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A Shareholder Derivative Action in a Deadlocked Company

A Shareholder Derivative Action in a Deadlocked Company

What happens if a company is in a deadlocked situation and one faction of shareholders commits wrongdoing against the company? Can the other half of the shareholders of the company seek redress against them?

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The recent case of Perak Integrated Network Services Sdn Bhd v Urban Domain Sdn Bhd (on behalf of themselves and Pins OSC & Maintenance Services Sdn Bhd through derivative action) & Anor gave us an insight on whether shareholders in a deadlocked company can institute a derivative action against other shareholders of the company for wrongdoings they committed against the company.

Before we begin, it must be noted that the above case was initiated in 2012, when derivative action is still considered common law. Any action that is initiated after the introduction of the Companies Act will have to bear in mind that the common law derivative action has since been abolished and replaced by statute.

What is a derivative action?

A derivative action is whereby an individual shareholder of a company (with leave from court) initiates, intervenes, or defends a proceeding on behalf of the company. This rule was created to circumvent the general rule that was laid down in Foss v Harbottle, where the court held that:

  1.  Only the company (via the appropriate individual) can initiate, intervenes, or defend a proceeding on behalf of the company; and
  2. If a majority shareholder of the company is in favor or willingly accepts the consequences of an action i.e. wrongdoing for or against the company, no individual member can revisit the matter again (or in Latin, cadit quaestio).

However, what happens if the wrongdoing is committed by the majority shareholder of the company or the wrongdoing is committed by a faction of the shareholders in a deadlocked company?

A keen observation would tell you that the minority shareholder could not rectify the issue as any means of bringing an action against the majority shareholders would undoubtedly be voted down by the majority shareholders or nothing can be passed if the votes are equally divided between one faction of shareholders and another in the company i.e. a deadlocked company and neither faction is allowed to seek relief against the other faction because of the general rule.
Therefore, to prevent the company from being incapacitated by the wrongdoings of the shareholders of the company, the exception was birthed to aid the minority shareholder or individual shareholders and shareholders in a deadlocked company to seek redress which is not allowed in the general rule.

What is a deadlocked company?

A deadlocked company occurs when the company is equally split between directors with opposing views. As the shareholding is split equally, no resolution can be passed, thus putting the operation of the company at a standstill and rendering it inoperable.

Can a derivative action be brought against a deadlocked company?

While the control of the company is not as clear cut as a majority-minority shareholding company, the court held that one faction of the shareholders can still bring a derivative action against the other faction provided that:

  1. the other faction committed wrongdoing; and 
  2. the other faction has control over the running of the affairs of the company. 

What amounts to control in a deadlocked company? The court relied on Justice Suriyadi’s judgment in Parallel Media Group Plc & Anor v Asia PGA Bhd & Ors held that control can come in many forms and be carried out in many ways. For example, a managing director with a casting vote could in theory manipulate the outcome of a vote by deliberately voting in a manner that would prevent the company from taking up any actions against any wrongdoing that was committed by a faction of the shareholder for the benefit of the company.

What happens if there are alternate remedies?

The court held that generally, a derivative action can only be instituted if there is no alternative recourse i.e. winding up on just and equitable ground that is available to a faction of the company shareholders. However, the above statement does not operate as an immediate or automatic bar to instituting a derivative action. The court held such a rule is dependent on the circumstances and facts of each case i.e. the nature of the relief sought and whether the elements of such relief (i.e. just and equitable winding up) can be satisfied in each case.

Make an appointment with Company Secretary and Business Lawyer for advice and consultation

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