COMPANY LAW: MEMBERS’ REMEDY

Derivative Action as a remedy to aggrieved company members (Kenyan context)

By: Felix O. Okanga| Managing Partner

Email: [email protected]

“Derivative actions are the pillars of corporate litigation. As I understand it, a derivative action is a mechanism which allows shareholder(s) to litigate on behalf of the corporation often against an insider (whether a director, majority shareholder or other officers) or a third party, whose action has allegedly injured the corporation. The action is designed as a tool of accountability to ensure redress is obtained against all wrongdoers, in the form of a representative suit filed by a shareholder on behalf of the corporation:” J. L Onguto, J in Ghelani Metals Limited & 3 others v Elesh Ghelani Natwarlal & another [2017] eKLR.

Prior to the enactment of the Companies Act, N0 17 of 2015, the rule in Foss vs Harbottle and the exceptions thereof held sway as regards institution of derivative actions. The rule was that the company was the proper claimant/plaintiff to institute proceedings for a wrong suffered by it. Hence it was a requirement that for one to institute a derivative action he needed to first demonstrate that his claim fell within either of the three judicially crafted exceptions to the rule which were:-

1. Where the persons who controlled the company (majority shareholders) had committed fraud on a minority; (this was the primary exception to the rule).
2. Where the act or omission complained about was illegal or ultra vires the company;
3. Where the act complained about infringed the personal right of a member. This included failure to pay dividends in accordance with the company’s constitution, failure to give sufficient notice of general meetings; and
4. Where the act complained about could be done by passing of special resolution

Suffice to say that until the year 2015 Common Law guided derivative actions in Kenya. However, this changed with the enactment of the Companies Act, NO 17 of 2015 with the consequential codification of derivative actions.

As rightfully observed by J.L Onguto, J in the Ghelani case, the requirement to fall under the exceptions to the rule in Foss v Harbottle was replaced with judicial discretion to grant permission to continue derivative action.

“Judicial approval of the action is what now counts and such approval is based on broad judicial discretion and sound judgment without limit but with statutory guidance” Onguto, J.

PART XI of the Companies Act deals exclusively with derivative actions. Under Section 238 a derivation claim has been defined as proceedings by a member of a company in respect of a cause of action vested in the company and seeking relief on behalf of the company. Pursuant to Section 238 (3) a derivative claim can only be brought in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company. Equally, a derivative claim can be brought against the directors or another person (majority shareholders) or both.

The courts have observed that there exists a two-stage process for the institution of derivative claims under PART XI of the Companies Act; firstly, it must be established existence is a prima facie case on any cause of action noted in Section 238(3). An application that fails to disclose a prima facie case will be dismissed by the court as stipulated in Section 239 (2) of the Companies Act. Secondly, having established a prima facie case the court then considers all factors that will inform the exercise of judicial discretion.

Such factors to be considered are those provided under Section 238 of the Act which is that the derivative claim is brought in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company. And that the person seeking to continue the derivative claim is a member of the company.

In addition to the statutory factors to be considered in section 241(2) of the Act, the High Court in Isaiah Waweru Njumi & 2 Others –v- Muturi Ndungu [2016]eKLR laid down the following factors for consideration:-

1. Whether the Plaintiff has pleaded particularized facts which plausibly reveal a cause of action against the proposed defendants. If the pleaded cause of action is against the directors, the pleaded facts must be sufficiently particularized to create a reasonable doubt whether the board of directors challenged actions or omissions deserve protection under the business judgment rule in determining whether they breached their duty of care or loyalty;
2. Whether the Plaintiff has made any efforts to bring about the action the Plaintiff desires from the directors or from the shareholders. Our Courts have developed this into a demand or futility requirement where a Plaintiff is required to either demonstrate that they made a demand on the board of directors or such a demand is excused;