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Springing into (Derivative) Action – Derivative Actions under the Corporations Act 2001 (Cth)
What area(s) of law does this episode consider? | Derivative actions brought by shareholders on behalf of the company in which they hold shares, under s 237 of the Corporations Act 2001 (Cth). |
Why is this topic relevant? | When the members and the officers of a company disagree on whether the company should bring litigation, the Corporations Act affords those members an opportunity to bring that litigation themselves, as a derivative action. A company’s directors may decline to pursue a claim where that claim is against the directors themselves; or the company may be unable to resolve to pursue a claim because of a deadlock between the company’s owners. Derivative actions are therefore often pursued in the event of disputes between shareholders. |
What legislation is considered in this episode? | Corporations Act 2001 (Cth) |
What cases are considered in this episode? | Charlton v Baber [2003] NSWSC 745
Carpenter v Pioneer Park Pty Ltd (in liq) [2004] NSWSC 1007
Chapman v E-Sports Club Worldwide Ltd [2000] VSC 403
In the matter of Global Advanced Metals Pty Ltd [2019] NSWSC 1804 A minority shareholder in Global Advanced Metals, Metallurg, sought leave to take action against the directors of Global Advanced Metals for breach of directors’ duties in relation to a sale they made in 2016: the directors agreed to sell a company assets for $60 million, which the shareholder believed was worth between $245 million and $900 million at the time. Metallurg indemnified the company for the cost of the prospective litigation. While the minority shareholders were found to be acting in good faith, the Court was not satisfied that the proceedings were in the Company’s best interests. Although the indemnity from Metallurg cured the detriment that might be suffered by the company from an adverse costs order, the proceedings would impose other detriments on the company, such as the distraction of the litigation for GAM’s executives and directors. These detriments were weight against the prospects of success of the proceedings in reaching the conclusion that the proceedings were not in the company’s best interests. |
What are the main points? |
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What are the practical takeaways? |
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Show notes | Chamberlains’ article ‘Winding Up On Just & Equitable Grounds: Quasi-Partnerships’ |
David Turner:
1:00 | Hello and welcome to Hearsay, a podcast about Australian laws and lawyers for the Australian legal profession, my name is David Turner. As always, this podcast is proudly supported by Assured Legal Solutions, a boutique commercial law firm making complex simple. A company acts through its officers and agents, chief among them its directors, whose responsibility it is to act in the best interests of the company’s shareholders. But what happens when the directors won’t, or can’t, take action on a claim that the shareholders believe is worthwhile? What happens if that claim is against those directors? Joining me today in the Hearsay studio to talk about derivative actions brought by shareholders on behalf of companies is Chamberlains Special Counsel, James d’Apice. James, thanks so much for joining me on Hearsay today. |
James d’Apice: | Thanks for having me David, good fun. Looking forward to it. |
DT: | Absolutely. Now, James, tell me a bit about your practice. You do a fair bit of work involving shareholder disputes don’t you? |
JD: | Yeah, that’s right. Look, broadly speaking I’m a commercial litigator but the highest volume and probably the most competence we have in our little team is getting into, sort of section 232/233 corporate oppression, section 131A director stuff, getting into just and equitable windups, and then the subject we’re going to discuss will be derivative actions. So broadly speaking commercial lit. with a bit of a shareholder director focus on it. So hopefully I’ll be able to, you know, say a couple of useful things today, or at least that’s the plan. |
DT: 2:00 | Now a couple of those actions that you just mentioned, just and equitable winding up for example, breach of director’s duties, those will often come up in tandem with or in parallel to a derivative action. When we’re talking about derivative actions what are we talking about? We’re not talking about actions on derivative financial assets for example, what do we mean? |
JD:
3:00
4:00 | Luckily for me we are not talking about complex financial instruments, yes. We are talking about a shareholder, and I say that loosely because as we’ll come to discuss there are a number of people, essentially standing in the shoes of the company to go and sue someone else on the company’s behalf. And so, essentially there’s a two-step process. The first step is, speaking loosely we’ll say it’s a shareholder saying ‘oof, I think there is a claim that the company might have here and it doesn’t look to me like the company is going to prosecute this claim.’ And so, step one is the shareholder coming to court to seek leave of the Court to sort of stand in the shoes of the company, to clothe themselves in the name of the company and with the legal entitlements of the company, to go and sue this third party. So that’s step one. Step two, if the shareholder, as I say speaking loosely when we say shareholder, succeeds in that application, then they’re off and running that piece of litigation going and suing whoever that third party might be someone who has breached a contract or something like that. TIP: Often derivative actions are brought in circumstances where the people in control of the company are also the people responsible for causing the company loss – after all, the directors of the company are unlikely to bring an action against themselves. Some circumstances that might encourage a shareholder to start the derivative action process include:
The most important thing to remember as we discuss derivative actions – and we will talk about the practical consequences of this later in the episode – is that the shareholder is being given permission by the Court to bring proceedings on the company’s behalf, not on their own behalf. |
DT: | Now let’s start with that first step – seeking leave from the Court to actually bring this derivative action. It’s not the case, is it, that our shareholder can just put on a draft pleading attached to a supporting affidavit, file a notice of motion and off you go. What do they have to satisfy the Court of before they’ll be given that leave? |
JD:
5:00
6:00 | It depends, and I might start with the smallest bit first, which is if a company is in liquidation, then the contributory which is very loosely speaking a word we can sort of use interchangeably for ‘shareholder’ although it’s not precisely the same thing, the contributory can say to the Court, ‘look, court,’ and they’ll use more polite language but essentially, ‘I would like to cause the Court to exercise its inherent jurisdiction to grant me leave to proceed on behalf of the company.’ Now if the company is in liquidation, there are some moving parts that that contributory is going to have to raise for the Court’s consideration. There are practical considerations, it is the attitude of the liquidator and there is a question about what prospect that claim might have. From a practical perspective we actually don’t end up dealing much for fairly obvious reasons with derivative actions brought in respect of companies in liquidation because often if there’s a real claim the liquidator will chase it, and if there’s no real claim the liquidator won’t and that will sort of be the end of that story. So if we turn then to the majority of occasions when a shareholder might want to come before the Court and seek the Court’s leave to go ahead, essentially we’re jumping into section 237 and section 237 has five little criteria in there David, that are probably familiar enough to you and I to the extent that you might have a two-thirds drafted advice that you might be able to wheel out from time to time. |
DT:
7:00 | And tell me a little bit about those limbs of that test, one of those is that there is a prima facie case to satisfy. What are the others? TIP: Before we hear from James about the other elements, let’s quickly discuss this need to establish a prima facie case. The shareholder seeking leave must provide the Court with sufficient material for the court to make a determination (Charlton v Baber [2003] NSWSC 745). Now, this could be in the form of a detailed legal opinion on the merits of the proposed claim that analyses the available documentary evidence and the relevant law, such as that the plaintiff relied on in Carpenter v Pioneer Park Pty Ltd (in liq) [2004] NSWSC 1007, where the plaintiff relied on an 83 page advice from senior counsel over which they sought to retain privilege. |
JD: | Yes, so good faith is an important criteria to satisfy. And good faith doesn’t mean holding hands and singing kumbaya. It simply means that the applicant has a genuine and real basis for bringing the application. And often, if we’re using the example of our shareholder, that will be a shareholder who genuinely thinks the value of their shares are going to be increased. Essentially saying, ‘look I think there’s this claim this company has, I want to cause the company to chase that claim, get some money and so increase the value of my shares.’ |
DT:
8:00 | I imagine some of our listeners will be thinking, ‘well what circumstances would a shareholder be bringing a claim not in good faith?’ And I imagine that the situation in which that occurs is when you’ve got these shareholder disputes when there might be a winding up on a just and equitable ground running parallel to these derivative actions, perhaps derivative actions being brought or being proposed to be brought on one another and there’s a real risk that one or maybe even both of those is actually just a kind of vexatious pleading brought to make the other shareholder’s life difficult. |
JD:
9:00 | It’s such a good example. So, to sort of start with the easy part of the question, personal animus doesn’t stand in the way of findings of good faith. So David if you and I are shareholders in David James Pty Ltd, the fact that you and I have had a personal falling out doesn’t mean that you or I will fail the good faith test. But I think it’s a really wise example you raised, if in the broader universe of our dispute or perhaps the group we might be involved in falling apart or some strategic advantage I might perceive to putting you in a tough position. If I’m bringing it for a reason other than attempting to increase the value of my shares in a genuine and legitimate way then it’s going to be open to you to raise this point. And if I can just give a bit of a mini war story from times when you see a good faith argument faltering, it can sometimes be that the beneficiary of a trust where the trustee is the legal owner of shares, can have some serious problems. Firstly in relation to standing, but often that beneficiary might be a former director or something like that and so they might have standing to come before the Court to seek leave but they might have a real problem attempting to essentially get around the trustee of their trust. |
DT: | Right. |
JD:
10:00
| To try to cause the Court to grant leave. It sort of almost becomes a derivative-derivative action. And you sometimes see that in estate disputes as well, where a beneficiary will be pretty grumpy that an executor won’t be chasing something that this family company that falls into the estate is or isn’t doing. So, it can sound a little bit artificial but if you just chuck in the example of a rich dead person which, David I guess is an example that many of us as litigators have to confront, you can sort of see how those corporate issues can start to fall into place. So we’ve got good faith, we’ve got the genuine prospects of success we raised… we’ll just knock out an easy one that’s notice. So, essentially there’s a certain amount of time that you are to provide but the Court can choose to grant leave in the absence of that notice being provided so we can just ignore that with respect. And the initial criteria is proving the company is not going to bring the action itself. |
DT: | Yes. |
JD: | And there’s a bit of a complexity here where I say that’s quite easy, if David you and I are in our dispute and I write to you as the director of David James to say ‘G’day David, attached please find a draft statement of claim, would you be so good as to file it so the company can go sue this third party. If you don’t file it within four weeks I’m going to consider you’re not going to file it unless I hear anything else from you.’ And so hopefully from an evidentiary standpoint that criterion will be reasonably easy to prove. |
DT: 11:00 | I’ve also seen this example from an evidentiary standpoint at satisfying that element which is where a quasi-partnership, you and I are the only directors, we’re also equal shareholders, I’ve tried to call a meeting to consider whether or not to bring litigation or instruct a solicitor in relation to it for the last six months. And I just can’t seem to get in the room with the person because we hate one another. That’s another common one I’ve seen. |
JD:
12:00 | It’s a great example, and I say either throw in a dead person or throw in some siblings or throw in some former business partners and I think we can all create that scenario out of anywhere. Yeah, David, that’s a fabulous example. And it sort of leads on to the final criterion, and when I say final, I mean the final one we’ll discuss, which is the best interests of the company. And it’s not merely a question of ‘is it in the best interests of the company if leave is granted to go and chase this third party?’ It is a question of ‘is it in the best interests of the party to James to go and chase that third party?’ And so, there are two moving parts there and you can see how they interplay. So, if we think about the best interests point, well it’s not particularly in the best interests of the company to bring a claim with poor prospects. So those two criteria can sort of interrupt. And if we think about the James point, ‘am I the right person to bring the claim?’ You can see that that can sort of interact with the good faith element, as well. So, well, maybe it is in the best interests of the company that the third party gets sued but perhaps James is actually not the ideal person to come and bring thatclaim. So again, with respect, the lines between those five criteria can look really bright when you’re reading through section 237 but as I’ve hopefully helpfully illustrated there, it’s taken me a couple of years to get to that illustration, you can see how they can sort of blur over each other and sort of cross each other a little bit. |
DT: 13:00 | Absolutely. And that point you raised about whether the proposed plaintiff is the right plaintiff in that last limb is such an interesting one and it’s one I hadn’t actually thought of before. I always thought of that element as, ‘well, even if the claim has good prospects, is there kind of a practical recoverability issues, is there kind of a commercial reason why you wouldn’t bring the claim?’ But that idea that it can be a good claim with good prospects and good recoverability prospects, but maybe you’re not the right person, even if you are, perhaps, edging your way over the good faith requirement is a really fascinating kind of consideration. |
JD: | And it adds to the complexity because, if I can just compare the liquidation example from the inherent jurisdiction of the Court to the Corporations Act example, if a company’s in liq. then there’s a discretion of the Court about whether or not leave is granted. If the company is solvent and arguably in receivership, but that’s another question for another time, and we’re relying on the Corporations Act, then the Court does not have that discretion. Which is to say, if those criteria are met, bang! Leave is granted. |
DT: | Yep. |
JD: 14:00 | And so, that’s the challenge when you are attempting to move the Court to seek these orders or indeed to resist them, to sort of bear in mind that that’s where the heavy lifting of your submissions will end up being done. Really getting to grips with these fine, often evidentiary issues or often matters for submission, again, if we’re choosing our appropriate applicant to bring the claim. So, it’s worth bearing in mind that that’s where the real meat and potatoes of these sorts of applications is for solvent companies. |
DT:
| Now, we’ve talked about the five elements to the test for actually being granted leave to bring a derivative action. James, what kind of actions are you seeing that are being brought as derivative actions by shareholders, what have you seen in your practice as the common ones? |
JD: 15:00
16:00 | To me, the classic is the breach of director’s duties. And if we just think that through, and David you wisely raised this in your introduction, if we just think it through, if we have David James Pty Ltd and David you are the sole director of David James Pty Ltd and we are 50/50 shareholders. I might form the view, David, that you’ve caused the company’s funds to flow to related entities of yours and so you’ve breached your director’s duties. And so, what I might do is I might jump up and down and whinge about that, but the technical answer is that a claim for those funds, which is to say a claim for compensation arising from a breach of your director’s duties is a claim of the company’s. And so it ought to be brought as a derivative action. And so, a commanding majority, I was going to say almost all and as we speak I’m sort of racking my brain for other examples, but I think I’m happy to say almost all derivative action matters that I’ve had come before me include at least, as an important element, chasing a director for a breach of their duties. And certainly the ones I’ve had litigated do almost universally. |
DT: | I suppose the category of where it might not be the case that it’s director’s duties is if it is an insolvent company because then the motivation not to bring the claim is not necessarily because the directors are in the driving seat. Although even then I think the examples that I can think of would be one where it is a claim against the directors anyway. |
JD: | Well, it’s interesting isn’t it because the commerciality of that, if David James Pty Ltd is in liquidation, and the liquidator doesn’t want to bring the claim, normally the liquidators you and I know would say ‘well put me in funds and I’ll go chase whoever you want me to chase.’ |
DT:
| That’s right. It would really be a funding issue wouldn’t it? There’s a will but not necessarily the means to bring the claim. |
JD:
17:00 | Yeah, and so, I think, even though I raised it earlier on in this discussion it’s not something I’ve seen litigated that I’ve been directly involved with. And as I run through the possible hypotheticals where it could come up, I think a contributory who’s upset about it is vastly more likely to put the liquidator in funds and, frankly, I think the liquidator would be more than happy to say ‘yeah I’ll chase whoever, that’s fine, give me the money and I’ll get to work.’ With the greatest of respect to our insolvency practitioners who you and I love very much, I don’t doubt, practicing in our area. |
DT: | That’s right, they certainly won’t shy away from litigation if they’re well-funded to pursue it, that’s for sure. |
JD: | Yes. |
DT:
18:00 | I suppose, we can say ‘well most of these claims are claims for breaches of director’s duties’ but claims for breaches of director’s duties come in every colour, stripe and size as well. I remember an example from my practice at the Bar. It was a claim in relation to misdirecting corporate opportunities. So, it was a company operated by two brothers in quasi-partnership and each of them had a son who wanted to start his own company in this area that the company also operated in. And so, every now and then one of the director’s would direct an opportunity that the company might otherwise have pursued to their son’s company. And there ended up being derivative actions brought by each of them against the other because they would say ‘well, that opportunity was one the company could’ve pursued and you shouldn’t have given it to your son, but these one’s on my side, well the company never could’ve done them anyway. I only gave them to my boy because the company didn’t have the capacity or the bandwidth to do it at the time.’ And so, there was this very complex evidentiary issue about what the company could’ve done with inventory available to it at the time of each of these opportunities. But, an unusual kind of breach of director’s duty claim there. |
JD: | Yeah, I more often see the scenario, especially in practice of a corporate oppression context, essentially ‘I’m not being oppressive, you are!’ And it just sort of becomes a tit-for-tat claim/cross-claim sort of position. |
DT: | Now, in your experience are these threshold issues kind of a high bar to satisfy or are they fairly easy to satisfy in terms of getting leave? |
JD: 19:00
20:00
21:00 | I tend to think the former, but it’s probably just because I’ve got a recency bias. The most recent one that I ran the applicant didn’t get leave. So there is a risk in seeing them as a bit of a roll in the arm over, ‘oh yeah, look we’ll just let the Court know what the position is and after that we’ll get into the real dispute.’ Frankly there will be times when that is the position, when you’ll be able to look through those criteria, a, b, c, d, e and go ,’yeah look pretty much we’re chasing some director who’s preventing the company from suing herself/himself/themself.’ And so we’ve got a fairly clear path here to march on. And there will be applications for leave like that. But, the most recent experience I’ve had has really seen the parties get stuck into the weeds of b, c, and d of section 237, essentially best interests, prospects, is this the right person, good faith, you know we all start to blur things. So, I think it is right to say that there’s marginally less of a coin flip to litigation of this kind than there is perhaps with a more 50/50 commercial construction or something like that type of argument. But I nonetheless say, that it would be a foolish thing to do as anyone’s lawyer to treat the outcome of an application for leave under this section as a fait accompli. TIP: According to research conducted by Ian Ramsay and Benjamin Saunders for the Centre for Corporate Law and Securities Regulation at The University of Melbourne, in the period from March 2000 to August 2005, about 61% of applications for leave to bring derivative actions were granted. Now, of those that failed, only 25% of those were because the applications weren’t made in good faith and weren’t in the company’s best interests. So in summary, James is right – one shouldn’t treat the application for leave as a foregone conclusion but nor is it a terribly high bar to satisfy. |
DT: | Can you tell us a little bit about the recent case that you’ve had where the applicant was unsuccessful? |
JD:
22:00 | Yes, so I was acting for what might be called a consultant. And I might just say, the outcome was reasonable at first instance and there may be an appeal coming, so I might just speak in as general terms as I can. My client was acting in a capacity that might be described as a consultant to a company. Now the company sold a very valuable piece of land and my client was a consultant in relation to the development and rezoning of that land. The plaintiff was not a shareholder of the company but was a former director and was the beneficiary of a trust and the corpus of the trust included shares of the company. The beneficiary alleged, in short, that the sale of the land that was in the hundreds of millions of dollars. It was the sort of sale that you and I will never be involved in David, I think. |
DT: | Speak for yourself, James! |
JD:
23:00 | Yeah ok sorry, sorry, I’m dealing with a mogul here! So, they were literally playing for sheep stations I think, but what was alleged essentially was that the first defendant, which is to say the first respondent to the application for leave, was a former director who was alleged to have breached their duties. And what was said was that other parties including our client breached their duties, leading to the sale taking place at an undervalue. And the short point is, we were successful at first instance and I’m as scared of a court appeal as the next person so all this can be whisked out from under us for reason one, the operation of this deed that we don’t need to go into now, and if their Honour was found to have erred in reaching their decision in relation to the deed, their Honour set out why they would not have granted leave pursuant to the little section 237 subsections, particularly the good faith, best interest prospects questions that we raised earlier. |
DT: | Now, one thing to remember, a practical consideration about derivative actions is, suppose you get leave, suppose you’re then in the happy circumstance of being entitled to pursue some expensive and time-consuming litigation. Ultimately, you’re doing that on behalf of the company and not yourself. And so, the remedies that you receive in relation to that action are the company’s remedies not your own. Tell me a little bit about the practical considerations there, maybe finish that thought for me, about what that means for a shareholder who has chosen to bring a derivative action. |
JD: 24:00
25:00 | Well, you’re wise to raise it. And the first point is a bit of a threshold point that relates to best interest and that is ‘has the shareholder indemnified the company in respect of the claim?’ And so, if you’re a shareholder who wants to stamp their feet about the company not chasing some third party or wants to embark on a very large piece of litigation, well, in considering whether it’s in the best interests of the Court to grant you leave, you know, ‘you’ in a very specific sense, the Court will dive into the nature of the indemnity you’re providing. And there’s a 2019 decision before Justice Black called Global Advanced Metals where the nature of the indemnity was considered at length. And while the applicant indemnified the company for costs orders and that sort of thing, that might be thought of as directly attributable to the litigation, the application failed for reasons including the fact the indemnity didn’t reach as far as covering the company for the sort of business interruption problems that might arise from suing these parties. So, the threshold practicality step from a shareholder clothing itself in the company, speaking loosely, will be to look at that indemnity. The next step is exactly as you rightly raised, ‘congratulations you got your damages! All of those are payable directly into the company’s coffers, and so that’s that!’ None of it’s ended up in your hands, you’ve got the nice legal bill that you’ve had to pay and essentially you’ve had to finance the company getting this money in. And it almost leads back to say, hopefully your good faith argument was well founded, which is to say hopefully that claim increased the value of your shares in a way that’s proportionate to the costs you might have incurred in chasing that claim on the company’s behalf. |
DT: | Yeah, I don’t suppose there’s any new shares issued in consideration for funding the litigation, is there? |
JD: | It’s a creative approach. |
DT: 26:00 | But that really is an issue, isn’t it? Because you’re unlikely to see a 2/3% shareholder commencing a derivative action unless that derivative action is potentially worth hundreds of millions, billions of dollars, because the proportionate return on some very expensive litigation is going to be quite low. It’s far more likely to see this in a closely held company and often in a quasi-partnership. |
JD:
27:00
28:00 | I completely agree with that. And you’re using the term ‘quasi-partnership’ wisely and precisely, David, because it does often crossover with those just and equitable type arguments. And as you again wisely alluded to earlier, or informed us about, you can often see these sort of derivative crossover, just and equitable, sometimes crossover corporate oppression stuff come in and blur things around a bit. TIP: In that same University of Melbourne research that we mentioned earlier, 29% of applications for leave to bring a derivative action were sought alongside applications for shareholder oppression orders. Now, those are usually sought as alternatives, rather than complementary remedies though – an application for leave can actually be refused if the Court finds that oppression is the more suitable remedy (Chapman v E-Sports Club Worldwide Ltd [2000] VSC 403). An application for leave to bring a derivative action might also be brought simultaneously with an application to wind up the company on just and equitable grounds. Section 461(1)(k) of the Corporations Act empowers the Court to wind up a company and appoint a liquidator if it is considered “just and equitable”, and this “just and equitable” test is most often satisfied where there is a dispute between the people who control the company, such that the company is no longer able to function; in turn, this often happens because the company is run by two equal shareholders as a ‘quasi-partnership’, as James has described it. To learn more about this topic, which is a little bit out of the scope of this episode, check out the article ‘Winding Up On Just & Equitable Grounds: Quasi-Partnerships’, on the Chamberlains website. But, keeping the focus at the centre of what your client is trying to do can sometimes be a challenge. But, if you’ve confronted the section 237 criteria, especially good faith, ‘what is your client trying to get out of this?’ If you’ve answered that satisfactorily at the start then hopefully you won’t have to have too many difficult chats with your client later in the matter when they win and find they’ve won the grand total of an improved balance sheet for the company they hold shares in. |
DT:
29:00 | That’s right. Now we’ve talked about, in terms of practical considerations, the nature of that indemnity that you’ll need to give to the company whether the proposed plaintiff is not just bringing a claim in good prospects and bringing it in good faith but whether they’re the right person to bring it. And also, in practical terms, say you succeed, what’s the value of the remedy to you rather than to the company? For a listener who’s about to advise a client about whether to pursue a derivative action, are there any other practical issues that you’d consider other than those five elements in the section? |
JD:
30:00 | Give them my contact details or yours David, of course. One of them is the costs and it goes without saying, you and I deal with litigation that can be very expensive. What’s important to bear in mind is essentially, this is a 1-2. So, once you succeed on the derivative action application you’ve then just succeeded in starting a piece of probably very expensive, probably hotly contested litigation against a defendant who may or may not be impecunious. So having that very cold, calculated, clear discussion with your client about costs and prospects, I think is the fundamental thing. The other element is being on top of your evidence. I mean, David all of this is trite and anyone listening to this is already aware but where there is such a fine, and I won’t use the word discretionary in a technical sense, but where there are fine judgments to be made by the Court on slightly amorphous issues like good faith, like best interests, which as you and I know can be challenging to give firm advice on, you want to make sure your person isn’t left in the lurch by them failing to give you all the information. So, I guess the big practical issue is how, sadly, expensive it can be to really get on top of one of these applications from the outset in order to prosecute it on behalf of your client. |
DT:
31:00 | I’m so glad you raised that practical consideration around the evidence that you’re going to need to get leave and realistically the evidence you’re going to need to succeed in the ultimate claim because it really raises this other practical issue about the cadence of the litigation. When you’re embarking on litigation on your own behalf, there’s a nice predictable sort of rhythm to it. You finish the pleadings and then you go on to your evidence, and we know what an evidence timetable sort of looks like, and when you finish that maybe there’s some expert evidence after that and then you have a mediation and hopefully it all finishes there but if not then you go to a hearing. With a derivative action, you’re sort of all out of whack, aren’t you? Because you probably need to be fairly well advanced in both the pleadings and the evidence just to have permission to commence? |
JD:
32:00 | Yes, and that’s a good point, well made, because some applications will fail if your pleadings are not in order. Which is to say, if your pleadings for the, well we might call them ‘main’ piece of litigation or the ‘successor’ piece of litigation are not in place. And if I’m being a bit vague there, just to be clear let’s say that you’re a shareholder who wanted to chase a director for breaching their duties and you wanted to apply for leave to sue that director. Well, the Court will be pretty interested to see precisely what those pleadings are in order to understand precisely how you plan to proceed against the director. There’s a leading case that is the failure of a contributory to obtain leave to bring a, essentially a derivative appeal, so they got leave to bring the derivative action, failed, wanted to appeal and one of the reasons leave was not granted for the appeal was that there was no material before the Court about the basis upon which such an appeal would be brought. It was merely saying, ‘hey, we want to appeal this other decision.’ So you really want to have your ducks in a row in relation to what is precisely the claim that your client is seeking leave to bring. |
DT: | I mean that would be interesting, wouldn’t it, because I’d be interested to see the sort of derivative appeal action where there was that material before the Court because the other thing you often see with matters before the Court of appeal, you see this in judgments all the time, ‘there were 26 grounds of appeal and at the hearing 3 were pressed and it was heard on that basis.’ I wonder how many you would make it pass the application for leave point? |
JD: 33:00
34:00 | Well it is a bit of a mind bender and you do get the derivative action inception you referred to earlier of the Court essentially having to form a fairly firm provisional view about prospects of bringing an appeal. The test isn’t so high that we ought to be too worried, it’s very similar to the interlocutory injunction test. If there’s something genuinely there and if all the indemnities are in place and if the other criteria are satisfied, then that serious question to be tried will often be met quite comfortably. But I wouldn’t particularly enjoy drafting the cost estimate relating to the initial derivative action, subsequent hearing, derivative action to bring on an appeal, hearing the appeal, yeah 1-2-3-4 that would be witheringly expensive I can imagine but, I presume for some clients, absolutely necessary and appropriate. TIP: The cost of litigation can be a major disincentive to shareholders bringing derivative actions. As in all civil proceedings, the Court has a wide discretion when it comes to awarding costs. Now on the one hand, this provides an additional safeguard for the company’s funds against unmeritorious or unsuccessful derivative actions, but that does have the consequence that an individual shareholder bears the adverse cost risk of bringing a claim which is actually for the benefit of the company and all of the shareholders, not just themselves. Across the Tasman Sea, there’s another approach – section 166 of the Companies Act, which is the New Zealand equivalent to our Corporations Act’s derivative action provisions, actually requires that the costs of derivative actions be paid by the company instead. |
DT:
35:00 | Absolutely. Although, I suppose my next question for you is, are there situations in which there are some alternatives to bringing a derivative action? It’s expensive, it’s risky, it might not produce a remedy for you as well as it does for the company. Are there any other options when a shareholder has what they think is a claim that they’d like to pursue against a director that they should, pursue or explore first before instructing you to commence their application for leave? |
JD:
36:00 | Yes and the answer to that is any possible. So if a shareholder is contemplating bringing a derivative action they will always be well advised to think about, ‘right, is there any other way we can recover this?’ Because if we just run through that hypothetical, disappointed shareholder comes into your office, says ‘I heard this great chat between David Turner and James d’Apice about derivative actions, that’s what I want to do.’ You firstly refresh their memory that they’re going to be paying for that first piece of litigation, the application for leave. You then clarify that it’s only then that you’ll run the substantial piece of litigation. You then clarify that even if you win that, the money is not going into your hands, the money is going into the company’s coffers. And if one of the problems you’ve had is getting money out of the company’s coffers then it may be that this isn’t a particularly appealing action for you to consider. And so, the ones we look at are the ones that tend to interplay and they get a bit blurry and that’s regrettable to an extent. But you would then look at speaking about corporate oppression and you’d look at speaking about potentially just and equitable windup of the company. |
DT:
| One of the, kind of practical ways to settle those disputes that I’ve often seen is the, and this is particularly in those quasi-partnership sort of cases where the person you’re planning on bringing this derivative action against is a shareholder as well and they’re probably thinking about doing the same to you, is a closed bid for one another’s shares. The high bidder buying at the low bidder’s price. Is that a sort of practical solution to those sorts of cases that you’ve seen? |
JD:
37:00
| Vey very wise, yes. I haven’t used that mechanism but having heard you explain it I like it. There’s an element as well where you sort of try to flip it. A disgruntled shareholder will say ‘well I’m going to buy all your shares for this,’ and you turn around and go ‘well, if you think that’s fair value that’s fine, we’ll buy yours for that, unless you were attempting to mislead us by saying you thought that was fair value.’ And you get into some numerical arguments. But frankly, it’s always going to be better for the client to get into a numerical argument rather than marching on for 2 or 3 years perhaps, trying to pursue something on behalf of the company and then to unwind the benefit you’ve obtained to get out of the company and back into your hands. The share sale/share purchase dichotomy or simultaneous outcome is almost literally always going to be the best. Unless and in some circumstances it’ll be true that a windup is appropriate, and you just need to get an independent person in to really just bring the whole thing to a halt, figure out how much money is left over and pay it out. But, with level headed people and with reasonably commercial parties on both sides, I think the outcome you’re proposing is the 11/10 perfect outcome. Hugely. |
DT: 38:00 | I mean, that’s really going to be one of those common dichotomies isn’t it? Do we wind up the company and let a liquidator sort all this out or is there some reason why a shareholder or someone else should be pursuing the litigation? It really seems like it would always be preferable for a liquidator to be doing that unless there’s some reason why the company continue in business, continue in operation after the litigation because otherwise why wouldn’t you just windup the company? The liquidator can pursue it. A neutral third party, assuming they’re funded as we were discussing before. |
JD: | There’s a degree of, ‘look. I’m crazy enough to do it!’ And trying to stare down your opposing shareholder with your eyes looking wild and holding essentially the gun to your head of winding up the company. And that’s a reasonable negotiating tactic because, again, like you and I both have love for our insolvency practitioner colleagues, but liquidation especially of a solvent company, is going to be a big chunk of the money the shareholders will be taking home. |
DT: 39:00 | That’s true. |
JD: | It’s also going to be a big chunk of time. So if it’s an ongoing venture that the company is operating, then essentially, either want you gone and for me to pay you out or frankly it’s almost a better result for me if I take a big chunk of your money and I get out of here. Rather than I cut off my nose to spite my face and get a liquidator in to just say ‘well, if I can’t have it, neither of us can have it.’ And there’s a degree to where that’s a useful negotiating tactic. But, it is extremely rare I say that that’ll be a good commercial outcome for the shareholders. Almost literally always it’ll be a better commercial outcome for the shareholders to reach a number, shake hands on it and have a sale purchase outcome. |
DT: 40:00 | Absolutely, I suppose that that valuation question is going to be very difficult to answer but at least it’s not entirely contingent on the prospects of the litigation. We touched on derivative actions brought on behalf of insolvent companies before, I just want to comeback to that. As you said, that’s an application for leave under the Court’s inherent jurisdiction rather than under the Corporations Act. Is the test for leave under the Court’s inherent jurisdiction a little different or is it considering largely the same factors? |
JD:
41:00
42:00
43:00 | I think, yes to both. It is a little different and it does consider largely the same factors. So, it’s a three set of criteria sort of test. But importantly, unlike the Corporations Act test, it is the exercise of a discretion. So, just to remind everyone, if the five criteria from section 237 of the Corporations Act are satisfied, bang, leave is granted. Whereas if a company is in liquidation, the Court will consider 3 criteria. They’ll consider, essentially, the prospects of the claim, they will then consider the liquidator’s attitude to the claim and they’ll then bear in mind practical considerations. And so, in relation to some litigated examples, I’ve actually never seen this happen because I think David as you and I were saying earlier I just can’t quite get my head to a hypothetical where I can imagine a contributory wanting to agitate a liquidator to do this rather than just putting the liquidator in funds. But you know, another question for another time. Maybe tomorrow I’ll get a phone call from someone who wants to chat about this, which is fine, and look, happy to take the call, good fun, but the way the Court would approach that question would be to work through those considerations and then consider exercising its discretion as to whether to grant leave and one failure that springs to mind was of a case relating to the Farm Debt Mediation Act, where there was some evidence before the Court that indeed the debt was a farm debt and that indeed the lender had enforced it before attending the Farm Debt Mediation Act mediation process.And so arguably that act was voidable or void, can’t remember how the Act operates but doesn’t matter for our purposes at the moment. TIP: James just mentioned the Farm Debt Mediation Act which is a NSW Act, although similar legislation exists in many Australian states and territories, and that act requires that the parties participate in a compulsory mediation before a creditor of a farm debtor can take possession of property or other enforcement action under a farm mortgage. But because the applicant was so heavily under water and, at sort of something like 45 million dollars in personal guarantees and an 11 million dollar judgment and all this terrifying stuff outstanding, and whose liabilities exceeded his assets by so much, the Court said, notwithstanding the apparent prospects of such a claim, the practical considerations arising from us considering the solvency or otherwise of the applicant lead the Court not to grant leave because of the applicant’s completely baseless indemnity. Because if the company had to call the indemnity, there’d be no assets behind it to support it. |
DT: | Yeah, I mean a very important practical consideration there and just the same for an indemnity granted as security for costs, or an undertaking as to damages or any one of those similar situations. I was just thinking, I suppose another situation in which you might want to bring a derivative action rather than put a liquidator in funds is if there’s some contention that the liquidator is aligned with the director, that it’s some kind of phoenixing scheme, but that’d be very, very rare indeed. I’m not sure I’ve seen a case where that’s been suggested. |
JD: 44:00
45:00 | I completely agree that the only hypothetical that I can imagine is one where the contributory doesn’t trust the liquidator for whatever reason. And look, again I keep saying we’ve got a love for our insolvency practitioners and we do, I can’t imagine many liquidators saying no if they’re put in funds to go and chase someone. But, again the degree of that trust of that IP arises. So perhaps it might be better for that contributory to try to get the Court to exercise its discretion in that way. What will sometimes arise is when it’s an entity in a group, there’ll be derivative actions brought in relation to the three or four different entities that operated some venture, some enterprise of some kind. One of them might be in liquidation, a number of them might be solvent, and so an application might be brought in relation to bring in derivative action for solvent Company 123 and solvent or insolvent company, but company in liq no. 4 and so it might be as part of the dominoes falling that an applicant will look to have the Court exercise its inherent jurisdiction to grant leave. |
DT: | I see. So, you want that litigation to be pursued by all four entities by the same person, by the same moving party, and so just as a operational or practical consideration, you want that pursued by the person who’s litigating on behalf of the other three who’s probably not going to be the liquidator. |
JD: | Yeah, 100%. |
DT:
46:00
47:00 | That makes a lot of sense. We were talking before about how a derivative action or an application for leave to bring a derivative action can often come up at the same time as or interact or run parallel with these other shareholder dispute actions, including an application in relation to minority shareholder oppression. TIP: The oppression of minority shareholders is dealt with under Part 2.1F of the Corporations Act. These provisions exist because majority shareholders in companies are in a position to use their voting power for their own benefit, rather than for the benefit of the whole company or all of the members of the company. Section 232 of the Corporations Act defines oppressive conduct as conduct on the part of a company, or a resolution or proposed resolution by its members, that’s either:
Section 233 lays out the remedies available for oppressive conduct. These remedies include but aren’t limited to:
When would you see both being an option and what are the difference between the two? |
JD:
48:00
49:00
50:00 | Yes, what’s the difference between an elephant and a basketball? There are a large number, but often similar sets of facts will give rise to similar considerations. So if we just try to be a little bit surgical and separate them out, corporate oppression is a right that a shareholder or member will have. Derivative action is a right that the company has that the shareholder or member or former officer will look to prosecute and a just an equitable wind up will be brought by a shareholder in those classic circumstances, if the substratum of the company has failed or the quasi partnership relationship of trust and confidence has broken down now. Now it’s all very well and good for you and I to say it’s easy to tell the difference, but if we can just be a bit more forensic today when we discuss derivative actions, we are really discussing getting money owed to the company back into the company. We can distinguish that from corporate oppression because that is a claim from a shareholder to either get its shares bought, so get some money for it by someone else’s shares so pay some money out or wind up the company or any number of other things listed in section 233. But broadly speaking, it’s a share sale or a wind up when we talk about corporate oppression. Just trying to bring the thing to a halt or kick the other person out or get kicked out ourselves. Then if we think about the just and equitable wind up, that is literally an attempt to do that, so you often see corporate oppression tied in with a just and equitable wind up. I think complexities arise when you try to tie those two things in with a derivative action, because you can often lead yourself or your client down the garden path. Because if you say for example a director has misbehaved, you then have a strategic choice. Do you say the director has misbehaved and that misbehaviour has been unfairly prejudicial to my rights as a shareholder and I want a sale or a wind up. Well, if you say that then you look at corporate oppression and you look at section 461. If you say, I think the director is misbehaved and I want that director to be sued for breach of its duties, then you are squarely looking at a derivative action, which is to say you’re squarely looking at causing the company to go sue that director to bring the money back in. So, it almost leads back to that initial chat we had about wanting to be supremely clear with your client about what their goals may be and then wanting to speak strategically about it. The derivative action will be quite a bespoke sort of instrument you’ll want to use, whereas with the greatest of respect, corporate oppression and a equitable windup are a little bit more scattergun to say, ‘things are going badly, let’s at least get me out. Let’s end our relationship, things are going badly!’ Whereas the derivative action identifies very, very clearly a claim. And very precisely the manner in which that claim is to be pursued, and very precisely the person who is holding themselves out as the right person to pursue it. |
DT:
51:00 | It is definitely more of a specialised tool, because if you think about the end destination for each of those kind of paths to the finish line, the derivative action might go on the other side of the mountain. It appears to be very different, you’re bringing a claim that will recover an amount for the company, and it’s not a transaction in relation to the shares, it’s not seeking a remedy in relation to the transfer or sale or purchase of the shares. But the end result is as we said before and appreciation in the share value and ultimately that effect of the conduct of the directors, usually, on the value of the shares is going to be squarely an issue in those other two parts So you’re still dealing with some very similar issues from a strategic perspective. You’re still dealing with, ‘to what extent has the value of my holding as a shareholder been affected by the conduct of the directors,’ and the end result is some consequence for the monetary value of those shares. But the nature of that result, whether it’s buy, sell or hold, kind of changes depending on which one you pursue. |
JD: 52:00 | But if we work that through, there’s almost a timing question, right? So, if we go for a share sale via a derivative action, you are hoping your valuation evidence that deals with your allegation about a breach of directors duties sees you get the share price you want. So that’s option one. If you’re chasing a wind up, pursue under 233 or pursue under 461, essentially you’re handing the reins over to liquidator. So essentially you’ll be saying, ‘look liquidate this thing, but don’t forget to go sue Blogsy who breached their directors duties.’ Whereas if you go by way of derivative action, you are driving the pursuit of Blogsy and you are entirely in the driver seat. So rather than going 50/50 will my valuation evidence be accepted, or rather than saying, hopefully I’ll get a tenacious and effective liquidator who’s excited about pursuing Blogsy, you are very much helping yourself to say right, ‘I’ll pursue Blogsy. I’ll get the money into the company and from there I’ll form my view about the next steps.’ Bespoke, I completely agree, but I think there is a time and a place for it. |
DT: 53:00 | Yeah, absolutely you can control your own destiny. And I guess we’ve been a little bit down on derivative actions, we’ve highlighted a lot of the risks, a lot of the practical problems in terms of not only getting leave, but then what remedy you get at the end, but you’re right, you can control your own destiny. It’s a tool with a specific function, and there’s a right time in place for it. Can you tell me a little bit about a case you’ve seen where you’ve seen a really great outcome from bringing a derivative action? |
JD: | I entered into it when I was happy with before where we resisted one, so that was a good outcome for my defendant client. But sadly the two that spring to mind aren’t litigated outcomes because they almost are precisely the example you raised earlier, David, which is to say that you kick the proceedings off, you send through your draft pleadings, draft pleadings you get no response. So you have one or two directions hearings to try to get ready to run this application, and in the meantime, everyone has an opportunity to sit around a table. You know these were both pre-COVID tables that we were sitting around. |
DT: | The real physical tables. |
JD: 54:00 | Yes, an actual and genuine table. One of them was a reasonably blunt meeting with some raised voices, that actually led to an outcome and one of them was a more formal mediation. So the actual huge successes I’ve seen on the part of applicants that I’ve been involved in have been bringing the application and that application causing a commercial outcome. Of course, the only people who lose on the commercial outcomes are lawyers, which is very sad because you don’t get to run them. |
DT: | I was going to say it’s the mark of a commercial litigator, James, that you said, sadly, they were not litigated out. |
JD: | I still look back with regret on those great settlements David. Just half joking. |
DT: | James, thanks so much for joining us today on Hearsay. |
JD: | Thanks for having us David, really enjoyed it. |
DT:
55:00
56:00 | As always, you’ve been listening to Hearsay The Legal Podcast. I’d like to thank my guest today, James d’Apice from Chamberlains for coming on the show. Now, instead of spruiking more Hearsay episodes this time, today, I’d like to encourage you to go and have a listen to James’ own show ‘Coffee and a Case Note’, a short video series where James summarises a recent piece of corporate and commercial litigation over a cup of coffee. They’re really engaging and you can find them on YouTube, Apple Podcasts, Spotify, TikTok, Instagram, Twitter, pretty much everywhere, so I’d check them out. Now, if you’re an Australian legal practitioner, you can claim one continuing professional development point for listening to this episode. Whether an activity entitles you to claim a CPD unit is self assessed, as you well know, but we suggest this episode entitles you to claim a substantive law point. More information on claiming and tracking your points on Hearsay can be found on our website. Hearsay The Legal Podcast is proudly supported by Assured Legal Solutions, a boutique commercial law firm making complex simple. You can find all of our episodes, as well as summary papers, transcripts, quizzes and more, on our website and if you’re a subscriber, we’ll let you know by email whenever we release a new episode. Also, our free trial episodes are available on Apple Podcasts and Spotify, so if you like us, please give us a rating on your preferred platform and tell a friend to listen to an episode as well. Thanks very much for listening and I’ll see you next time.
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