Is common law derivative action available to close corporations? – Shareholders

A derivative action is an action brought by a person on behalf of a company to protect the legal interests of a company. This is a well-known corporate remedy, but what about the Close Corporations Act 69 of 1984 (“Close Corporations Act”)?

Yes, existing private companies continued to exist beyond the enactment of Companies Act 71 of 2008 as amended (the “Companies Act”), but does that mean private companies benefit of the same thing?

Recent court case

In Naidoo and another against The Dube Tradeport Corporation and others [2022] ZASCA 14 (the “case”), the facts were as follows:

The case was an appeal against the order of the KwaZulu-Natal Division of the High Court in Durban. In action, Mr. Sagadava Naidoo (Sagadava) and related company Odora Trading CC (Odora) sued Mr. Sivaraj Naidoo (Sivaraj) and Dube Tradeport to reverse the sale of specific farms, known as Penare Farm Properties (properties) by Odora at Dube Tradeport. Sagadava and Sivaraj are brothers, hence the reference to them by their first names. Sivaraj is the only registered member of Odora and therefore owns the entire member interest.

In December 2001, Odora purchased the properties. On January 20, 2001, Sagadava and Sivaraj entered into an oral agreement whereby certain assets in Sagadava’s possession would be divided between the two brothers on a 50/50 basis (the “2001 Agreement”). These assets included interest and the loan account of Sagadava members in Odora. As we have already said, the properties in question were already Odora’s assets at this point. As a result, the properties became part of the 2001 agreement. The final agreement was that the assets would be registered in the personal names of Sagadava and Sivaraj. However, the latter repudiated the 2001 agreement and refused to sign any trace of it. In response, Sagadava refused to accept Sivaraj’s repudiation and opted to hold him responsible for the deal.

As an alternative to the 2001 Agreement, Sagadava and Sivaraj entered into an agreement in which Sivaraj would hold certain assets on behalf of Sagadava as its agent (the 1998 Agreement). Shortly thereafter, in 2001, Odora purchased the properties, which formed part of the 1998 deal. On January 13, 2014, Sagadava filed suit in the High Court against Sivaraj, asking that his (of Sagadava) in Odora be transferred and handed over to him. Sivaraj defended the action, saying he was also acting on Odora’s behalf.

In its judgment, the High Court first considered whether common law derivative action was available in respect of closed companies and found that it was. Then, however, he concluded that because Sagadava was not a registered member of Odora, he was not entitled to it. Therefore, according to the High Court, neither Section 49 nor Section 50 of the Closed Companies Act granted Sagadava the right to bring an action on behalf of Odora. In any event, the High Court concluded, as Sagadava had relied on the common law derivative action to advance Odora’s prosecution, he could not rely on Section 50 of the Close Corporations Act.

The law

In the English decision of Foss vs Harbottle (1843) 2 Hare 461; 67 ER 189 that individual shareholders have no cause of action at law for any wrong done to the corporation. Further, if an action is to be brought in respect of such losses, it must be brought by the company itself. Additionally, the exception is available when what has been done amounts to fraud and the wrongdoers control the business. Although there has been no express adoption by this Court of the English law of derivative actions as part of our common law, it has been applied consistently.

In this case, the Court of Cassation noted that before the promulgation of the Companies Act, a derivative action under common law was recognized with regard to companies, and by extension, to closed companies. Accordingly, statutory rights have always been parallel and complementary to the common law rights of corporate shareholders and related corporate members to bring derivative actions on behalf of their respective corporations. They were never intended to oust common law rights.

However, the Companies Act abolished the common law derivative right of action in section 165 and replaced it with a statutory right. However, this did not affect the common law rights in respect of private companies incorporated before the Companies Act came into force but which did not incorporate under that Act. Therefore, the situation remains that the common law rights of members of private companies, including a beneficial and unregistered owner of a member’s interest, to bring a derivative action are still available. Accordingly, the appeal was allowed.

Conclusion

In the case of agreements not honored in equity or in participation, the remedy of common law is always available. Therefore, such agreements should not be entered into lightly and should be accompanied by professional legal advice. Contact a SchoemanLaw expert for assistance.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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