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THE DERIVATIVE ACTION
Nicholas Petzwinkler
9 December 2021

The general dictates of corporate law is that majority vote rules the day. This is a trite corporate law principle that was entrenched in our law in Sammel v President Brand Gold Mining Co Ltd 1969 (3) SA 629 (A). In this case it was stated that should the decision of the majority be arrived at in a lawful manner, even if this adversely affected the rights of the minority, the majority’s rule would bind the dissenting minority as the “supremacy of the majority is essential to the proper functioning of companies”.

However, what does one do as a minority shareholder when the majority unlawfully abuse their dominant position? In these instances, a minority shareholder must rely on one of the minority shareholder protection mechanisms as provided for in the Companies Act, 71 of 2008 (hereafter referred to as the “Companies Act”). One such minority protection remedy is the derivative action.

Based on the principle of separate legal personality a company is a separate entity apart from its owners. Therefore, the debts of the company will remain the debts of the company and the owners of the company (the shareholders) will not be liable for these debts. Likewise, a company’s assets and profits will remain the company’s assets and profits and at no stage will it belong to the owners of the company. Should a shareholder wish to extrapolate profits from the well performing company they must withdraw these profits in a lawful manner (by means of declaring a dividend, for example).

The above principles lay the theoretical groundwork for an important aspect of the derivative action, namely – who may bring an action on behalf of the company. Due to the principle of separate legal personality, it is the company that must institute and defend actions in its own name. Accordingly, section 66 of the Companies Act states that the board of directors of the company are endowed with the necessary authority to decide when to defend and institute action on behalf of the company, as the board of directors must manage the business and the affairs of the company.

The problem, however, arises when it is the directors who act unlawfully in order to make a profit at the expense of the company, for their personal gain (by misdirecting corporate opportunities, for example). When this happens it is the board which must institute action against such a person who caused the company harm in order to recover such loss or damages suffered. It is all fine and well to state that the board should act against one of their own as this is their statutory duty, however, in practice this is very often not the case.  

In such an instance the minority shareholder is often the shareholder left to suffer at the hands of the majority as he or she can neither out vote the other shareholders, is often left unrepresented on the board of directors and cannot force or encourage the board of directors to institute action against the miscreant director in order to recover the financial loss experienced by the company. Thus, the minority shareholder is left with a rather grim looking position as they may have undervalued or unwanted shares and the company will not recover the loss as it is at the helm of self-serving directors and action.

It is in this instance that section 165 of the Companies Act allows for the minority shareholder to bring an action on behalf of the company in order to recover the loss it has suffered. As the name suggests, the shareholder derives this power to bring the action (which under normal circumstances he or she would not have) from the company, and in so doing acts on the company’s behalf to recover any loss or damage suffered.

Should the shareholder be successful in bringing the derivative action the company will be awarded the relief. The shareholder may in such instances request the company to reimburse him or her for any costs incurred in bringing the action. As there are various procedural hurdles and practical cost considerations to be borne in mind up until a successful award and recovery of costs this remedy has not been implemented as freely nor successfully as one would think. However, should the right circumstances present themselves this remedy could aid any minority shareholder (or another interested party) with corporate governance even when the power of the majority vote or representation is not on their side. If this remedy will be used more frequently in the future – with good corporate governance on the rise – remains to be seen.