Abstract
Before the introduction of a statutory derivative action, a shareholder’s institution of legal proceedings on behalf of a company was subject to the proper plaintiff rule as laid down in Foss v Harbottle (1843) 2 Hare 461, 67 ER 189 (“Foss”). According to the proper plaintiff rule it is the company that must institute the necessary legal proceedings against the wrongdoer when a wrong is committed against it. Effectively this rule enforced the separate legal personality of a company. The decision to institute legal proceedings against the wrongdoer forms part of the company’s internal affairs. Courts are reluctant to interfere with the internal affairs of a company when such affairs were conducted lawfully. As a strict and mechanical enforcement of the rule in Foss may have inequitable consequences, certain “exceptions” to the rule were developed in case law. These “exceptions” were also problematic as the scope of their application was difficult to establish. In an attempt to promote legal certainty the legislatures in England and South Africa responded by the introduction of statutory forms of the derivative and personal actions. The latest forms of the South African statutory personal and derivative actions are found in sections 163 and 165 of the Companies Act 71 of 2008 (“the act”).
In line with the common law position the act also maintains a strict distinction between the statutory personal action and the statutory derivative action. The maintenance of this distinction was “reluctantly” confirmed in the judgment of Larrett v Coega Development Corporation (Pty) Ltd 2015 6 SA 16 (OKG). The derivative and personal action must be distinguished from each other based on the cause of action and the remedies available in terms of each of the actions. While a wrong committed against a company may directly infringe on the legal rights of a company, it may also indirectly prejudice the interest of the shareholders. The purpose of statutory derivative action in section 165 of the act is the protection of the direct legal interest of the company. Any relief that is granted in legal proceedings instituted on behalf of the company subsequent to an application in terms of section 165 will be for the direct benefit of the company. In contrast with section 165, the purpose of section 163 is to protect the interests of a company’s shareholder or director. Any relief granted in terms of section 163(2) will be for the benefit of the shareholder or director who relied on section 163. At first glance the distinction between section 163 and section 165 appears clear and straightforward, but in certain practical scenarios the division between the rights of the company and the interests of its shareholders may become blurred. These circumstances create difficulty for a potential litigant as it is often uncertain on which of the two sections reliance must be placed to obtain relief. This problem is further exacerbated by the cumbersome procedure in section 165, which makes section 163 a more attractive alternative option to litigants due to the wide and flexible terms in which it is drafted.
In an attempt to find possible solutions to these problems a comparative study was conducted with jurisdictions such as the United Kingdom and Australia. Firstly, the purpose of the comparative study was to determine how legislators in these jurisdictions addressed these issues in the drafting of the statutory forms of the derivative and personal actions. Secondly, an analysis was conducted of the interpretation and application of the relevant provisions of the statutory derivative and personal action by the courts in Australia and the United Kingdom.
Similarly to the position in South Africa the UK Companies Act 2006 provides for the statutory derivative and personal actions in separate sections. This is a continuation of the traditional approach where a clear distinction between the derivative and the personal action is maintained. However, the UK statutory personal action in section 996(2)(c) does provide for relief in the form of an order authorising a member of a company to institute legal proceeding on behalf of the company. This is a form of relief that is usually associated with the derivative action. The inclusion of this form of relief as part of the personal action recognises the potential overlap that may occasionally occur between the interests of a company and its members or shareholders. More importantly, a litigant that relies on the statutory personal action is not left without relief if a court finds that the institution of legal proceedings on behalf of the company is more appropriate than granting relief of a personal nature. The court in Clark v Cutland [2003] EWCA Civ 810; [2003] 4 All ER 733 took the matter a step further by granting relief for the direct benefit of the company, based on the statutory personal action. The adoption of this approach is, however, not without criticism. The Australian statutory personal action also allows the granting of relief in the form of authorising the institution of legal proceedings on behalf of a company.
The legislative approaches adopted in the United Kingdom and Australia reveal that in some circumstances a mechanical and rigid distinction between the statutory derivative and personal actions fails to recognise that it may be impractical and difficult to distinguish between the interests of a company and those of its shareholders. In this article the justification for maintaining the sharp distinction between these actions in South Africa is questioned in the light of legal developments in jurisdictions such as the United Kingdom and Australia. The article concludes by recommending an amendment to section 163(2) to provide for relief in the form of authorising a shareholder or director to institute legal proceedings on behalf of the company. However, to ensure that the remedy is not abused for unjustifiable circumvention or avoidance of the provisions of section 165, this form of relief would be available only in limited circumstances. Such amendment would be in line with international treads and legal developments.
Keywords: Companies Act 71 of 2008 sections 163, 165; derivative action; personal action; shareholder protection
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