Derivative Action: A shareholder’s remedy to protect the interests of the Company

This article analyses the recent judgment of the Court of Civil Appeal (CCA) in Bay Capital Investments Ltd v Mohinani Harry Hassomal 2023 SCJ 516 where the Court restated the conditions that must be met for a derivative action to be successful and briefly looks at the potential remedies available and the issue of costs for derivative actions.

The case

The Appellant Company, Bay Capital Investments Ltd (BCI Ltd) appealed against the decision of the Supreme Court granting to the Respondent (Mr Mohinani) leave to bring a derivative action against the directors of the BCI Ltd.

Mr Mohinani is an investor and bought shares in a total amount of GBP 1.5 million in BCI Ltd. A restructuring proposal was made by the Board of Directors of BCI Ltd towards its investors in relation to the funding of a particular project known as the ‘Park Chinois Project’.

Subsequent to the implementation of the restructuring proposal, Mr Mohinani made an application to the Commercial Division of the Supreme Court for leave to enter a derivative action, pursuant to Section 170(1)(a) of the Companies Act [the Act] in the name and on behalf of BCI Ltd, alleging, inter-alia, that the restructuring of investments was tainted with fraud and was set up for the benefits and interests of Bay Capital Partners Ltd (Investment Manager) and its Founding and Managing Partner, one Mr Mehta and not for those of BCI Ltd. Mr Mohinani alleged that the ‘scheme’ devised benefitted from the complicity of the board of directors of BCI Ltd who, according to him, have condoned the acts and doings of the Investment Manager and Mr Mehta in breach of their fiduciary duties and fraudulently.

Who can bring a derivative action

Section 170(1) of the Act provides for who can bring a derivative action.
Upon the application of a shareholder or director of a company, the Court may grant leave to that shareholder or director to:

• bring proceedings in the name and on behalf of the company or its subsidiary; or
• intervene in proceedings to which the company or any related company is a party for the purpose of continuing, defending, or discontinuing the proceedings on behalf of the company or its subsidiary, as the case may be.

Such action can therefore only be initiated by “a shareholder or director” of the company, in the name and on behalf of the company or its subsidiary.

When can a derivative action be initiated

The Act sets out a two-stage process for initiating a derivative claim:

Firstly, the shareholder or director has to seek leave of the Court to start derivative proceedings. This procedural requirement provides a necessary filter against spurious claims whereby the Court will consider whether there is a prima facie case before granting leave.

Secondly, where the Court is satisfied that there is a prima facie case and grants leave, the derivative claim on behalf of the company, can proceed in the same way as the court action would have done if the company had decided to initiate the proceedings itself.
Section 170(3) of the Act outlines the circumstances in which leave to enter a derivative action may be granted as follows:

1. Where the company or related company does not intend to bring, diligently continue or defend, or discontinue, the proceedings, as the case may be; or
2. it is in the interests of the company or its subsidiary that the conduct of the proceedings should not be left to the directors or to the determination of the shareholders as a whole.

Section 170(2) prescribes the factors that ought to be considered when determining an application for leave for a derivative action. These factors are:

• the likelihood of the proceedings that may follow;
• the costs of the proceedings in relation to the relief likely to be obtained;
• any action already taken by the company or its subsidiary to obtain relief;
• the interests of the company or its subsidiary in the proceedings being commenced, continued, defended, or discontinued, as the case may be.

The applicable test

The CCA explained that the trial court had to ascertain whether “… there is a real question to be tried, that is to say, whether the applicant is able to identify the legal and equitable rights to be determined at trial in respect of which the final relief is sought.” For that purpose, the test that ought to be applied is “…….what a prudent business person with knowledge of his or her rights and the actions of the other parties would do, bearing in mind the potential costs of the litigation and the possible benefits of the litigation to that person (or in this case the company).”

The CCA further observed that the overriding factor in such an application is, the interests of the company. An applicant must satisfy the court that it is the company itself which is injured by the alleged wrongdoing and for that purpose, the company will be injured “when all shareholders are affected equally, with none experiencing any special harm”.

The conditions to be met

The CCA upheld the decision of the trial court and concluded that the application disclosed an arguable case for a derivative action inasmuch as the conditions for such an action were present and were in the interests of BCI Ltd. Whilst the Supreme Court has previously addressed what conditions ought to be satisfied for a derivative action¹ , the CCA, in this particular case, has sought to bring further clarity on those conditions which ought to be satisfied on a prima facie basis when bringing such actions. These are:

1. the alleged wrongdoing averred against the company;
2. that the company itself has been injured by such alleged wrongdoing; and
3. that it is the company which would be the ultimate beneficiary of any judgment in the proposed proceedings.

Derivative action remedies

There are many potential remedies for derivative claims; in cases involving the payment or repayment of money by the directors held liable towards the company, the money will be paid or repaid to the company for the benefit of the company as a whole and not to the shareholder or director who initiated the derivative claim. However, the Court, having wide powers, can direct that any amount to be paid by a defendant in the proceedings shall be paid to former and present shareholders of the company instead of to the company. (vide section 172 (d) of the Act). Some of the potential remedies available are:

• Damages payable to the company from the director(s) who has acted against the interests of the company;
• An injunction to prevent the director(s) against committing any further breaches;
• Restoration of any company asset held by the director(s); and
• An order for restitution or requiring the director(s) to account for any profits they have made.

Costs of derivative action

In terms of costs of derivative actions, the Court shall, on the application of the shareholder or director to whom leave was granted under section 170, order that the whole or part of the reasonable costs of bringing or intervening in the proceedings, including any costs relating to any settlement, compromise, or discontinuance approved under section 170, shall be met by the company, unless the Court considers that it would be unjust or inequitable for the company to bear those costs.

Conclusion

Derivative actions must necessarily and ultimately benefit the company from any advantage or relief which the Court will grant. It remains a powerful recourse available to either, a director or shareholder, to pursue an action against a wrongdoer who has the power to control the affairs of the company and this is of particular significance in circumstances where the company’s board of directors refuse to act and initiate proceedings on the company’s behalf.

¹SEWTOHUL D. v GUTTY K. & ORS 2021 SCJ 303;

ALPINE ASSET APPRECIATION FUND LIMITED v JM FINANCIAL –OLD LANE INDIA CORPORATE FUND I LIMITED 2020 SCJ 134