Case Update: A Shareholder Derivative Action Can Be Brought for Benefit of a Deadlocked Company

The Federal Court in Perak Integrated Networks Services Sdn Bhd v Urban Domain Sdn Bhd & Ors (see the Federal Court Grounds of Judgment dated 16 April 2018) has ruled on the issue of  whether a common law derivative action can be initiated where the company is in a 50:50 deadlock.

The question of law before the Federal Court was:

Whether a derivative action may in law be brought for the benefit of a company, the management and control of which are deadlocked.

 

The Federal Court answered the question in the affirmative. The Federal Court has also set out the definitive test on wrongdoer control for the purposes of a common law derivative action. The possibility of initiating a just and equitable winding up petition based on the deadlock does not in itself prevent a shareholder from bringing a derivative action.

Brief Facts

In 2005, the company, Perak Integrated, was granted a license by the Malaysian Communications and Multimedia Commission to provide network facilities to telecommunication providers.

In 2007, through a Shareholders Agreement, the company, Urban Domain, and Perak Integrated formed a separate company called PINS.

The shareholding of PINS was a 50:50 split between Urban Domain and Perak Integrated. The Board of PINS was also only two directors, each director appointed by Urban Domain and Perak Integrated respectively.

Through various agreements, PINS constructed and maintained several telecommunications towers. A dispute arose where Urban Domain claimed that PINS was due additional rental proceeds and other payments from various telecommunication providers. Perak Integrated disputed this.

Eventually, in March 2011, Perak Integrated took over all the books and accounts of PINS.

After that, in July 2012, Urban Domain filed a common law derivative action on behalf of itself and PINS. A derivative action is essentially an action where a shareholder can bring an action on behalf of the company. The reliefs will ultimately be for the benefit of the company.

This derivative action was to claim against Perak Integrated and Perak Integrated’s nominated director on PINS for the loss and damage suffered by Urban Domain and PINS. After a full trial at the High Court, in 2013, Urban Domain’s claim was allowed against Perak Integrated.

In 2014, Urban Domain filed a just and equitable winding up petition to wind up PINS but the petition was not allowed.

At the Court of Appeal, on appeal against the derivative action suit, Perak Integrated’s counsel raised a preliminary issue on whether the suit was a properly constituted derivative action. The Court of Appeal dismissed this preliminary issue.

The Court of Appeal held that the test to established wrongdoer control for a derivative action is one of de facto control and that being a majority or minority shareholder is not conclusive. Wrongdoer control could be satisfied in a deadlocked company where the shareholding is split 50-50.

The Federal Court Decision

The Federal Court first analysed the history behind the common law derivative action. Where wrongdoers are in control of the company such that the company cannot bring an action, the Court would allow an action to be brought by the individual shareholders on behalf of the company to obtain redress.

In this case, the argument was whether it could be said that the company was in the control of the wrongdoers. The company was in a deadlock situation, at the shareholder and director level.

It was held that a derivative action may be brought by a shareholder for the benefit of a company in which the board of directors and body of members are deadlocked. The requirement of wrongdoer control is satisfied if it can be shown that the company is practically incapable of bringing an action against the wrongdoers for its benefit.

Next, the Federal Court considered the interplay between the derivative action and a just and equitable winding up petition. It was held that the availability of an alternative remedy of winding up in a deadlock scenario would not prevent a shareholder from pursuing a derivative action.

The Federal Court also distinguished certain English cases where the derivative action was not allowed as the companies were already in liquidation. Once the company was in liquidation, the necessity for a derivative action disappears. It could not be said that the minority shareholder was at the mercy of the majority. The aggrieved shareholder could not seek recourse with the liquidator. The liquidator could be asked to bring an action in the name of the company. If the liquidator is unwilling to do so, relief could be obtained from the court.

Comments

Firstly, this decision is useful in clarifying that a deadlock situation will not prevent a shareholder from still seeking relief under the common law derivative action. However, as noted by the Federal Court, section 347(3) of the Companies Act 2016 has abrogated the right of any person to initiate a common law derivative action. So moving ahead, there may be limited cases where this issue on common law derivative action will arise. There may still be the application of this decision in a multiple derivative action. You can read more on the multiple derivative action here.

Secondly, while the common law derivative action is abrogated, the statutory derivative action will then be the only method to bring such a derivative action. The statutory derivative action, contained in sections 347 to 350 of the Companies Act 2016, would allow, among others, any shareholder of the company to seek permission to bring such a derivative action. There is no restriction of there being wrongdoer control or not. So a shareholder, even in a deadlock situation or in a majority shareholding situation, would still be able to seek relief in a statutory derivative action.

Thirdly, the Federal Court has also adopted the case law that has held that a common law derivative action cannot be sought once the company is in winding up. It is very likely that a similar principle would apply for a statutory derivative action such that there cannot be a statutory derivative action once the company is in winding up. This is consistent with the Singapore Court of Appeal case in Petroships Investment as well as other case law from the UK and Australia.

 

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