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Statutory derivative action allows a person to bring or take part in proceedings on behalf of a company. The action is deemed derivative as the individual is taking responsibility for proceedings that belong to the company, and not to themselves personally.
A. The Purpose of Statutory Derivative Action
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.”
B. Who can make an Application for Statutory Derivative Action?
Section 236(1)(a) of the Corporations Act stipulates that a person wanting to apply for derivative actions must be:
- A member, former member, or person entitled to be registered as a member of the company or of a related body corporate; or
- An officer or former officer of the company; and
- Acting with leave granted under section 237.
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.
C. The Requirements of the Application for Leave
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:
- It is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them;
- The applicant is acting in good faith;
- It is in the best interests of the company that the applicant be granted leave;
- If the applicant is applying for leave to bring proceedings – there is a serious question to be tried; and
- at least 14 days before making the application, the applicant gave written notice to the company of the intention to apply for leave and of the reasons for applying; or
- it is appropriate to grant leave even though the above subparagraph is not satisfied.
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.
C.1. Section 237(2)(a) – The Company will not Bring the Proceedings
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:
- The company is a family business or the majority of its members are related;
- A member of the company has a material personal interest in the proceeding;
- The defendant is denying allegations; or
- The company does not have adequate funds to bring the action.
In these instances, and more, the Court may grant an individual leave in order to bring derivative action on behalf of the company.
C.2. Section 237(2)(b) – The Applicant is Acting in Good Faith
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.
C.3. Section 237(2)(c) – Derivative Action is in the Company’s Best Interests
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 proceedings are:
- by the company against a third party; or
- by a third party against the company; and
- the company has decided:
- not to bring the proceedings; or
- not to defend the proceedings; or
- to discontinue, settle or compromise the proceedings; and
- all of the directors who participated in that decision:
- acted in good faith for a proper purpose; and
- did not have a material personal interest in the decision; and
- informed themselves about the subject matter of the decision to the extent they reasonably believed to be appropriate; and
- rationally believed that the decision was in the best interests of the company.
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.
C.4. Section 237(2)(d) – A Serious Issue should be Tried
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.
C.5. Section 237(2)(e) – Sufficient Notice must be Given
Pursuant to section 237(2)(e)(i), the applicant must give written notice to the company of:
- Their intention to apply for leave; and
- Their reasons for doing so.
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.
D. What will Statutory Derivative Action Achieve?
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.
1 Swansson v Pratt  NSWSC 583.
2 Talisman Technologies Inc v Qld Electronic Switching P/L  QSC 32.
3 Colin Anthony Mead v David Patrick Watson & Ors  NSWSC 38.
© 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.