The general rule is that only the company, being a legal entity, has the right to sue if there is wrongdoing against the company. The exercise of this duty is vested in the board of directors however, in some instances, the alleged wrongdoer is himself or herself a member of the board, or for other reasons such as conflict of interest, fails to do what is in the best interest of the company and its members.
Section 236(1) of the Corporations Act thereby provides that “a person may bring proceedings on behalf of a company, or intervene in any proceedings to which the company is a party for the purpose of taking responsibility on behalf of the company for those proceedings, or for a particular step in those proceedings.”
Section 236(1)(a) of the Corporations Act stipulates that a person wanting to apply for derivative actions must be:
Despite common misconception, an applicant is not required to have been a member of the company at the time the supposed offence or misconduct occurred. Any person that satisfies the requirements above is able to bring a derivative action.
For derivative action to occur, the individual must first be granted leave by the Court. Under section 237(2) of the Corporations Act, the Court will only grant application for leave if:
Each of the criteria must be satisfied for the Court to grant leave to the applicant to proceed with the derivative action. The criteria are examined in more detail below.
This is the critical criterion that must be satisfied for leave to be granted. For example, companies will not bring actions or take responsibility where:
In these instances, and more, the Court may grant an individual leave in order to bring derivative action on behalf of the company.
Good faith refers to the applicant’s motives in bringing the action to Court. The Court will consider whether the applicant honestly believes that a good cause of action exists and has a reasonable prospect of success and whether the belief is one that a reasonable person in the circumstances could hold. Additionally, the Court will also consider whether the derivative action will be used to pursue the best interests of the company as a whole and not the personal agenda of the applicant. Where the applicant is bringing proceedings for personal gain, the Court is unlikely to grant leave.
Similar to above, derivative action should not be pursued for the interests of the applicant but instead for what would most benefit the company and its members. This is demonstrated by looking at the context in which leave is being sought and from the perspective of the company and not from the applicant’s.
Section 237(3) also sets out the rebuttable presumption that granting leave is not in the best interests of the company if it is established that:
The director’s belief that the decision was in the best interests of the company is a rational one unless the belief is one that no reasonable person in their position would hold.
The claim brought before the Court must be arguable, having ‘a solid foundation [that would give] … rise to a serious dispute’. As such, the applicant must have a valid reason to bring a statutory derivative action, supported with evidentiary material. However, it does not require the Court to go into the merits of the proposed derivative action or to reach any conclusion as to the strength of the case.
Pursuant to section 237(2)(e)(i), the applicant must give written notice to the company of:
Unless otherwise stated by the Court, notice of the above must be given to the company fourteen (14) days prior to the making of the application. The Court is only prepared to dispense of this requirement where the company is already well aware of the applicant’s intention to seek leave.
If application of leave is granted, proceedings will ensue on behalf of the company in the company’s name. It is again important to note that any benefits from these actions will be received by the company and not the applicant.
Comasters can assist the client in the process of applying for leave to bring statutory derivative action on behalf of the company.
© Comasters September 2015.
Important: This is not advice. Clients should not act solely on the basis of the material contained in this paper. Our formal advice should be sought before acting on any aspect of the above information.