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What Is a Derivative Action?

Proceedings brought by a shareholder or director in the name of the company, with the leave of the Court. Leave is granted only where the company will not act itself, or where the conduct of the proceedings should not be left to the directors or the shareholders.

The company law series, no. 74 · Enforcing rights against the company · 6 min read

A wrong done to a company is the company’s claim — and the company is controlled by the very directors who may have committed it. Section 143 of the Companies Act 1997 solves that.

Section 143(1) — what leave permits

Subject to subsection (3), the Court may, on the application of a shareholder or director, grant leave to that shareholder or director to

(a) bring proceedings in the name and on behalf of the company or any related company; or

(b) intervene in proceedings to which the company or any related company is a party, for the purpose of continuing, defending, or discontinuing them on behalf of the company.

Three features worth noting

Directors as well as shareholders may apply — a minority director outvoted on the board can use section 143.

“Or any related company” lets a shareholder of a parent sue in the name of a subsidiary, which matters in group structures where the wrong was done at a lower level.

Paragraph (b) covers defence and discontinuance, not just suing. Where directors are allowing a claim against the company to go undefended, or are settling it too cheaply, a shareholder may seek leave to take over the conduct of the defence.

Section 143(3) — the threshold

Leave may be granted only where the Court is satisfied that either

(a) the company or related company does not intend to bring, diligently continue or defend, or discontinue the proceedings; or

(b) it is in the interests of the company or related company that the conduct of the proceedings should not be left to the directors or to the determination of the shareholders as a whole.

Paragraph (a) is the ordinary case: the company will not sue. Note the word “diligently” — a company that has issued a writ and then let it sit is within paragraph (a) just as much as one that has done nothing.

Paragraph (b) is the answer to a company that says it will act. Where the wrongdoers control the board, or control the votes, leaving the claim to them is not in the company’s interests — and the reference to the shareholders as a whole makes clear that a majority vote not to sue does not defeat the application.

Section 143(2) — what the Court weighs

In determining whether to grant leave, the Court shall have regard to

(a) the likelihood of the proceedings succeeding; and

(b) the costs of the proceedings in relation to the relief likely to be obtained; and

(c) any action already taken by the company or related company to obtain relief; and

(d) the interests of the company or related company in the proceedings being commenced, continued, defended or discontinued.

The test is the company’s interest, not the applicant’s

Every factor is directed at whether the litigation is good for the company. A shareholder with a strong sense of grievance but a weak case, or a case worth less than it costs to run, will not get leave. Paragraph (b) is a real filter in small companies.

An applicant should therefore come with a pleaded case, an estimate of costs, an assessment of the defendant’s ability to pay, and evidence of what the company has and has not done.

Sections 143(4) and (5) — the company’s role

Sections 143(4) and (5)

(4) Notice of the application shall be served on the company or related company.

(5) The company (a) may appear and be heard; and (b) shall inform the Court whether or not it intends to bring, continue, defend, or discontinue the proceedings.

Paragraph (b) is an obligation, not an option. The company must state its position — which forces the board to commit itself, and gives the Court the material it needs for the section 143(3)(a) gateway.

Section 143(6) — the remedy is exclusive

Section 143(6)

Except as provided in this section, a shareholder is not entitled to bring or intervene in any proceedings in the name of, or on behalf of, a company or a related company.

No leave, no standing

The general law exceptions to the rule that only the company may sue for a wrong to itself are displaced. A shareholder who issues proceedings in the company’s name without leave has no standing, and the proceedings are liable to be struck out.

Note that section 143(6) restrains proceedings in the name of or on behalf of the company. It does not affect a shareholder’s own claims — a personal action under section 147, an action against the company under section 149, a section 152 application, or a section 142 injunction.

Derivative or personal?

Choosing between the shareholder remedies
The complaintThe remedy
A director has caused loss to the company — breach of s 112, s 115 or s 123Derivative action under s 143 — s 147(3) makes these duties owed to the company
A director has breached a duty owed to you as a shareholder — ss 70, 118, 126Personal action under s 147
A proposed contravention of the Act or the constitutionInjunction under s 142 — but only before it is completed
The affairs are conducted oppressively or unfairly towards youSection 152
The company or a director will not do something required of themSections 148 and 150 orders
Many shareholders share the same complaintRepresentative action under s 151
The reflective loss bar

Section 147(2) prevents a shareholder recovering a reduction in the value of shares, or a failure of the shares to increase in value, by reason only of a loss suffered or a gain forgone by the company. So where the real loss is the company’s, the derivative action under section 143 is the only route to recovery — which is why the leave application matters so much.

Under section 145(d), however, the Court may direct that an amount ordered to be paid be paid to former and present shareholders instead of to the company.

Sources

Check the section yourself

Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.

Disclaimer: This article provides general information about Papua New Guinea law and does not constitute legal advice. Laws may change, and their application depends on individual circumstances. You should obtain professional legal advice for your specific situation. Read the full disclaimer.