Tuesday, December 8, 2009

Derivative Actions - Part I

The issue of shareholders making claims on behalf of a corporation has been a bone of contention ever since the decision in Foss v. Harbottle. However, in recent times, two particular aspects of this controversial area of corporate jurisprudence have received significant attention. These are the issues of multiple derivative claims, and the statutory requirements laid down for a derivative claim. Over the course of the next few posts, I shall discuss these issues in detail. Since the second of these issues involves a detailed examination of the evolution of the rule in Foss, and a comparison of the statutory modifications to the common law rule in various jurisdictions, I begin with the relatively smaller issue of multiple derivatives.

Multiple derivative actions are essentially actions by a shareholder of a company for a wrong on the subsidiary. It is called a multiple action because it involves an action on behalf of both the holding company (of which the claimant is a direct shareholder) and the on behalf of the subsidiary company. One of the most comprehensive discussions of the issue of multiple derivatives is seen in the decision of the Court Of Final Appeal of the Hong Kong Special Administrative Region, in Waddington Ltd. v. Chan Chun Hoo Thomas, delivered in September last year. The question before the Court was basically whether the shareholder of a company could bring a claim on behalf of a subsidiary of the company. This indirect derivative claim was referred to by the Court as a ‘multiple derivative claim’. The validity of such a claim was challenged on the basis that the statutory regime in Hong Kong (Section 168BC, Companies Ordinance, Cap. 32) allowed only for single derivative claims, and thus excluded such multiple actions. The Court rejected this contention, on the dual basis that the statutory regime did not exclude the application of common law, and that the common law allowed such multiple actions. It is the second of these two conclusions that is of relevance here.

The Court examined in the detail the evolution of derivative claims in general, before moving on to the specific issue before it. Examining this common law position, it concluded that while there was nothing in English law that specifically affirmed the legality of multiple derivative claims, there was nothing that went against it either. To the contrary, the Court observed that in several instances, the Courts had accepted the validity of such indirect claims without comment. The Court then observed that such multiple claims had been accepted in the United States on a variety of bases, not strictly applicable to the UK or Hong Kong jurisprudence. However, its acceptance in the US was seen as an affirmation that there was nothing per se incorrect with accepting multiple claims. The only argument against allowing the claim was that the shareholder of the parent would not have requisite standing to bring a claim on behalf of the subsidiary. However, the Court again examined the possible authority for this proposition, concluding that it either pertained to a different issue, or was distinguishable on facts. As long as the shareholder has a real and legitimate interest in the subsidiary, the Court opined that a claim on behalf of the subsidiary would lie. On this basis, the Court gave its affirmative vote for a derivative action by a shareholder of a company on behalf of the company and its subsidiary. It has also led to proposed legislative reforms, discussed here.

This decision gives rise to questions under two broad heads-

How has the common law on derivative claims evolved since Foss v. Harbottle, and what are the major statutory modifications made since then?

Is the Court’s assessment of the common law position on the validity multiple derivative actions correct?

It is these two questions that I will examine in the two posts that follow.

3 comments:

parinaz88 said...

Dear Shantanu,

would like to ask you two things.
Firstly, can the same principle be extended in the Indian context of oppression and mismanagement u/Sec. 397 & 398 of Companies Act.
Secondly, are there any judicial precedents in India where a shareholder of parent company can sue for the acts of its subsidiary or JV company(JV between parent and third party)

Regards,
Law student

Shantanu Naravane said...

Hi,

I do not think the same logic can be extended to oppression and mismanagement claims, since those can only be initiated by a 'member' of the company, which has been interpreted as being the shareholder alone. Please let me know if there is any authority to the contrary.

The answer to your second question is given by the Bombay High Court in BSN v. Janardan Pillai, [1996] 86 Comp Cas 371 (Bom). The Court there opined that neither the English nor the Indian law allowed derivative claims by shareholders of a parent company. The same position has also been affirmed in other contexts by the Bombay High Court in Chloro Controls, [2006] 131 Comp Cas 501 (Bom). However, the rationale of Janardan Pillai seems to be that since only members can bring oppression/mismanagement claims, derivative claims should also be brought by members alone. However, since derivative claims are a common law remedy, and not necessarily governed by the Companies Act, this reasoning seems suspect.

For another discussion of the Bombay High Court decision in Janardan Pillai, see Mihir's post on Law and Legal Developments, available at- http://legaldevelopments.blogspot.com/2009/12/multiple-derivative-actions.html.

Vinay vishen said...

What is qualified membership right?