Time and time again, individuals partner with good intention to build lucrative businesses. However, and more often than not, partners realise that the shareholder they have brought into their business does not share the same good intentions to see the business flourish.
There are numerous cases about shareholders or directors plundering company resources to the detriment of the company. What legal recourse does a shareholder have, when they realise that one or more shareholders/directors have the as their sole objective, to plunder company resources or act in any other manner that is detrimental to the company?
Derivative action is the answer! This week we look at what derivative action is and how it may be utilised to protect the company. The derivative action is available to companies of all sizes from your small to medium enterprises, family businesses and the large corporations.
So, what is derivative action?
Derivative action is a device designed to enable the court to do justice to a company controlled by its wrongdoers. It’s a device that prevents a serious wrong from going unremedied.
In a derivative action, a shareholder approaches the court seeking recourse. The Shareholder acts, not as representative of the other shareholders, but as a representative of the company to enforce rights derived from the company. The shareholder must however institute proceedings in its own name, and not in the company’s name. Derivative action is utilised when the wrongdoers are insiders who defraud or act in some other detrimental manner and also control the company affairs.
The action is therefore brought by the shareholder in his/her own capacity to vindicate the company’s rights as the internal wrongdoers would obviously not allow the company to sue them so that the wrong can be remedied.
In Zimbabwe, section 61 of the Companies and Other Business Entities Act [Chapter 24:31] provides for derivative actions. In summary the provisions of that section, allows a member or shareholder of a company or business corporation to bring an action in such person’s name and on behalf of the company against any manager, director of officer to enforce or recover from the officer, manager or director damages caused by violations of duties owed to the company under the Act or any other law, including laws against fraud and misappropriation.
Because the perpetrators of the wrong are in control of the company, the company will be incapacitated to act to protect itself and as such it cannot sue. So, a member or shareholder sues on behalf of the company to protect the company’s interests. The third parties that that are sued are insiders of the company such as managers, officers or directors and they are sued for allegedly causing harm to the company. Derivative action may be taken not just in cases of fraud, but also in instances where the company is exposed to harm by those in control.
Requirements to derivative action?
Derivative action is only available when certain requirements are met.
Firstly, it must be clear that the company has been prevented from instituting proceedings by alleged wrongdoers in control of the company.
One must show that both the directors and the shareholders have been invited to institute proceedings in the name of the company and have refused to do so, and that the refusal was because of the votes cast by the wrongdoers. In the alternative a derivative action may be successfully instituted, if it is proved that calling a meeting would be an exercise in futility, because the majority shareholders or equal shareholders, are the wrongdoers and would not want the company to institute proceedings, and are thus in effective control.
- Additionally, a shareholder or a group of shareholders with a total of at least 10% of the shareholding in the company must be complaining of a damage or breach of duty suffered by the company. The action must be in the best interest of the company.
There are a multiplicity of remedies that an affected party can pursue before the court in a derivative action. Possible actions may include interdicting the wrongdoers from continuing with the conduct complained of, or seeking their removal through a declaratory order. A claim may also be made for damages incurred by the company as a result of the wrongdoers’ conduct.
These remedies may also be combined and sought in one action depending on the circumstances. Essentially the court will order the remedy which is in the best interests of the company moving forward. If a director who is also a shareholder, is declared to have not acted in the best interests of the company, a share-buy out may be the ideal outcome.
In conclusion, shareholders should not despair when the scales seem tipped against them and where certain improper conduct is being carried out by internal majority shareholders and their agents.
There is recourse to protect the company; and the shareholder is entitled to proceed against the wrongdoers by way of a derivative action in order to protect or vindicate its rights and those of the company. It is critical for one contemplating this action to engage a legal practitioner to ensure it is carried out in line with the Act and to a successful end.
It is also critical for the shareholder to gather written evidence to support its claim for the action.
- Moyo is a lawyer and co-author of the Directors Handbook in Zimbabwe, a comprehensive guide on the company law provisions every director must know. — email@example.com. The information and opinions expressed above are for general information only. They are not intended to constitute legal or other professional advice. For clarification, assistance, or if you have questions about the article, contact Beatrice.