Representative action under the spotlight: Law Reporter

Do shareholders have sufficient flexibility in challenging the actions of directors?

When the Federal Government amended the Corporations Act to introduce the business judgment rule, the so-called quid pro quo for the introduction of this safe harbour for directors was the simplification of the rules for shareholders wishing to challenge actions of directors which they believed were wrong or which involved breach of duty. The old rule of Foss v Harbottle which had raised certain obstacles for shareholders wishing to sue directors was seen as a matter that should be disposed of and changes were made to the Corporations Act (then the Corporations Law) to overcome these matters. There have been very few cases in which these particular matters have been the subject of court consideration. Now, in two cases, one in the Supreme Court of New South Wales and one in the Queensland Court of Appeal, the ramifications of the new representative action have been considered. The Queensland Court of Appeal decision of Metyor Inc (formerly Talisman Technologies Inc) v Queensland Electronic Switching Pty Ltd ((2002) 42 ACSR 398) is the first Full Court or Court of Appeal decision which has considered the ramifications of the new representative action contained in sections 236 and 237 of the Corporations Act in any detail. The second case, Swanson v R A Pratt Properties Pty Ltd & Anor ((2002) 40 ACSR 313) may be appealed.

The facts of the Metyor case are these. A contract had been entered into for the provision of services, technology and equipment to the Bank of Queensland by a joint venture company owned in part by the Bank of Queensland (or rather its wholly owned subsidiary) (as to 49 percent) and by certain other companies including the appellant in this particular case, Metyor. It was argued by the minority shareholders (Metyor which owned 22.5 percent of the share capital and one other minority shareholder) that the majority shareholders, including the Bank of Queensland, had repudiated the various contracts. The majority shareholders argued that the minority shareholders could not bring the action on behalf of the company because of the old rule in Foss v Harbottle which states that the company must be the plaintiff in such cases. The defendants also argued that any loss of capital on the part of the minority shareholders in the joint venture company was not recoverable by them – it was only recoverable by the joint venture company.

When these technical pleadings were raised, the minority shareholders sought leave under the new representative action contained in sections 236 (and 237) to bring proceedings in effect on behalf of the joint venture company. This meant joining the joint venture company as a co-defendant. When the matter came to the court, first in the Supreme Court of Queensland, leave to join the joint venture company was refused on the basis that until the contractual disputes between the shareholders had been resolved it could not be determined what was in the best interests of the joint venture company. The view adopted by the judge at first instance in this case was supported, in part, by Justice Palmer in the New South Wales Supreme Court in Swanson v R A Pratt Properties. We shall return to that case shortly. However, in my view the issues raised by the trial judge are the kind of matters that the court should consider under the representative action provisions. Under these provisions, before the court grants leave for proceedings to be brought against the company it must be satisfied that:

"(a) it is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; and

(b) the applicant is acting in good faith; and

(c) it is in the best interests of the company (that is the defendant company) that the applicant be granted leave;

(d) ... there is a serious question to be tried (as well as certain typical other rules in relation to granting of information etc)." The Queensland Court of Appeal had the following arguments put to it by the majority shareholders:

1. It was undesirable that minority shareholders should be authorised on behalf of the joint venture company to conduct proceedings to enforce corporate claims that may compete with the personal claims that the minority shareholders may have in the relevant action.

2. The minority shareholders should not be permitted to join the joint venture company as a defendant because the statute did not envisage that the joint venture company would be a defendant. The Court of Appeal rejected the arguments put forward by the respondents. In its view, to require that all disputes between the shareholders should be resolved before an action of this kind would be brought would defeat the very purpose for which the relevant sections had been introduced into the legislation. In the past when actions were brought on behalf of the company (known as derivative actions), the rule in Foss v Harbottle generally required the company to be the plaintiff unless the special exception could be taken.

The approach suggested by the majority shareholders was in the opinion of MacPherson CJ (on behalf of the court) against the spirit of the legislation that had been enacted. Indeed, he suggested that it was against the spirit of the exceptions to the rule in Foss v Harbottle that had been developed by the courts. The Court of Appeal took a generous view about the reforms introduced by the new provisions. McPherson CJ on behalf of the majority stated that this particular case was one which was clearly contemplated by the amendments to the statute (that is sections 236 and 237). He held that the plaintiffs should be granted leave on behalf of the company: "There are two conflicting groups of shareholders, of whom one is, as the minority, unable to set the company in motion to vindicate its rights because the majority, who are alleged to be the wrongdoers, oppose the company's doing so. If under such conditions the statutory procedure is not available to the plaintiffs as the minority members, it is unlikely that it will be available in many, perhaps most, other circumstances. For my part, I cannot accept that, in speaking of 'the best interests of the company', what the [relevant section] has in mind is some kind of cost benefit analysis of the possible outcomes of the prospective litigation, which is an assessment that it would be almost impossible to make with any degree of confidence or accuracy. There may be cases in which it will plainly not be in the best interests of a corporation considered as a trading entity to engage in litigation that is likely to result in much harm and little or no evident benefit to the company. The present is, however, not a case of that kind." (para 11)

In this case the plaintiffs argued that the defendants, or at least the bank and one other shareholder, had for commercial reasons set out to frustrate the contract which was the prerequisite to the success of their joint venture. Whether the plaintiffs could make out this claim of course depended on the facts to be argued before the court. McPherson CJ felt the court would not stand in the way of the plaintiffs in allowing them to pursue this matter so this issue could be evaluated. In the NSW case the facts were quite different. Unlike the Queensland case where the dispute was current and the parties were commercially at risk in the context of the decision that the court had to make, the NSW case involved allegations of breaches of duty on the part the directors some years before the relevant litigation. The facts of the case were these: S was a director and shareholder of the company and sought leave under section 237 of the Corporations Act to bring proceedings against H in the name of the company. H was the former director of the company and the former husband of S.

It was alleged by S that in 1994 H, while a director of the company, procured a payment of nearly half a million dollars from a sale of property in which the company had an interest for his own benefit or at least for the benefit of two companies in which they were directors. S further alleged that this payment was in breach of his duties as a director both at common law and under the statute. She further alleged that while she had signed the relevant document she was unaware of the true purposes of the particular transaction and only when she became aware of it did she wish to seek the payment. Her brother, who was also a director, objected to her application. One of the grounds he argued was that the application was not appropriate because the beneficiary of any successful action in this case would not be the company. In dismissing S's application Palmer J made some interesting observations about how the legislation should be interpreted. In this context he probably would have benefited from the reasoning of MacPherson CJ in the Metyor case. Indeed, he referred in passing to the decision of the trial judge in the Metyor case to support his view that leave should not be granted in this particular case. Although Palmer J rejected leave in this case his consideration of some of the matters that the applicant would have to establish to a court in showing that the proposed action was in the best interests of the company, are quite interesting and bear repeating.

"The character of the company; different considerations may well apply depending on whether the company is a small, private company whose few shareholders are the members of the family or whether it is a large public listed company. If the company is a closely held family company, it may be relevant to take into account the effect of the proposed litigation and the purpose for which the company was established and on the family members who are the shareholders. If the company is a public listed company, such considerations will be irrelevant. Again, the company may be a joint venture company in which the venturers are deadlocked so that the proposed derivative action [could be seen] as being for the purpose of vindicating one side's position rather than the other's." (para 57) In addition to determining the nature of the company, the applicant must also bring evidence of the business that the company conducted to enable the court to assess the effect that the proposed litigation would have. Thirdly, the court needed to know whether the relevant litigation was the most appropriate way for the issues to be addresses. For example, could an alternative action (for specific performance of the contract or for an injunction) be a more appropriate action?

Finally, the court had to determine whether if the court made an order the relevant order could be given effect to by appropriate monetary and other payments that would flow. The court was not satisfied that an order should be made in this case. For a start the particular complaints were now nearly eight years old and therefore any statutory breaches were no longer relevant. While the common law duties were still relevant (because no statute of limitations applied) the court was not satisfied that this was a case in which any benefit would accrue to the company in pursuing the action. Palmer J relied in part, in reaching the conclusions that leave should not be granted on the trial Judges decision in the Metyor case which we discussed earlier. Clearly each case will turn on its own facts. In the Metyor case the dispute was a current dispute in relation to a contract. The Queensland Court of Appeal had no difficulty in agreeing with the proposal that the plaintiffs should be given leave to bring proceedings – whether they would have been successful, as MacPherson CJ noted, would depend on how the facts were argued before the court.

It will be interesting to see whether any appeal is brought in the Pratt case in light of the Court of Appeal decision in Metyor. From my perspective, the situations are very different and one can fully understand why a court does not want to wind the clock back in relation to a matter of the kind enunciated in the Pratt case unless some additional factors need to be taken into account. In each case, the plaintiffs could have sought a different remedy – a remedy in oppression under section 232 of the Corporations Act. That wasn't part of the proceedings brought – perhaps they were proceedings being held in abeyance pending the outcome of litigation in this case.

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