The Company
11.5 Corporate governance in China
11.6.5 Shareholder derivative action Section 165 of the new Company Act provides
(1) Any right at common law of a person other than a company to bring or prosecute any legal proceedings on behalf of that company is abol- ished, and the rights in this section are in substitution for any such abolished right.
(2) A person may serve a demand upon a company to commence or continue legal proceedings, or take related steps, to protect the legal interests of the company if the person –
(a) is a shareholder or a person entitled to be registered as a share- holder, of the company or of a related company;
(b) is a director or prescribed officer of the company or of a related company;
(c) is a registered trade union that represents employees of the com- pany, or another representative of employees of the company;
or
(d) has been granted leave of the court to do so, which may be granted only if the court is satisfied that it is necessary or expedient to do so to protect a legal right of that other person.
(3) A company that has been served with a demand in terms of subsection (2) may apply within 15 business days to a court to set aside the demand only on the grounds that it is frivolous, vexatious or without merit.
(4) If a company does not make an application contemplated in subsec- tion (3) that subsection, or the court does not set aside the demand in terms:
(a) appoint an independent and impartial person or committee to investigate the demand, and report to the board on -
(i) any facts or circumstances –
(aa) that may give rise to a cause of action contemplated in the demand or;
(bb) that may relate to any proceedings contemplated in the demand;
(ii) the probable costs that would be incurred if the company pursued any such cause of action or continued any such pro- ceedings; and
(iii) whether it appears to be in the best interests of the company to pursue any such cause of action or continue any such pro- ceedings; and
(b) within 60 business days after being served with the demand, or within a longer time as a court, on application by the company, may allow, either –
(i) initiate or continue legal proceedings, or take related legal steps to protect the legal interests of the company, as contem- plated in the demand; or
(ii) serve a notice on the person who made the demand, refusing to comply with it.
(5) A person who has made a demand in terms of subsection (2) may apply to a court for leave to bring or continue proceedings in the name and on behalf of the company, and the court may grant leave only if –
(a) the company –
(i) has failed to take any particular step required by subsection (4);
(ii) appointed an investigator or committee who was not inde- pendent and impartial;
(iii) accepted a report that was inadequate in its preparation, or was irrational or unreasonable in its conclusions or recom- mendations;
(iv) acted in a manner that was inconsistent with the reasonable report of an independent impartial investigator or commit- tee; or
(v) has served a notice refusing to comply with the demand, as contemplated in subsection (4)(b)(ii); and
(b) the court is satisfied that –
(i) the applicant is acting in good faith;
(ii) the proposed or continuing proceedings involve the trial of a serious question of material consequence to the company;
and
(iii) it is in the best interests of the company that the applicant be granted leave to commence the proposed proceedings or continue the proceedings, as the case may be.
In a recent case, Kenneth H. Mouritzen v. Greystones Enterprises (Pty) Limited , 16 the Kwazulu Natal High Court, Durban, clarified the prerequisite demand and the good faith requirement under the new statutory shareholder derivative action set out in section 165.
The facts of the case can be summarized as follow:
Plaintiffs, Kennneth Hansen Mouritzen and Digby Hall Mouritzen, are
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brothers and the only directors of Greystones Enterprises (Pty) Limited (‘the company’).
The company has 198 shares in issue, all of which rank pari passu and
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98 of these are held by the Mouritzen Family Trust, a trust established for the benefit of the Mouritzen family.
Digby Hall Mouritzen and his wife, Agnes, each hold 49 shares (a total
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of 98) and the remaining two are held by Shirley Johnston and Merle Larka, the sisters of the Mouritzens.
Kenneth Hansen Mouritzen and Digby Hall Mouritzen, as co-directors,
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are paid equal monthly salaries by the company. In addition to their salaries an arrangement was put in place in terms of which personal credit cards were issued in the names of each one of them.
The credit cards were linked to the company’s First National Bank
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account in the sense that all credit card transactions are automatically debited to, and paid by, the company.
Plaintiff, Kenneth Mouritzeno alleged gross abuse of the personal
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credit card used by his brother, Digby Mourtizen, to the detriment and prejudice of both the company and its shareholders, particu- larly the Mouritzen Family Trust, of which Kenneth Mouritzen is the trustee.
Plaintiff, Kenneth Mouritzen quoted the following instances in which
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he alleged the company was caused to pay for the applicant’s personal expenses:
(1) Luxurious world travel, unrelated to the company, undertaken by the applicant and his life partner, Jo Ann Mellon.
(2) Entertainment unrelated to the company.
(3) Payment of expenses on behalf of entities other than the company in which the applicant had a direct or indirect interest.
(4) Purchase of spares on behalf of entities in which the applicant had a direct or indirect interest.
(5) Payment of general personal expenses, including the dental and medical bills for the applicant and Jo Ann Mellon.
Kenneth Mouritzen, through his attorneys, delivered by post to the
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company a letter dated May 23, 2011, which letter served as a demand in terms of section 165 of the Act (‘the demand’). The demand was responded to by his brother Digby Hall Mouritzen by an email dated May 30, 2011 which he addressed to Mr Graham Cox, the plaintiff’s attorney.
Digby Mouritzen objected to the demand on the ground that the
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demand does not meet the requirement envisaged in subsection (2) of section 165 of the Act which prescribes that the demand has to be served on the company. Mr Harrison argued that, in this context, the word ‘serve’ can only be understood to mean service on the company at its registered office or at its principal place of business.
On the merits, Mr Harrison submitted that this application is not being
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instituted in good faith and that the applicant has been driven by an ulterior motive occasioned by the animosity which exists between them.
The Kwazulu Natal High Court started by examining in section 165(2)
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the ‘may’ used under section 165(a) as to the prerequisite demand. The High Court held that despite the use of the ‘may’ under section 165(5), the service of the demand on the company is an essential prerequisite for the institution of an application under section 165(5). That in the absence of such a demand a derivative-plaintiff would obviously be barred from initiating legal proceedings on behalf or at the behest of the company. Such a demand is imperative and it is compulsory that any prospective applicant must comply with the service requirement before proceeding in terms of section 165(5).
Then the High Court moved to consider the requirement that a plaintiff under section 165 must act in good faith and in the interests of the com- pany. The High Court started by expressing a general principle that in instances where a person does not act in good faith but is driven by an ulterior motive, such as personal vendetta, it will generally not be in the best interests of the company. The High Court looked at the facts of the case. It found that the plaintiff, Kenneth Mouritzen, himself offered to have his own credit card account examined in the same way as he sought to be done to his brother. Such conduct would be consistent in a person acting in good faith. Accordingly, the High Court found that the appli- cant succeeded in demonstrating on a preponderance of facts that he was acting in good faith, and that the proposed legal action was in the best interests of the company as envisaged in section 165(5)(b)(iii) of the Act.