A Deadlocked Company and The Shareholder’s Derivative Action

What happens if a company is in a deadlocked situation and one faction of shareholders commits wrongdoing against the company? Can the other half of the shareholders of the company seek redress against them? This question was tackled in Perak Integrated Network Services Sdn Bhd v Urban Domain Sdn Bhd (on behalf of themselves and Pins OSC & Maintenance Services Sdn Bhd through derivative action) & Anor, where the court allowed a faction of shareholders of a company to initiate a derivative action against the other half of the shareholders of the company. 

What is a derivative action?

A derivative action is a court application whereby an individual shareholder of a company (with leave from the court) initiates, intervenes or defends a proceeding on behalf of the company. This is an exception to the rule laid down in Foss v Harbottle, where the court held that only the company (via the appropriate individual) can initiate, intervenes or defend a proceedings on behalf of the company and no other individual member can complain their grievances if a majority shareholder of the company is in favour or willingly accepts the consequences of an action i.e. wrongdoing for or against the company.

However, what happens if the wrongdoing is committed by the majority shareholder of the company or the wrongdoing is committed by a faction of the shareholders in a deadlocked company? In such a situation, the minority shareholder could not rectify the issue because any intention of them to bring an action against the majority shareholders would undoubtedly be voted down by the majority shareholders.

Therefore, this exception came into play to allow the minority shareholder or individual shareholders and shareholders in a deadlocked company to seek redress which is not allowed in the general rule.

What is a deadlocked company?

A deadlocked company occurs when the company is equally split between directors with opposing views. In such a situation, no resolution can be passed, effectively putting the operation of the company at a standstill and rendering it inoperable.

Can a derivative action be brought against a deadlocked company?

Yes. The court held that one faction of the shareholders can still bring a derivative action against the other faction provided that:

1. The other faction committed wrongdoing; and 
2. The faction who committed wrongdoing has control over the running of the affairs of the company. 

How does one determine which faction is in control of a deadlocked company? In this case, the court relied on the case of Parallel Media Group Plc & Anor v Asia PGA Bhd & Ors and stated that control can come in many forms and carried out in many ways. For example, a managing director with casting vote could, in theory, manipulate the outcome of a vote by deliberately vote in a manner that would prevent the company from taking up any actions against any wrongdoing that was committed by a faction of the shareholder for the benefit of the company. 

What happens if there are alternate remedies?

The court held that generally, a derivative action can only be instituted if there are no other ways to institute an action against the company. However, this does not mean that one can immediately institute a derivative action- it is dependant on the circumstances and facts of each case i.e. the nature of the relief sought and whether the elements of such relief (i.e. just and equitable winding up) can be satisfied in each case. 

However, this case was heard in 2012, where derivative action is still considered common law. Since then, the common law principle has since been replaced by written law, namely the new Companies Act 2016.  Anyone who wishes to institute a derivative action should take note of it.

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