The Board of Directors have to duty to make management decisions in the best interests of the company. Typically, such duties include decisions to commence legal action(s) to right a wrong suffered by the Company and recover losses resulting from such wrongdoing.
However, what happens when it is the directors themselves that are the ones responsible for the wrongdoing? In that scenario, there is a risk that the company will not receive vindication for the harm done to it because the very perpetrators of the wrongdoing, i.e., the directors, are unlikely to have the company taken action against themselves, which is to say they certainly would not vote in the boardroom to authorize the company to commence lawsuits against themselves.
Thus, a “derivative action” gives the company adequate recourse by allowing certain stakeholders to, on the company’s behalf, sue the offending director(s) or initiate arbitration proceedings against them.
It should be noted that pursuing derivative action(s) requires the permission of the court. Section 216A of the Companies Act of Singapore governs an application to commence a derivative action (also known as a ‘statutory derivative action’). Derivative action may also be available under common law (as opposed to statute), though the governing principles are slightly different. Regardless, permission from the Court is still required.
The following is a non-exhaustive list of situations in which a derivative action may be the appropriate or even necessary course of action:
It is important to note that there is a distinction to be made between losses suffered by the company and losses suffered by individual shareholders. This is a common point of confusion due to the fact that this typically both occurs at the same time, or a combination of different losses are suffered by the company and individual shareholders arising from the same chain of events / wrongdoing.
The key distinction is where the loss in question affects individual shareholders rather than the company, then the statutory derivative action is not the appropriate remedy because such an action is to vindicate the rights of the company, not the individual shareholders.
To illustrate, take for an example a drop in share prices which could be considered a loss caused to shareholders personally. However, it is important to delve deeper to understand what has caused such a drop.
This drop in share prices could be because of a director’s wrongdoing in accepting bribes and entering into loss-making contracts – this would be wrong committed by the director on the company, where the company suffers the loss, but at the same time, the natural consequence is also that the share prices drop. In this scenario, this may be more of a corporate wrong / loss suffered by the company, where only the incidental / consequential loss is suffered by the shareholder (and not a personal wrong). This would mean that a statutory derivative action would be more appropriate.
Now take a different situation where the drop in share price is due to dilution of share pattern to minority shareholders, where more shares are issued by the majority at depressed prices but in such a design where the majority receives some of the issued shares such that their total value is not affected and only the minority shareholders’ true value is affected. This would now be more akin to a personal wrong rather than a corporate wrong, where a minority oppression action under section 216 of the Companies Act may be more appropriate.
We have discussed Minority Oppression separately in this other article.
One further important requirement to note is that a statutory derivative action must be initiated in respect of a company incorporated in Singapore; not outside Singapore.
Additionally, where a company is in liquidation, then a statutory derivative action cannot be brought on behalf of a company. This is because when a company goes into liquidation, the liquidator takes over and the board of directors is no long in control and has no ability to initiate or authorize any type of legal action, much less prevent the company’s rights from being vindicated which is now within the power of the liquidator.
Furthermore, even if the applicant stands to benefit personally from a successful derivative action, this will not be considered bad faith if his personal interests are aligned with those of the company.
After grant of permission for statutory derivate action by the Court:
After granting permission for the applicant to file the statutory derivative action, the court may make any order it deems fit, including:
Without the court’s permission, statutory derivative actions (or applications for such actions) cannot be stayed, discontinued, settled, or dismissed.
Ultimately, while there are clear routes to right the wrongs committed against the company, there are important considerations to take note of, particularly in identifying the proper route to remedies and obtaining the Court’s permission to do so.
If you require any assistance, you may contact: