Court Sets Higher threshold for Statutory Derivative Actions

Claudia Cheah explains the decision of the Court of Appeal in Celcom (Malaysia) Berhad v Mohd Shuaib Ishak

 

 

The Court of Appeal in the recent decision of Celcom (Malaysia) Berhad v Mohd Shuaib Ishak [2010] 1 LNS 560 unanimously overturned the High Court’s decision which granted leave to a former member to commence a statutory derivative action under Section 181A of the Companies Act, 1965 ("Act").

 

We have commented on the High Court’s decision in LEGAL INSIGHTS Issue No. 4/2008. This is a follow-up commentary on the decision of the Court of Appeal.

 

 

BRIEF FACTS

The brief facts of the case are as follows:

 

The Plaintiff is a former member of Celcom (Malaysia) Bhd (“Celcom”). He applied for leave to sue the directors of Celcom, the ultimate holding company of Celcom i.e. Telekom Malaysia Bhd (“TM”), Telekom Enterprise Sdn Bhd (“TESB”) as well as the directors of TM and TESB.

 

The proposed derivative action was based on the following facts (“Proposed Action”):

 

(1) Celcom and DeTeAsia ("DTA") entered into an Amended and Restated Supplemental Agreement (“ARSA”) whereby Celcom agreed that it would not merge its business to allot or issue new shares without DTA's consent and that in default thereof, Celcom would procure a third party to acquire DTA's shares in Celcom at RM7.00 per share ("Buy Out Provision").

(2) Celcom entered into an agreement with TM to acquire TM's entire shareholding in Telekom Cellular Sdn Bhd (“TM Cellular”) for a consideration which was satisfied wholly by the issue of new fully-paid Celcom shares to TESB at an issue price of RM2.65 per share ("SPA"). Celcom did not obtain the consent of DTA for the transaction under the SPA.

(3) The issue of new Celcom shares under the SPA gave rise to an obligation for TESB to make a Mandatory General Offer (“MGO”) to acquire all the remaining shares in Celcom at an offer price of RM2.75 per share.

(4) As TESB acquired 96.32% of Celcom’s shareholding vide the MGO, it exercised the right of compulsory acquisition under Section 34 of the Securities Commission Act, 1993 ("SCA") to acquire the remaining Celcom shares. The Plaintiff’s Celcom shares were acquired by TESB at the price of RM2.75 per share pursuant to this compulsory acquisition.

(5) DTA commenced arbitration proceedings against Celcom for breach of the Buy Out Provision and was awarded damages of approximately USD177 million and costs of USD1.23 million. Celcom paid the arbitration award sum (“Award Sum”) in full.

 

The Plaintiff contended that the Celcom directors had caused Celcom to breach the ARSA by procuring Celcom to enter into the SPA without DTA's consent and had thereby caused loss to Celcom by reason of the liability it incurred for the Award Sum.

 

The Plaintiff further contended that by causing Celcom to breach the Buy Out Provision, the Celcom directors had caused the MGO to take place at RM2.75 per share instead of RM7.00 if TM had offered to buy DTA's Celcom shares pursuant to the Buy Out Provision. Thus, it was alleged that the Celcom Directors had cause loss to Celcom's former shareholders by causing the MGO to take place at a lower price of RM2.75 per share instead of RM7.00 per share.

 

 

THE HIGH COURT’S DECISION

The High Court held that the Plaintiff was a competent complainant for the following reasons:

 

(1) the Plaintiff's application relates to the circumstances in which he ceased to be a member of Celcom; and

(2) the nexus (connection) between the Plaintiff ceasing to be a member of Celcom and the circumstances of the proposed claim could easily be seen from the events that culminated in his shares being acquired through the compulsory acquisition scheme under Section 34 of the SCA.

 

 

THE COURT OF APPEAL’S DECISION

The Court of Appeal ("Court") held that leave to commence a statutory derivative action under Section 181A must not be lightly granted and that the High Court Judge had erred by adopting a low threshold of merely determining if there existed a prima facie case. The Court ruled that the provision must be given a restrictive interpretation and an applicant must strictly satisfy each requirement stipulated therein.

 

Amongst other requirements, it would be necessary for an applicant to satisfy the court that (i) he has the locus standi (legal status) to initiate the proceedings; (ii) that he is acting in good faith; and (iii) it appears prima facie to be in the best interest of the company that the application for leave be granted.

 

 

Locus standi

On the issue of locus standi under Section 181A(4)(b), the Court found that the Plaintiff failed to prove a direct causal nexus between the complaint and how the Plaintiff ceased to be a member of Celcom. The Court took the view that the alleged breach of the ARSA resulted in the Award Sum being paid to DTA but did not cause the Plaintiff to cease to be a member of Celcom.

 

 

Good faith

On the issue as to whether the Plaintiff was acting in good faith within the meaning of Section 181B(4)(a), the Court adopted the inter-related two-fold test in the Australian case of Swansson v R.A. Pratt Properties Pty Ltd & Anor [2002] NSWSC 583, that is:

 

(1) firstly, whether the applicant honestly believes that a good cause of action exists and has a reasonable prospect of success; and

(2) secondly, whether the applicant is seeking to bring the derivative suit for such a collateral purpose as would amount to an abuse of process.

 

In respect of the first test, Palmer J in Swannson clarified that a mere bald assertion would not suffice and an applicant may be disbelieved if no reasonable person in the circumstances would hold that belief.

 

The Court then referred to the following facts:

 

(1) A committee of independent directors ("Committee") had been constituted as TM’s and DTA’s nominee directors on Celcom's board were in a position of conflict of interest;

(2) The Committee had sought independent legal advice on whether the Buy Out Provision in the ARSA was enforceable;

(3) The Committee had been advised that there were a number of grounds in the Buy Out Provision that violated Malaysian law, amongst which was that there was no commercial or legal justification why the Celcom shares were priced at RM7.00 each in the Buy Out Provision when the market price of such shares was around RM2.31 per share at the material time.

 

In the above premises, the Committee had exercised prudent business and commercial judgment and decided to approve the SPA without DTA’s consent.

 

The Court agreed with the submission by Celcom's counsel that the above-referred facts showed that the decision of the independent directors had been an exercise of the prudent business judgment rule by a completely honest and disinterested section of Celcom's board. Accordingly, the Court declined to interfere and substitute its own judgment in place of what it held to be a proper and prudent business and commercial decision of the directors.

 

The Court also considered the fact that the Plaintiff had not made any averment in his intended Statement of Claim that the independent directors had conspired with TM. The Court was of the further view that the Proposed Action did not have any reasonable prospect of success.

 

The Court further found that the Plaintiff was actuated by an ulterior motive in making the leave application. This was because the Plaintiff had instituted a separate personal action which was virtually identical to the derivative action and with identical reliefs sought. The Court ruled that the law does not allow the bringing of a personal action against the company and simultaneously seeking leave to bring a concurrent and inconsistent statutory derivative action on the same cause of action.

 

In concluding its findings on the requirement for good faith, the Court held that the Plaintiff failed to discharge the burden of proving good faith on a balance of probabilities and had been guilty of an abuse of process.

 

 

Reasonable prospects of success

The Court then considered the requirement stipulated in Swannson that there must be reasonable prospects of the derivative action being successful.

 

The Court held that the High Court Judge had erred in concluding that if Celcom had complied with the Buy Out Provision under the ARSA, the MGO had to be made at RM7.00 per share. This was because the obligation of the offeror in a mandatory takeover is to pay the highest price during a 6 month period preceding the offer pursuant to Section 20(1) of the Malaysian Code on Take-overs and Mergers. As it was undisputed that the highest market price of Celcom's shares at the time of the SPA was only RM2.75 per share, the Court was of the view that there was no reasonable prospect of the Plaintiff's claim being successful.

 

 

Prima facie in the best interest of the company

The Court proceeded to deal with the requirement under Section 181B(4)(b) of the Act that the Proposed Action should prima facie be in the best interest of the company. The Court adopted the interest test laid down in the Singapore case of Pang Yong Hock & Anor v PKS Contracts Services Pte Ltd [2004] SGCA 18 which held that a company may have genuine commercial considerations for not pursuing certain claims, even if those claims may be meritorious.

 

The Court cited a passage from the Canadian case of Ontario Ltd v Bernstein [2000] OTC Lexis 3480 where the following statement is attributed to Justice Brandeis in United Copper Securities So. et. al v Amalgamated Copper Co. et. al [1917] 244 U.S. 261 at p. 263-4:

 

"Whether or not a corporation shall seek to enforce in the courts a course of action for damages is, like other business questions, ordinarily a matter of internal management and is left to the discretion of the directors, in the absence of instruction by vote of the stockholders. Courts interfere seldom to control such discretion intra vires the corporation, except where the directors are guilty of misconduct equivalent to a breach of trust or where they stand in a dual relation which prevents unprejudiced exercise of judgment."

 

In the opinion of the Court, the Proposed Action sought to unwind the MGO more than 6 years after the event would be a laborious, costly and complicated process. It would have a disastrous effect on Celcom’s credibility and market reputation and could cause substantial hardships to shareholders who had expended the sales proceeds from the MGO. Adding to the complication would be the fact that there could have been many changes in the shareholders during the intervening period.

 

In the above premises, the Court found that there was no reasonable commercial sense in the Proposed Action as prima facie, it was apparent that the whole unwinding exercise would be counter-productive to the interest of Celcom.

 

 

CONCLUSION

The Court in Celcom (Malaysia) Berhad v Mohd Shuaib Ishak has adopted a narrow interpretation of Section 181A of the Act and has made it clear that leave will not be lightly granted to an applicant to commence a statutory derivative action. It will no longer be sufficient for an applicant to satisfy the Court that he has a prima facie case. Instead, he must satisfy the following requirements in order to succeed in obtaining leave to commence such a derivative action:

 

(1) the applicant must, if he is a former member, establish a direct causal nexus between the application and the circumstances in which he ceased to be a member;

(2) he must satisfy the court that he is acting in good faith. To discharge this burden, he is required to go into the merits of the proposed action and to satisfy the court that there is a good cause of action and a reasonable prospect of success;

(3) the derivative action must not be initiated for a collateral purpose as would amount to an abuse of process; and

(4) he must satisfy the court that the derivative action appears prima facie to be in the best interest of the company. In this regard, the court will not interfere with commercial decisions made by the directors except where the directors are guilty of misconduct akin to a breach of trust or where conflicts of interest exist which prevent them from exercising their judgment in an unprejudiced manner.

 

The Court has set a higher threshold to be satisfied by an applicant who wishes to commence a statutory derivative action under Seciton 181A of the Act.

 

 

EPILOGUE

The Federal Court has recently dismissed the Plaintiff’s application for leave to appeal against the decision of the Court of Appeal. As such, High Court judges will be bound by the doctrine of stare decisis to follow the principles laid down by the Court of Appeal in this case when they consider applications under Section 181A of the Act.

 

 

CLAUDIA CHEAH PEK YEE ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it )

Claudia is a Partner in the Dispute Resolution Division of SKRINE. Her main practice areas are banking and commercial litigation.

 
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