this proposed derivative action. His Lordship we feel, had also failed to seriously take into account the interests of the appellant and its former shareholders when allowing this leave application. This issue is of course a mandatory ingredient in considering whether to allow leave, as is expressed in s 181B(4) which needs repeating:
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To us, prima facie, it is apparent that the whole unwinding exercise is counter productive to the appellant's interest.
[30] Leave is a filtering process which in this instance, the court should have used with vigilance. We found that the learned judge had erred in law and had misconceived the facts and circumstances in so readily granting this leave.
[31] For these reasons, this appeal is allowed with costs here and below.
Important takeaways from Celcom
As outlined above, all practitioners must read Celcom in its entirety to understand the factual matrix from which the judges decided. A few takeaways are immediately apparent:
General findings
Leave to commence a statutory derivative action must not be given lightly
If leave is granted, it is final
Granting leave is not of an interlocutory nature
There is a very high threshold; a low threshold is wrong in law
Judges must exercise great caution in ensuring that the requirements of S. 181A are met
A strict and restrictive interpretation of S. 181A is necessary
The locus standi of an applicant must be fully scrutinised
All issues must be determined on the facts at hand
Acting in good faith
The onus of proof is on the applicant
The onus is on a balance of probabilities
The test of good faith is two-fold: (a) there must be an honest belief on the part of the applicant and (b) the application must not be for a collateral purpose
There must be a direct causal nexus between the complaint and how the formermember ceased to be a shareholder
Filing numerous and identical suits shows a lack of good faith
Action is brought in the best interests of the company
If the company has initiated legal proceedings to recover the loss, the derivative action will fail
A risk of double-recovery will always be decided in favour of the company (reflective loss will not be claimable by a shareholder)
Time-lines- Late derivative actions will not be in the company's best interests
Expediency of the action
Commercial considerations on the part of the company- Goodwill, adverse publicity, long-term relationships, etc.
How onerous is the derivative action? The more costly, drawn-out and painful it is, the less likely it is in the best interests of the company
The above is NOT exhaustive. Everything will turn on the facts before the Court and it will be incumbent on the presiding Judge to carefully and judiciously determine all applications for leave.
I would venture an opinion that if the Judge is unsure as to a particular issue, leave ought not be granted. This will jealously guard the sacrosanct nature of companies and filter out mendacious applications.
Practitioners must read these authorities for a better understanding:
Ong Keng Huat v Fortune Frontier [2015] 11 MLJ 604 (HC)
Koh Jui Hiong v Ki Tak Sang [2014] 3 MLJ 10 (FC)
After leave?
Should leave be granted, the director/shareholder will be able to instruct his solicitors to file a fresh suit in the company's name against the alleged wrongdoers.
This will be either an Originating Summons or Writ action, depending on the nature of the claim.
Conclusion
From the above, it is apparent that leave to commence a statutory derivative action is not a simple process. Care must be taken to ensure that every statutory requirement is met; O. 1A would be of no assistance to a disinterested drafter.
Lawyers and clients must ask themselves hard questions and consider the issue in totality; vacuums will be disastrous for any proposed statutory derivative action. Only a holistic understanding of the dispute and its seriousness will allow leave to be granted.
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