Why derivative actions against companies are becoming so popular in Kenya

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By gatuyu tj

Once upon a time, this being before August 2015, there was rule, based on common law. It was the rule in Foss v Harbottle. It affirmed, that a company is a separate legal personality, distinct from its shareholders.

Thus, a shareholder could not bring an action on behalf of the company, however aggrieved. It was the company, and the company alone, that could sue on a wrong suffered by it. But there were exceptions to the rule, which a potential derivative claimant had to satisfy.

In 2015, there came the Companies Act. The Act found the rule in Foss v Harbottle to be unhelpful, and scrapped it. It means that a shareholder dissatisfied with the running of the company, can sue the directors of the company, on behalf of the company. We call this a derivative action.

By way of a definition therefore, a derivative action is a mechanism which allows shareholders to litigate on behalf of the company. Often, this is against an insider (whether a director, majority shareholder or other officer), whose action has allegedly injured the company.

Since the enactment of the Kenyan Companies Act, the overarching question has been. What are the parameters upon which the action could be founded and explored? It was not clear.

It was not clear until recently, when the High Court in Ghelani Metals Limited & 3 others v Elesh Ghelani Natwarlal & another, clarified the issue. Facts of the case. Directors of Ghelani Metals allotted and issued shares of the company and changed a company secretary without knowledge of its members and following required procedure. The plaintiff filed a case on behalf of the company, citing a wrong done. He alleged the erring director was committing fraud against the company.

In the judgement, the court first, settled the procedural aspect of pursuing a derivative action. It affirmed that derivative action is pursued as a two stage process. In the first stage, the Court would first consider whether the action pleaded disclosed the existence of a case, on the face of it. Frivolous claims, will be denied judicial approval, and struck out.

In the second stage, the Court will then go into depth. It will consider statutory provisions and factors which would ordinarily guide judicial discretion in the realm of derivative action.

Therefore, the court said, derivative actions can be commenced only in respect of a causes of action arising from an actual or proposed act or omission involving negligencedefaultbreach of dutybreach of trust by a director of the company.

In this, the court will consider three factors. One, the seriousness of the alleged wrong. This will be determined by conducting a cost-benefit analysis of the intended action. A derivative claimant would need to know.The intended litigation should not disrupt the company’s business. The cost of the intended litigation should not be burdensome to the company. Issues of reputational damage, will also be considered.

Two, the derivative suit ought to be allowed if it was in the best interests of the company. Three, other alternative remedies must have been explored and considered. This should be a last result option.

With this judicial clarification, the days ahead, are the days of derivative claimants.

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