It is not uncommon to see cracks start to form in business partnerships; however, it often makes it difficult when dealing with a proprietary run by co-directors who also happen to be family members or friends. Many directors, shareholders and other company officers are often unaware that when a dispute arises between directors and/or shareholders of the same company, they have legal standing to do something about it on behalf of the company. The following provides information on the avenue of bringing a derivative action.
WHAT IS THE DEFINITION OF A DERIVATIVE ACTION?
If a director and/or a shareholder consider that actions taken by another director or shareholder are causing loss and damage to the company, they have the right to bring an action against the responsible person on behalf of the company – these types of actions are known as 'derivative actions'. Derivative actions are governed by Part 2F.1A Corporations Act 2001 (Cth).
There are two avenues which can be pursued. Firstly, the director of a company may choose to pursue a derivative action by establishing certain factors giving rise to the right to act on behalf of the company. Examples of actionable conduct carried out by directors include:
- Using the position as director to gain an advantage whether it be for personal benefit or for the advantage of someone else;
- Failing to avoid/manage conflicts of interest which may arise due to personal motives conflicting with what is in the best interest of the company; and
- Using information which was obtained in the course of carrying out a director's role for personal benefit to the detriment of the Company.
Alternatively, where shareholders have been oppressed by the conduct of the directors, they also have a right to bring an action against the directors on behalf of the company. Some examples of oppressive conduct are:
- Directors diverting corporate opportunities in the pursuance of personal profits;
- Manipulating control of the board either by appointing additional directors or issuing shares to the majority;
- Excluding a minority shareholder from involvement with the company and its dealings;
- Denying a shareholder the right to remain informed about the affairs of the company; and
- Altering the company's constitution to impose unrealistic conditions on minority shareholders.
WHAT IS REQUIRED TO BRING A DERIVATIVE ACTION?
There are two key elements which need to be established for a director to bring a claim on behalf of a company:
- First, it must be established that the company itself is unlikely to commence proceedings;
- Second, it must be established that the director bringing the claim is acting in good faith. In other words, the action being commenced must be in the best interests of the company. There are many factors taken into consideration when determining whether a derivative action would be in the best interests of the company. What is in the best interests of the company is not solely determined by the financial implications. This is also important to consider where the dispute has not yet impacted the company's ability to continue to operate.
WHAT ARE THE AVAILABLE REMEDIES?
Once the right to bring a derivative action is established, there are a number of remedies the affected party can pursue before the court. The court will order the remedy which is in the best interests of the company moving forward. If a director is found to have not acted in the best interests of the company, a share-buy out may be the ideal outcome. Alternatively, the court may make an order that the director compensate the company.
When conflict arises, it is common for parties to take a purely financial perspective and request for a liquidator to be appointed to recover funds invested in the business or joint venture. Whilst the winding up of a company is an option; it is only available in extreme circumstances where the company is unable to continue to operate.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.