MOST business people understand that directors owe duties to the companies they manage. Fewer appreciate what happens when those duties are breached and the company itself refuses to act.

In a well-governed company, the board would investigate the wrongdoing and, where necessary, commence legal proceedings. However, corporate reality is not always so straightforward. Sometimes the very individuals who are alleged to have engaged in misconduct are the persons who control the company’s decision-making processes. In such circumstances, the company may never authorise proceedings against them.

Recognising this problem, section 212 of the Companies Act provides a powerful remedy known as a derivative action. This mechanism enables a shareholder to bring proceedings in the name and on behalf of the company where those in control refuse to do so. It is one of the most important corporate governance safeguards available under modern company law.

At the same time, derivative actions are frequently confused with shareholder oppression claims. While both remedies may arise from the same dispute, they serve fundamentally different purposes and address different forms of harm.

The Company is Usually the Proper Claimant

The starting point is the well-established principle that a company is a separate legal person distinct from its shareholders and directors.

As a consequence, where a wrong is committed against the company, it is generally the company that has the right to sue. This rule promotes commercial certainty and prevents multiple shareholders from bringing separate actions arising from the same alleged misconduct.

For example, where directors divert company assets, misappropriate funds, or cause the company to enter into transactions that benefit themselves at the company’s expense, it is the company that suffers the loss. Any claim arising from such wrongdoing therefore belongs to the company.

This principle works effectively in most cases. Difficulties arise, however, where the alleged wrongdoers control the company. If the directors who engaged in the misconduct form the majority of the board or control the voting power of the company, they may simply refuse to authorise proceedings against themselves.

Without an exception to the general rule, serious wrongdoing could therefore go unchallenged.

The Derivative Action

A derivative action allows a complainant, with the court’s permission, to step into the shoes of the company or one of its subsidiaries and pursue a claim that properly belongs to that company. The complainant may, for example, be a shareholder or former shareholder, a debenture holder or former debenture holder, or a current or former director or officer of the company or an affiliated company.

Importantly, the complainant is not advancing a personal cause of action. Rather, they are enforcing the company’s rights because those charged with managing the company have failed or refused to act.

The distinction is important because the claim remains the company’s claim throughout. The complainant merely acts as the vehicle through which the proceedings are brought.

As a result, any damages recovered usually belong to the company on whose behalf the action is pursued, and not to the complainant, subject to the court’s power to direct otherwise.

A derivative action is therefore not principally concerned with compensating shareholders. Its primary objective is protecting the company and restoring losses suffered by the company.

When Derivative Actions May Arise

Derivative claims most commonly arise where there are allegations of breaches of directors’ fiduciary duties, fraud on the company, misappropriation of corporate assets, diversion of business opportunities, self-dealing transactions, undisclosed conflicts of interest, improper transfers of company property, excessive remuneration paid to controlling directors, and other misconduct causing loss to the company.

Obtaining Leave to Bring the Claim

The law recognises that the derivative action is an exception to the general rule that a company must bring proceedings to enforce its own rights. As such, the court’s permission, known as leave, is required before the claim can be brought.

The court must be satisfied that:

• the complainant has given reasonable notice to the directors of the intention to apply for leave if they do not take appropriate action;

• the complainant is acting in good faith; and

• it appears to be in the interests of the company or its subsidiary for the action to proceed.

It is only if those requirements are established that the court will grant leave.

Good Faith

A derivative action is intended to benefit the company, not merely to advance a personal feud or gain leverage in a shareholder dispute.

Therefore, the complainant must demonstrate that the application is being brought in good faith. It is a question of fact and the courts are careful to prevent a derivative action from being used for strategic or tactical advantage. However, the existence of personal animosity or self-interest does not, by itself, establish bad faith. The court will consider whether the complainant genuinely believes that the proposed claim has merit and should be pursued.

Adequate Notice

The notice given to the directors must be sufficient for them to assess the situation and take remedial action to address the complaints if they deem it necessary. This assessment is based on the facts of the case and is an objective one. Accordingly, the complainant should identify to the directors the acts or omissions which would form the basis of their intended complaint and make clear their intention to apply for leave if appropriate action is not taken.

The Company’s Interests

The court will assess whether it appears to be in the company’s interests to pursue the claim. Included in this analysis is whether the claim is arguable, rather than frivolous or vexatious. The factors it may consider include the strength of the claim, likely costs involved in pursuing it, the prospects of recovery, the potential impact on the company’s business, and whether a reasonable director would regard the litigation as worthwhile. The court is not, however, conducting a trial of the underlying allegations at this stage.

The Court’s Powers

The court has the power in connection with a derivative action to make such interim or final orders as it deems fit, including an order:

i. authorising the complainant, the Registrar or any other person to control the conduct of the action;

ii. giving directions for the conduct of the action;

iii. directing that any amount adjudged payable by a defendant in the action be paid, in whole or in part, directly to former and present shareholders or debenture holders of the company or its subsidiary, instead of to the company or its subsidiary; or

iv. requiring the company or its subsidiary to pay reasonable legal fees incurred by the complainant in connection with the action.

Derivative Actions vs Oppression Claims

One of the most common misconceptions in shareholder litigation is the belief that derivative actions and oppression claims are interchangeable.

In an oppression claim, the central question is whether the conduct complained of is oppressive or unfairly prejudicial to, or unfairly disregards the interests of, a shareholder or another person protected by the Act. An oppression claim is principally concerned with protecting the complainant’s own interests, whereas a derivative action is concerned with enforcing the company’s rights.

Where the same conduct affects both the company’s rights and a shareholder’s personal interests, it may give rise to both an oppression claim and an application for leave to bring a derivative action. However, each claim must satisfy its own legal requirements, and the derivative action must be pursued to enforce the company’s rights rather than merely the shareholder’s personal interests.

Conclusion

Derivative actions represent one of the most significant accountability mechanisms in Jamaican company law. The leave requirement helps ensure that only proceedings brought in good faith and appearing to be in the company’s interests are permitted to proceed.

In this way, the remedy provides an important safeguard against corporate wrongdoing, particularly where those responsible for managing a company are unwilling to take action to protect its interests.

Ronaldo Richards is an Associate at Myers, Fletcher and Gordon and a member of the firm’s Litigation Department. He may be contacted at ronaldo.richards@mfg.com.jm  or through the firm’s website:www.myersfletcher.com.

This article is for general information purposes only and does not constitute legal advice.

Ronaldo Richards.