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GETTING AWAY WITH FRAUD: DEFRAUD THE SUBSIDIARY?

 

Lee Shih and Nathalie Ker discuss the multiple derivative action

Where a wrong has been carried out against a company, the rule in Foss v Harbottle provides that the company itself must bring an action and not the shareholder of the company. An aggrieved shareholder may be left powerless in the face of wrongdoing by the majority.

The common law then carved out an exception for a shareholder to bring an action on behalf of the company where the company itself is unable to do so. This is allowed where a wrong is committed against the company and at the same time, the wrongdoers are in control of the company. This is known as a ‘fraud on the minority’ as the wrongdoers are able to prevent the company from taking action against them. In these circumstances, a derivative action by the shareholder on behalf of the company is allowed.

Certain jurisdictions have also extended the derivative action to allow a shareholder of a parent company to bring an action on behalf of a subsidiary of that parent company. Such an action has been termed as a multiple derivative action.

The ability to bring a multiple derivative action is extremely pertinent in today’s world, where businesses can be and are often structured into a multi-tiered group of companies and subsidiaries. Shareholders may invest in the investment holding company, with the actual businesses being run and assets held by the first-tier or second-tier subsidiaries further down the corporate structure.

Lord Millet, writing extra-judicially in Multiple Derivative Actions, Gore-Browne bulletin July 2010, succinctly describes the consequences if the situation were otherwise:

The moral for would be fraudsters is simple; choose [a] company, and be careful to defraud its subsidiary and not the company itself.”

We will discuss the availability of the multiple derivative action in various jurisdictions and the application of these cases in Malaysia.

THE MULTIPLE DERIVATIVE ACTION

 

The ability to bring a multiple derivative action has not been universally adopted in all jurisdictions but there has been a more positive reception in recent times.

 

England

In England, prior to the coming into force of the English Companies Act 2006 (“2006 Act”), there were a number of reported cases where the Court permitted the bringing of a multiple derivative action. Examples of these are the cases of Wallersteiner v Moir (No 2) [1975] QB 373, Halle v Trax BW Ltd [2000] BCC 1020, Truman Investment Group v Societe General SA [2003] EWHC 1316 (Ch) and Airey v Cordell [2006] EWHC 2728 (Ch). However, in these cases, the right of the aggrieved shareholder to bring such a multiple derivative action was never directly challenged and it was assumed that it was possible.

 

With the enactment of the 2006 Act, a statutory derivative action was introduced. The provisions provided that a derivative claim “may only be brought under this Chapter” or pursuant to an order brought in unfair prejudice proceedings. There was uncertainty whether this provision resulted in the abolition of the common law derivative action, both in its single or multiple derivative form.

 

The English High Court case of Universal Project Management Service Ltd v Fort Gilkicker Ltd and others [2013] Ch 551 (“Fort Gilkicker”) considered this issue and held that the multiple derivative action continued to survive at common law.

Briefly, the case of Fort Gilkicker involved two members holding equal shares in a limited liability partnership (“LLP”) which in turn owned all the shares in a company (“Company”). The Company had been incorporated as a special purpose vehicle to carry out a development project. A disagreement arose between the two members of the LLP. The aggrieved member alleged that the other had misappropriated a valuable business opportunity of the Company for his personal benefit and in breach of his fiduciary duty to the Company.

The English High Court acknowledged that the single derivative action at common law had been removed and replaced with the codified statutory derivative action. Recognising that the 2006 Act did not contain provisions allowing for a statutory multiple derivative action, the Court held that the multiple derivative action at common law still survived even after the 2006 Act. The Court could find no persuasive reason why Parliament ought to have intended to have provided no scheme for doing justice where the wrongdoer was a holding company in the wrongdoer’s hands.

Therefore, English law continues to recognise the common law right to bring a multiple derivative action.

 

Hong Kong

 

In Hong Kong, the landmark case on the multiple derivative action is the Court of Final Appeal case of Waddington Ltd v Chan Chun Hoo Thomas and others [2008] HKCU 1381 (“Waddington”). Here, the Court considered the slightly more complex situation of a shareholder of a holding company suing on behalf of its sub-subsidiaries.

 

In Waddington, the plaintiff was a minority shareholder in Company A. Company A wholly owned Company B, which in turn owned Company C and Company D. The plaintiff alleged that the chairman and executive director of Company A (“first defendant”), who controlled all the companies, had caused the subsidiaries to enter into uncommercial transactions. The plaintiff brought a common law multiple derivative action on behalf of Company C and Company D against the first defendant.

 

Justice Ribeiro held that section 168B of the Hong Kong Companies Ordinance (Cap 32) at the time did not allow for the multiple derivative action and that such actions continued to be available under the common law. Lord Millet, one of the presiding judges in this appeal, further held that on a question of standing, the court must ask itself whether the plaintiff has a legitimate interest in the relief claimed sufficient to justify him in bringing proceedings to obtain it. The learned judge held that this is fulfilled in the case of a person wishing to bring a multiple derivative action as any depletion of a subsidiary's assets causes indirect loss to its parent company and its shareholders.

 

The multiple derivative action was subsequently codified in the new Hong Kong Companies Ordinance (Cap 622) which came into force on 3 March 2014. Section 732(1) of the new Hong Kong Companies Ordinance states:

 

(1) If misconduct is committed against a company, a member of the company or of an associated company of the company may, with the leave of the Court granted under section 733, bring proceedings in respect of the misconduct before the court on behalf of the company.” (Emphasis ours)

 

“Associated company” is defined in the new Hong Kong Companies Ordinance as a subsidiary of the body corporate, a holding company of the body corporate or a subsidiary of such a holding company. The Hong Kong Companies Ordinance also expressly preserves the common law right to bring a single or multiple derivative action.

 

Therefore, Hong Kong law allows for both a statutory and common law multiple derivative action.

 

The British Virgin Islands

 

The current position in the British Virgin Islands (“BVI”) is that it appears that no multiple derivative action may be brought. BVI law provides for a statutory derivative action and has the restriction that “a member is not entitled to bring … any proceedings in the name of or on behalf of a company” except through the statutory provisions.

 

In the 2013 BVI Court of Appeal case of Microsoft Corporation v Vadem Ltd [BVIHCVAP2013/0007] (“Microsoft Case”), Microsoft Corporation (“Microsoft”) was a minority shareholder in the BVI registered respondent company, Vadem BVI. In turn, Vadem BVI owned all the shares in Vadem Inc (“Vadem California”), a California corporation.

 

One of the crucial issues in the Microsoft Case was whether Microsoft could seek leave from the BVI Court to pursue causes of action on behalf of Vadem California. Hence, whether a multiple derivative action would be allowed.

 

Leave was granted by the learned judge to bring a derivative action on behalf of Vadem BVI but not on behalf of Vadem California. The learned judge stated that Microsoft had no authority to prosecute causes of action on behalf of Vadem California in BVI or anywhere else. On appeal, the BVI Court of Appeal decided that the question as to whether Microsoft could bring an action on behalf of Vadem California was a matter for the lex fori (law of the forum, i.e. law of California) to determine. Further, Justice Mario Michel made it very clear that the BVI Courts had no authority to grant leave for Microsoft to bring proceedings in the name of and on behalf of Vadem California as “BVI law does not permit double derivative proceedings.”

 

Therefore, BVI law does not allow for a multiple derivative action to be brought under its statutory provisions. Nonetheless, it remains to be seen whether the BVI Courts in future will adopt the reasoning in Fort Gilkicker and Waddington in finding that a multiple derivative action continues to exist through the common law route.

 

CODIFICATION OF THE MULTIPLE DERIVATIVE ACTION

 

Similar to the present position in Hong Kong, other jurisdictions have provided for a statutory multiple derivative action.

 

Australia

 

In Australia, a person may bring proceedings on behalf of a company if he is a member, former member, or person entitled to be registered as a member, of the company “or of a related body corporate (section 236(1)(a) of the Australian Corporations Act 2001 (“2001 Act”)). A company is related to another company if the first company is the holding company, a subsidiary, or a subsidiary of the holding company of the first company (section 50 of the 2001 Act). The 2001 Act also states that the right of a person to bring a derivative action at general law (common law) is abolished.

 

Canada

 

In Canada, in allowing for a statutory derivative action, there seems to be a wider definition of who a ‘complainant’ may be. A complainant bringing a derivative action may be a shareholder of the corporation “or any of its affiliates” and may sue on behalf of the corporation or any of its subsidiaries (sections 238 and 239(1) of the Canadian Business Corporations Act 1985 (“1985 Act”)).

 

A company is affiliated with another if one of the companies is a subsidiary of the other or both are subsidiaries of the same body corporate or each of them is controlled by the same person. Further, if two companies are affiliated with the same company at the same time, they are deemed to be affiliated with each other (section 2(2) of the 1985 Act). A complainant also includes any other person who, in the discretion of the Court, is a proper person to make an application (section 238(d) of the 1985 Act).

 

IS THERE ROOM FOR THE MULTIPLE DERIVATIVE ACTION IN MALAYSIA?

The Malaysian position is that a derivative action can be brought either under the statutory derivative action provisions of sections 181A-181E of the Companies Act 1965 or through the common law derivative action route.

However, Malaysia’s statutory derivative action does not contain wording to suggest that a multiple derivative action route is possible. The authorities of Fort Gilkicker and Waddington would be persuasive here in Malaysia and it is likely that a multiple derivative action would be possible under the common law.

CONCLUSION

It is therefore hoped that the Malaysian Courts will endorse the availability of the multiple derivative action should it be an issue before the Courts.

It is also hoped that there will be an eventual amendment to our statutory derivative action provisions to expressly allow for a multiple derivative action. The common law route would still be filled with its complexities and uncertainties. Recognising this, the statutory derivative action was introduced in Malaysia in order to make it easier for an aggrieved shareholder to seek redress on behalf of the company. It would therefore be beneficial to widen the statutory route to allow a multiple derivative action.

In conclusion, the very same reasons which justify the derivative action would also justify the multiple derivative action. Therefore if wrongdoers must not be allowed to defraud a parent company with impunity, they must also not be allowed to defraud its subsidiary with impunity.

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