How to Commence a Derivative Action on Behalf of a Company in Singapore

What is a Derivative Action?

When a company suffers damage and loss from wrongs done to it, the decision whether to sue or commence arbitral proceedings is usually considered a management decision, and thus within the exclusive control of the board of directors.

However, where the directors themselves are the wrongdoers, there is a risk that the company receives no redress for the harm caused to it, because wrongdoing directors are unlikely to authorise lawsuits against themselves.

Thus, a “derivative action” provides an alternative voice for the company by allowing certain persons to sue the wrongdoing director(s), or commence arbitration proceedings against them, on the company’s behalf.

Do note that the court’s permission is required before one can pursue derivative action.

In Singapore, the rules governing an application to commence a derivative action are laid out in section 216A of the Companies Act (CA) (known as a “statutory derivative action”).

Derivative action may also be available via common law (i.e. law that is based on past legal cases/decisions made by judges), although this is subject to slightly different governing principles. The court’s permission is still required.

This article focuses on the statutory derivative action.

Situations Where it Might be Appropriate or Necessary to Commence a Derivative Action

The following non-exhaustive list are examples of situations where a derivative action may be an appropriate or necessary option for recourse:

• When director(s) engage in unauthorised acts causing loss to the company. For instance, by entering into a transaction expressly forbidden by the company’s constitution, and causing loss to the company. In such a situation, it could be in the interest of the company to sue the director(s) to remedy the loss.
• When director(s) owe money to the company and refuse to repay the debt. This forces the company to sue for repayment of that debt;
• When director(s) act in breach of their directors’ duties, causing loss to the company. Examples of this include:
  • When directors cause the company to enter into unprofitable transactions because they were bribed to do so, thus breaching the duty to avoid unauthorised profit for themselves;
  • When directors breach the duty to not make improper use of his position to gain a personal advantage, for instance by taking advantage of confidential information accessible only to them to engage in any personal profit-making.
  • When directors fail to act honestly or with reasonable skill and diligence in discharging his duties.
  • When directors divert to themselves resources or contracts to the exclusion of the company, causing business and profits, that would have otherwise accrued to the company, to accrue to others instead;

Even if the director’s own wrongful pursuit of personal profit causes no loss to the company, the company might be entitled to sue to obtain that profit.

When Might Derivative Action Not Be an Option for Recourse?

It is important to note that where the loss in question accrues to individual shareholders personally, and not to the company, the statutory derivative action is not the correct avenue to seek remedy.

An example of this is minority oppression, where minority shareholders allege that wrongdoing by directors have caused losses to these shareholders personally. In such cases, an oppression action under section 216 of the Companies Act may be more appropriate.

Another example of this may be when any shareholder claims that wrongful or negligent acts by a director caused a fall in share prices, resulting in financial loss for the shareholder. As this is a situation where the loss in question accrues to the individual shareholder personally, the statutory derivative action is not the correct avenue to seek a remedy.

Applicability of Statutory Derivative Action

The statutory derivative action is only applicable in cases where the claimant (i.e. the person commencing the legal action, and who may also be referred to as the “plaintiff”) wishes to sue on behalf of a company that is incorporated in Singapore, rather than elsewhere.

However, a statutory derivative action cannot be commenced in relation to a claim on behalf of a company in liquidation. This is because when a company is in liquidation, the liquidator is now in charge of the company, and the board of directors is effectively defunct. Directors therefore cannot commence or authorise legal action of any kind.

Requirements to Be Met to Obtain Permission from Court to Commence a Derivative Action

Be a proper person to commence a derivative action

The applicant (i.e. the person bringing the derivative action) must be:

• A member of the company; or
• The Minister for Finance in the case of companies under investigation (for reasons such as fraud).

Nonetheless, if neither requirement is satisfied, the court retains the discretion to rule that any appropriate person is a proper person to bring a statutory derivative action.

Give directors notice of intention to commence derivative action

The applicant must have given 14 days’ notice to the directors of the company of his intention to apply to court for permission to undertake the statutory derivative action, if the directors themselves do not commence or continue the lawsuit or arbitration demanded.

At this stage, the applicant must prove that despite the 14 days’ notice being given to the directors, it is probable that the directors would not bring or continue the action diligently.

This may be satisfied, for example, in a case where a wrongdoing director is a sole director and he, in anticipation of a derivative action, causes the company to sue himself. While there is technically a lawsuit, the court might be satisfied that the company is not likely to diligently prosecute the case. The court may then grant permission to commence a derivative action.

However, if the board of directors decides to sue the wrongdoing director upon receipt of the notice of intention to commence a derivative action, this will render the application for statutory derivative action redundant.

If a court is satisfied that strict compliance with the notice period is undesirable (e.g. because the company or errant director can use the 14 days to hide evidence or assets), the court may make any interim order pending the applicant giving the required notice.

Act in good faith

The applicant must prove he is acting in good faith, which requires proof that he honestly or reasonably believes that good grounds for a legal action exists.

The applicant must prove that the action is, on the face of things, in the interests of the company. This means that the action must have legal merit, and also be practically and commercially sensible to the company.

For instance, if the costs of litigation to the company far exceed the damages recoverable, the court might hold that allowing the action would not satisfy this requirement.

The presence of some hostility between the applicant and the potential defendant directors is not sufficient to constitute bad faith that will cause the application to fail. This is unless the court is of the opinion that the applicant was so motivated by vendetta that his judgement will be clouded by purely personal considerations when he brings the derivative action.

In addition, even if the applicant stands to gain personally from a successful derivative action, this will not be construed as bad faith if his personal interests are aligned with the company’s interests.

Shareholder approval not a bar to derivative action

Even if shareholders vote at a general meeting to uphold and approve of a wrongful act, such approval will not in itself conclusively cause the application for a statutory derivative action to fail.

What Happens After Permission to Commence the Statutory Derivative Action Is Granted?

After the court grants permission for the applicant to commence the statutory derivative action, it may make any order as it sees fit, such as:

• An order authorising the applicant or some other authorised person to control the conduct of the lawsuit or arbitration on behalf of the company
• An order requiring the company to pay reasonable legal fees and disbursements incurred in connection with the lawsuit or arbitration

Any statutory derivative actions (or applications made for such an action) cannot be stayed, discontinued, settled or dismissed without the approval of the court.

Should I Engage a Lawyer and Why?

If you wish to pursue a statutory derivative action against an errant director for wrongs done to a company, you are encouraged to engage a commercial disputes lawyer to help you with both the application for court approval to commence such an action, as well as the main action itself if your application is approved.

This is because if you do not hire a lawyer, you might have difficulty convincing the court that the lawsuit is in the company’s best interests. Seeing as the losing party must generally compensate the other party’s legal costs (which further increases the company’s expenses), continuing a lawsuit without legal counsel may be seen as unwise and unconducive to obtaining a good result.

Hiring a commercial disputes lawyer is also recommended because both the application for permission to commence a derivative action, and the main trial itself, are technical and procedural in nature. There are many procedural rules (like filing deadlines) to follow, and falling afoul of any procedural rules may result in your application being struck out. The suit may also involve legal concepts that you may not be prepared to handle on your own.

Commercial dispute lawyers are trained in the particular subject-matter of your dispute and can help present your case in the strongest possible manner. They may also bring with them expertise in negotiating a settlement if necessary.

If you are considering bringing a statutory derivative action, you can get in touch with one of our experienced commercial disputes lawyers here.