Derivative proceedings: leave of court is substantive legal requirement

Background
Facts
Application of Section 347
Comment

In Ng Boon Teik v Chang Tong Lee, the Court of Appeal ruled that Sections 347(1) and (2) of the Companies Act 2016, which require leave of court to be obtained before any action may be initiated on behalf of a company and any such action to be brought in the name of the company, are substantive law and not merely procedural.

Background

Section 347 of the Companies Act 2016 provides for statutory derivative proceedings. It reads as follows:

(1) A complainant may, with the leave of the Court initiate, intervene in or defend a proceeding on behalf of the company.

(2) Proceedings brought under this section shall be brought in the company's name.

(3) The right of any person to bring, intervene in, defend or discontinue any proceedings on behalf of a company at common law is abrogated.

In Ng Boon Teik, one of the arguments raised by the respondent was that its non-compliance with Sections 347(1) and (2) was a mere irregularity which could be remedied or amended.

Facts

The respondent obtained an order from the high court to commence a legal action, purportedly on behalf of a company. The respondent then brought a writ action against the alleged wrongdoers, including the appellant (a director of the company), and named the company as a nominal defendant. In the writ action, the respondent pleaded that the action was being commenced pursuant to the high court order and sought remedies on behalf of the company.

However, the high court order did not state that leave was granted for the respondent to initiate an action on behalf of the company. On the contrary, the order stated that it gave leave to the respondent to initiate an action against the company. Therefore, the appellant applied to strike out the writ action against him.

Application of Section 347

The appellant argued that the requirement for leave of court under Section 347(1) is not merely formal or procedural in nature; rather, it should be regarded as substantive because it is only with the court's permission that a complainant has standing to bring a claim for or on behalf of a company.

Further, the appellant contended that the writ action could not be remedied by amendments because the illegalities concerned the locus standi of the respondent to bring the action on behalf of the company.

As this was a novel point of law in Malaysia, the appellant sought guidance from foreign authorities.

The BVI Business Companies Act 2004 has a similar provision to Section 347 of the Companies Act 2016:

184C. (1) Subject to subsection (3), the Court may, on the application of a member of a company, grant leave to that member to (a) bring proceedings in the name and on behalf of that company; or (b) intervene in the proceedings to which the company is a party for the purpose of continuing, defending or discontinuing the proceedings on behalf of the company.

On the application of Section 184C, it was observed in Novatrust Ltd v Kea Investments Ltd that:

40. Vaughn v. LJ International Inc, an unreported decision of the Court of Appeal of the State of California, was concerned with a derivative claim commenced in California in respect of a BVI registered company. Permission to commence the proceedings had not been obtained from the BVI Court and the claim was struck out. That decision was upheld on appeal. There as here it was argued that the requirement for permission was procedural rather than substantive and thus the absence of permission from the BVI Court was not a bar to bringing the claim. That argument was rejected both at first instance and on appeal. The Court of Appeal of California held that s.184C had the effect of limiting the entitlement to sue to those shareholders who had complied with its provisions. It acknowledged that the requirement to apply for leave was in a sense procedural but the requirement for permission from the BVI court was to be regarded as substantive because it was only with permission that a shareholder had standing to bring the claim. In reaching that conclusion, the Court of Appeal of California applied Hausman (ante) – the authority applied in the authority approved and followed by Lawrence Collins J in Konananeni at [50]. (Emphasis added.)

Also, in Wong Ming Bun v Wang Ming Fan, a derivative claim was brought in Hong Kong by a shareholder in a BVI-registered company. Leave had not been obtained from the BVI High Court as required by Section 184C and the case was struck out. Justice Ng analysed the position in these terms:

whether a shareholder can commence a derivative action in the name and on behalf of the company is a matter of substantive law, and is governed by the law of the place of incorporation… In the present case, this question is governed by BVI law. Under BVI law, a shareholder can commence a derivative action… with leave of the BVI Court. No leave has been obtained. The action as presently constituted is defective (Emphasis added.).

Comment

Following the Court of Appeal's decision, it is clear that violations of Sections 347(1) and (2) are not mere irregularities, but illegalities.

Therefore, it is a plain and obvious case for striking out where leave of the court has not been obtained to commence a derivative action on behalf of a company. Leave of the court must be obtained before commencing a derivative proceeding and the leave order must reflect that the leave granted is for the complainant to take action on behalf of the company.

Further, the common law derivative action has been abrogated. Thus, a derivative action on behalf of a company cannot be initiated by way of a representative capacity. A complainant, upon obtaining leave of the court to commence an action on behalf of a company, must name the company as the plaintiff in the intended action. Failure to do so has proven futile, even if the pleadings make it clear that the action has been brought for the benefit of the company.

For further information on this topic please contact Gan Khong Aik or Kang Mei Yee at Gan Partnership by telephone (+603 2201 1130) or email (khongaik@ganlaw.my or meiyee@ganlaw.my). The Gan Partnership website can be accessed at www.ganlaw.my.