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Disputes often arise between directors or shareholders of a company in respect of some conduct that has the consequence of causing the company to suffer some form of loss or damage. Reaching a negotiated commercial outcome is most typically preferred to resolve such disputes. However, some parties may be left with no other option but to seek the assistance of the court, which could include bringing a derivative action. 

Often, the difficulty with bringing a court action is that the director or shareholder complaining over the alleged conduct would generally find itself as the wrong party to bring such a claim to court. This is because, in those circumstances, it would be the company that is aggrieved from the conduct complained of. Therefore, the company is the proper plaintiff to commence the relevant court proceedings. As the company will necessarily require its directors to commence such proceedings, a director, whose alleged wrongful conduct would be the subject of the proceedings, will unlikely be willing to bring such a claim. What then can the other shareholder or director do? This article will explain:

  • what a derivative action is;
  • when you can bring a derivative action claim on behalf of a company; and
  • when oppression proceedings might be an alternative option.

What is a Derivative Action?

Have you found yourself in a situation where the conduct of a director or shareholder of a company that you have an interest in (whether in the capacity of a shareholder or director) is causing some form of harm, loss or damage to the company? Then you might be able to bring a derivative action on behalf of the company, against the relevant director. Such action would typically involve a breach of their fiduciary duty owed to the company. 

A derivative action is a claim or proceeding brought by a person on behalf of a company. It aids in circumstances where the company suffers the loss or damage complained of, rather than the person bringing the claim. In bringing that claim, you would be taking responsibility on behalf of the company for the proceedings. 

Who Can Bring a Derivative Action?

You can bring a derivative action if you are:

  • a shareholder, former shareholder, or a person entitled to be registered as a shareholder of the company; or
  • an officer or former officer of the company, including an existing or former director or secretary of the company. 

Any proceedings you bring on behalf of the company will be in the company’s name. That is, the plaintiff in the proceedings will be the company.    

Examples of Disputes Where You May Seek to Bring a Derivative Action on Behalf of the Company

You would typically bring a derivative action where the people in control of the company are responsible for causing the company harm, loss or damage. In those circumstances, the directors of the company are unlikely to bring an action against themselves. These circumstances may include:

  • abuse in management of the company;
  • misappropriation of company funds;
  • where a director has sought to establish a new company that competes with the business of the existing company; or
  • a transfer of company assets that is otherwise not in the best interest of the company.

When Can You Bring a Derivative Action?

Before you can bring a derivative action on behalf of the company, you must first apply to the court to seek leave to bring the claim. A court will grant you this leave if it is satisfied that:

  • the company will not bring the claim itself; and
  • you, as the applicant, is acting in good faith in bringing the claim; and
  • it is in the best interest of the company that you be granted the leave sought; and
  • there is a serious question to be tried. For example, if the evidence remained as what is brought before the court in seeking leave, then there is a probability at trial that the company would be entitled to relief.

In addition to the above, you must have written to the company, notifying it of your intention to seek leave from the court to bring proceedings on behalf of the company and why. You must issue this notice at least 14 days before making the relevant court application.

If you fail to provide this notice, or if the circumstances do not allow you to give this notice (e.g. if you are bringing the application on an urgent basis), then the court must be satisfied that it is appropriate to grant leave even though you have not issued the company with the requisite notice. 

Cost Orders

The court may make cost orders that it thinks appropriate at any time when you bring a derivative action for the company. These cost orders may relate to:

  • yourself, as the party who applied for or received leave to bring the action; 
  • the company; or 
  • any other party to the proceedings or application. 

Such cost orders may include an indemnification for costs. For example, the court will have the discretion to make an order that your costs in bringing the proceedings be indemnified from the company’s fund. Conversely, the court may make an order that requires you to indemnify the company for its costs in the proceedings. This means that you will need to satisfy the court that you will:

  • be able to fund the costs the company will incur in respect of prosecuting the claims; and
  • meet any adverse cost orders that may be made against the company if the defendant(s) are successful in defending the claims brought against them.

It will also be open for the court to find that a derivative action is in the ‘best interest of the company’ if the company will not lose anything if the claim is ultimately unsuccessful. Ultimately, the kind of costs orders the court can make will largely depend on the facts of each case.  

Oppression Proceedings as an Alternative

As a director/shareholder of the company, you may also have another option to bringing a derivative action. For example, suppose the conduct of the affairs of the company you are complaining of has the effect of being oppressive or unfairly prejudicial or discriminatory against you as a shareholder of a company. Then, you may be able to bring an oppression claim against the other shareholder or director of the company directly. A shareholder can directly bring oppression proceedings. They will generally not face the costs orders associated with a derivative action described above.  

Further information on oppression proceedings can be found here

Key Takeaways

Remember that bringing a derivative action will not necessarily bring you, the person bringing the action, any direct advantage. Rather, any advantage or relief that the court grants will generally accrue to the company. However, a derivative action provides you with the means, either as a director or shareholder, to pursue an action against a wrongdoer who has the power to control the affairs of the company. This assists when the company’s board of directors refuse to act and bring the claim on the company’s behalf.

There are certain hurdles that you must meet before the court grants you leave to bring a derivative action. This includes that you must satisfy any early cost orders. If you require any assistance or would like to discuss whether or not a derivative action is appropriate in your circumstances, contact LegalVision’s dispute resolution lawyers on 1300 544 755 or fill out the form on this page.  

Frequently Asked Questions

What is a derivative action?

A derivative action is a claim or proceeding brought by a person on behalf of a company. It assists in circumstances where the loss or damage complained of is suffered by the company as opposed to by the person bringing the claim. In bringing that claim, you would be taking responsibility on behalf of the company for the proceedings.  

Who can bring a derivative action?

If you are a shareholder, former shareholder, or a person entitled to be registered as a shareholder of the company you can bring a derivative action. Additionally, you can bring legal action if you are an officer or former officer of the company, including an existing or former director or secretary of the company. 

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