Day 136 Derivative action

Derivative action

As a separate legal entity, the right to enter the legal proceeding would generally be allocated to the company itself. However, in some cases the company is unwilling or refuses to do so because the majority votes overpower the minorities. More importantly, if the minorities are in a small private company, they may not be able to escape from this abuse of power, due to the constitution prohibits them to sell their shares. In order to protect the legal rights for the minority, the Corporations Act has introduced the derivative action provision. 

Under S.236 Corporations Act(2001), the member or officer may apply to obtain a court order, hence they may act on behalf of the company to enter legal proceedings. In other words, the power of intervene legal proceedings will be transferred to members/officers if this session applies. This provision is further explained under S.237, which defines the consideration for the court to comply in regard to grant the leave. Basically, there are five elements that ratify the derivative action. First of all, if the company is not taking actions to bring the proceeding, or not properly taking responsibility of them, For instance, if the director breached his duty of care and diligence, it is possible the company will not sue him for this misconduct since he controls the majority of votes. In addition, the court stated that the purpose of bring this application must be in good faith. Therefore, the court will consider whether the motivation of the applicant is a good cause, and he/she on reasonable ground believes there is a probability to success. Moreover, the action must carry out the best interest of the company. Thus the court may disapprove the application if the matter is minor or the cost is larger than the benefits. Furthermore, a serious questions to be tried in this application, where the claim must be supported with sufficient evidence in order to allow the court to determine the characteristic of the problem. At last, the applicant must give the notification about relative matters to the company 14 days prior, and the court may also grant the leave even if the notice is not given, 

The diversification action is a statutory remedy used to protect the rights of the minority members. It is important for us to understand once this process started, it cannot be stopped unless receiving court’s permission.