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12 November 2018
It has long been recognised that where wrongdoers control a company and thus prevent it from bringing an action, the courts will allow shareholders to do so on the company's behalf in order to obtain redress by way of a derivative action. While the courts have recognised a range of scenarios where wrongdoers can be said to control the company (thus preventing the company from suing for its own benefit), can this concept of wrongdoer control apply where there is a deadlock at both the board and shareholder level obfuscating any clear majority or minority in the company?
The Federal Court answered this question in the affirmative in Perak Integrated Networks Services Sdn Bhd v Urban Domain Sdn Bhd.(1) This decision has provided a pragmatic solution to resolve the corporate impasses frequently faced by companies where their shareholders and boards of directors are split equally.
Urban Domain Sdn Bhd and Perak Integrated Network Services Sdn Bhd each held 50% of the shares in PINS OSC & Maintenance Services – a special purpose vehicle formed to construct and maintain telecoms towers. The board of directors consisted of only two directors, appointed by each of the shareholders, respectively.
Disputes arose over, among other things, the entitlement to maintenance fees and other payments owed to PINS from several telecoms providers and Perak Integrated. Subsequently, Perak Integrated took control over all of PIN's books and accounts and allegedly deprived PINS of funds to sustain its operations.
As a result, Urban Domain, in its capacity as a shareholder and for the benefit of PINS, commenced a common law derivative action against Perak Integrated and its appointed director for breach of contract and fiduciary duties, respectively.
Urban Domain succeeded at first instance and, on appeal, a preliminary issue was raised as to whether the derivative action had been properly constituted since there was allegedly no wrongdoer control in PINS.
In dismissing the preliminary issue, the court of appeal held that the test to establish wrongdoer control is one of de facto control. Thus, the wrongdoer test could still be satisfied in a deadlocked company where the shareholding is split 50-50. In the case at hand, it was determined that Urban Domain could be considered an aggrieved minority shareholder, as PINS could not bring any action against Perak Integrated.
Thereafter, Perak Integrated obtained leave to appeal to the Federal Court on the following question of law: "Whether a derivative action may in law be brought for the benefit of a company, the management and control of which are deadlocked."
The Federal Court agreed with the court of appeal and answered the leave question in the affirmative. In doing so, the Federal Court found that the test to establish wrongdoer control is essentially one of substance. The requirement of control will be satisfied if it can be shown that the company is incapable of bringing an action against the wrongdoers to protect itself.
This would of course apply in a deadlock situation with no clear-cut majority or minority shareholders or board. In such circumstances, the aggrieved equal shareholder may file a derivative action on the company's behalf, provided that the company is not in liquidation.
While the common law right to bring any derivative action on behalf of a company has now been abrogated by Section 347 of the Companies Act 2016,(2) the Federal Court's observation in this case still stands as useful guidance in deciding whether leave should be granted for a statutory derivative action under Section 348 of the act. To borrow the words of Justice Nathaniel Nemetz(3) in respect of the Canadian equivalent section:
How is a Court to exercise its discretion in coming to a determination that… 'it appears to be in the interests of the corporation' to allow the derivative action to be brought… despite its breadth, nowhere does Parliament say, nor, in my opinion, was it intended, that the logic of the common law in cases of this kind be disregarded.
By liberalising and adopting an expansive reading into the scope of the wrongdoer control test, this decision provides useful judicial clarification on the rights and remedies available in a true deadlock situation. This pragmatic approach by the Malaysian courts is in line with other commonwealth jurisdictions and affirms that derivative actions are no longer confined to situations with a clear majority-minority shareholder demarcation. Derivative actions now potentially extend to any situation where a company has been rendered impotent (by other less conventional control elements) from bringing an action against the wrongdoers.
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