Preventing directors getting away with it Law Reporter

Using the Corporations Law representative action – the onus is quite high.

When the Corporations Law amendments in the year 2000 introduced a statutory representative action to overcome the alleged difficulty created by the rule in Foss v Harbottle ((1843) 67ER 189) (which states basically that only the company can take action to prevent certain conduct from being pursued), it was felt that this would provide shareholders with an appropriate remedy to prevent directors or others who are misbehaving from "getting away with it". One of the attractive features of the new statutory representative action was that the company would pay the costs of the litigation. But, the legislation had been carefully drafted to ensure that before action was brought on behalf of the company by a shareholder that the court should assess whether the statutory representative action should in fact be brought. In Chapman v E-Sports Club Worldwide Ltd & Anor ((2000) 35 ACSR 462) Mandie J in the Victorian Supreme Court in one of the first reported case on the merits of a claim ruled against the shareholder. Our treatment of the case comes from the Butterworths Law Report.

The plaintiff, Chapman, commenced proceedings in substance as a representative or a derivative action on behalf of the E-Sports Club Ltd (E) against another company, the E-Sports Club Worldwide Ltd (EW) in relation to certain intellectual property which had been transferred by E to the second company EW. Mandie J agreed that the statutory representative or derivative action now replaced the rule in Foss v Harbottle (following the decision of Santow J in Karam v Australia and New Zealand Banking Group Ltd (2000) 34 ACSR 545). Under these circumstances the only way in which Chapman could pursue the action in the name of E was to obtain the court's permission. Having reached that conclusion Mandie J then went on to consider the terms of the relevant section of the legislation. He noted that section 237(2) was "oddly worded". He further noted that the section provides that the court had to grant an application (the word used in the section is "must") if it is satisfied of the relevant matters. He decided that it was not necessary to consider whether the court had a residual discretion in the matter because "the conclusion I have reached is that even if the court did have such a residual discretion it ought not be exercised in favour of the plaintiff [in this case]." He then added that it would be difficult to imagine that a court would grant leave unless it was satisfied that the relevant applicant was acting in good faith, or was otherwise not satisfied that the application was in the best interests of the company, or that there was a serious question to be evaluated by the court.

When he looked at the facts of the case the judge felt that the affidavit evidence in support of the applicants was unsatisfactory. The statements were that there were inaccuracies in the relevant documentation relating to the transfer of the intellectual property (which apparently was transferred for no real value). As against what the applicants stated – namely that the minutes were inaccurate – the directors of the company "have put in substantial material supported by a large body of exhibits which appear to show that the transaction was done for good commercial reasons, and not only that, [but] that [Chapman] has not been harmed by the transaction because he is entitled to an equivalent shareholding in the new company [EW] . . . The material tends to show – if it shows anything at all – that [Chapman] is attempting to use this proceeding as a device to put pressure on the other parties to buy him out." (para 10) While not required to make a positive finding in relation to these issues, the judge noted that when he looked at all of the material he was not satisfied that Chapman was acting in good faith.

In examining what was in the best interests of the company the judge noted that he was not satisfied that the material showed that it was in the best interests of the company for the proceedings to be brought. He further noted that very little had been said about the company itself in the materials. However, it was important, on the basis of the legislation, for the potential litigation to be examined from the perspective of the company. The information brought before the court (and the onus lay with the plaintiff who wanted to bring the proceedings) was that there was no material information about how the company would be affected by the relevant litigation. Finally, the judge was not satisfied on the material before him that there was a serious question to be tried. In fact, in his view, the evidence was heavily one way "and it seems to me that a lot more material would be required and a lot more explanation would be required from the applicant in order to establish that there is a serious question to be tried." (para 14)

In all the circumstances the court would not grant leave for these proceedings to be brought. The judge noted in passing in reaching this conclusion that he was fortified by his conclusion by considering that Chapman "has a right to bring oppression proceedings [under section 246AA of the Corporations Law] as a shareholder in relation to E, and if he can establish that there has been oppressive or unfair conduct within the meaning of the legislation towards him in his capacity as a shareholder of [that company], he could no doubt obtain appropriate relief . . ." (para 15). Indeed, Mandie J noted that, although it may be a more long-winded way of achieving certain results, it may be "a fairer approach because it can then be determined whether the interests of the 10 percent shareholder [Chapman] should outweigh the interests of the other 90 percent [shareholders] who do not wish the company to bring this proceeding." (para 15) The decision is a good example of the significant burden that will apply in relation to these new statutory derivative or representative actions. The better way for shareholders to proceed may well be to use the oppression remedy (ie section 246AA) or to rely on section 1324 of the Corporations Law if breaches of duty are involved.

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The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.