1.0 INTRODUCTION
The board of directors who manages the affairs of a company decides whether the company should pursue a legal action and this process is generally straightforward. However, it becomes a ‘catch 22’ situation when the wrongdoers who caused damage or loss to the company control the board. Naturally, those directors will not cause the company to sue themselves.
Under these circumstances, a derivative action may be commenced by a shareholder on behalf of the company against the wrongdoers. Pursuant to section 348(1) of the Companies Act 2016 (‘CA 2016’), leave from the Court shall first be obtained by the applicant prior to commencing a legal action on behalf of the company.
2.0 LEAVE REQUIREMENTS
2.1 Who may initiate the action
Under section 345 of the CA 2016, a company’s member, former member or a director may seek leave of the Court to commence, intervene in or defend a proceeding in the name of the company.
2.2 30 days’ notice
It is pertinent to note that under section 348(2) of the CA 2016, prior to filing the leave application, an applicant has to give a 30-days’ notice in writing to the company’s directors of his intention to apply to Court for leave. In the same vein with the now repealed and abrogated common law rights afforded to a complainant to file a derivative action, this requirement is to enable the board of directors to make a decision whether or not to initiate the action.
If leave is granted by the Court, the applicant is required under section 348(3) of the CA 2016 to initiate the intended legal action on behalf of the company within 30 days from the granting of leave.
2.3 Material Considerations For Leave To Be Granted By Court
The legal threshold to be satisfied before the Court grants leave broaches mainly on the following 2 requirements:
(I) Whether the applicant is acting in good faith (Section 348(4)(a) of the CA 2016):
The conduct of the applicant is paramount – whether the applicant is sincere in commencing the action for the good of the company or the application for leave to commence a derivative action is made for a collateral purpose to enrich himself or herself. The Court will scrutinize the intention of the applicant. If the applicant is found to have arrived in Court with unclean hands, he or she will not fulfil the legal threshold for obtaining leave to commence a derivative action.
In Celcom (M) Bhd v Mohd Shuaib Ishak [2011] 3 MLJ 636, the Court of Appeal held that the test of good faith is two-fold. First is an honest belief on the part of the applicant, and secondly, that the application was not brought for a collateral purpose. A further and material consideration for the Court when deciding whether to grant leave is that the company must benefit commercially from the action, if granted. Therefore, the Court of Appeal in reconciling the test with the facts in this case held, inter alia, that the application by the applicant, which in effect sought the unwinding of the entire Mandatory General Offer (MGO) would be a laborious, costly and complicated process. As such, the applicant has failed to prove that there is a reasonable commercial sense of the intended derivative action.
(II) Whether there is a prima facie case that the application is in the best interests of the company? (Section 348(4)(b) of the CA 2016):
A material factor to be taken into consideration before granting leave to pursue the action would depend chiefly on whether the company stands to gain significantly in pecuniary or monetary worth from the proposed action. The Court may still refuse the application if the company does not stand to benefit financially from the proposed action even though it is made in good faith.
In Abdul Rahim bin Suleiman & Anor v Faridah bt Md Lazim & Ors [2016] 6 MLJ 449, the Court of Appeal granted leave to the applicant to commence a derivative action on the basis, inter alia, that the company would stand to recover an estimated sum of RM12 million which would translate into a commercially beneficial gain for the company.
3.0 PLAUSIBLE SCENARIOS
Instances of: (i) failure of directors to properly audit the company’s accounts for years; (ii) misappropriation of company’s funds; and (iii) gross dereliction of directors for failing to pursue and recover sums owing to the company have seen the Court granted leave to applicants to commence derivative action. The above instances are by no means absolute and are non-exhaustive.
3.1 Examples Where Leave Was Granted
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- Abdul Rahim bin Suleiman & Anor v Faridah bt Md Lazim & Ors [2016] 6 MLJ 449
Prospective applicants for leave to initiate action on behalf of the company should note that the Court of Appeal in this decision succinctly held that ‘the Court, in an application for leave, should not go into the merits of the case at the leave stage. Its role is to see if the application for leave is frivolous (Tang Kwor Ham & Ors v Pengurusan Danaharta Nasional Bhd & Ors [2006] 5 MLJ 60).’ It is made clear by the Court of Appeal here that at leave stage, the issue is only whether it is in the best interests of the company to pursue the claim and that the apposite question therefore should be whether the company would gain substantially in money’s worth.
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- Ong Keng Huat v Fortune Frontier (M) Sdn Bhd & Anor [2015] 11 MLJ 604
The Court in granting leave held that the onus is on the applicant to establish good faith on his part and the Court must assess the motivations of an applicant in order to determine whether he is acting in good faith. Good faith was stated to be less dependent on the motives which trigger the application, but more on the purpose of the proposed derivative action, which must have a clear nexus with the company’s benefits or interests. The motivations of the applicant would only amount to a lack of good faith if they revealed that the applicant’s judgment was influenced by purely personal considerations. The applicant must demonstrate that he is genuinely aggrieved and that his collateral purpose is sufficiently consistent with the objective of doing justice to the company.
3.2 Example Where Leave Was Not Granted
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- Pang Yong Hock and Anor v PKS Contracts Services Pte Ltd [2004] 3 SLR 1
The sole fact that the applicants are acting in good faith alone is insufficient for the Court to grant leave. The overriding interests of the company still takes precedence as the Court must still be satisfied that in the light of all the circumstances, the intended action would be in the best interest of the company. The Singapore Court of Appeal in this case, despite being satisfied that the applicants were acting in good faith on the grounds that there could possibly have been a breach of duties by all the directors, nonetheless held that it would not be in the best interest of the company for leave to be granted as the breach implicated all of the directors of the company and that allowing one faction to commence an action against the other would only result in protracted and long-drawn litigation between the factions in the company.
4.0 ORDERS WHICH THE COURT MAY GIVE
In granting leave, the Court has power to grant various consequential orders. It is pertinent for the applicants to note that the Court may order that the company pays the legal costs (i.e. legal fees, disbursements, etc) incurred by the applicant in filing the application and/or action.
In fact, the following orders may be made by the Court under section 350 of the CA 2016:
- Authorizing the complainant or any other person to control the conduct of the proceedings;
- Giving directions for the conduct of the proceedings;
- For any person to provide assistance and information to the complainant, including to allow inspection of the company’s books;
- Requiring the company to pay reasonable legal fees and disbursements incurred by the complainant in connection with the application or action, or pending the grant of the leave or pending the grant of any injunction by the Court hearing the application for leave under this section; or
- The costs of the complainant, the company or any other person for proceedings taken under this secretion, including an order as to indemnity for costs.
5.0 KEY TAKEAWAYS
The origins of a derivative action emanated from common law. Albeit abrogated, the lawmakers of the country, however, have galvanized the law on this subject in codifying the same in the provisions of the CA 2016 and by virtue of section 347(3), litigants are afforded assurance and further conviction in regards to the specific pre-requisites for a derivative proceeding.
In that regard, the Court will also benefit from the thorough scrutiny of the 2 requirements under the CA 2016 as these will assist greatly in filtering and separating the genuine actions from the vexatious and frivolous claims.
On the other hand, there is no denying that cost is a material consideration and as such any member or director of a company who intends to take out an action in the name of the company against the wrongdoer should take heed of the fact that the Court in granting leave may make an order for the applicant to be reimbursed with reasonable legal costs incurred in connection with the application or action.
If you require further advice on the above, kindly contact Dennis Yuean Jin Han at dennisyuean@cheangariff.com.
Disclaimer: The contents of this write-up are intended for general informational purposes only and do not constitute legal advice.
