Clear legal principles for derivative actions by shareholders or directors

In this case, the High Court stated that there is no dispute as to the legal principles applying to applications by a shareholder or director for leave to bring derivative action on behalf of a company under section 165 of the Companies Act 1993.

Tweedie and Newcombe, the directors and shareholders of Packsys, fell out. Tweedie sought leave of the Court (1) to sue Newcombe in Packsys's name and at its expense because Newcombe had set up a Packsys business in Australia without proper authorisation or consent. The Court observed that the falling out of the parties was not helped by Tweedie twice covertly gaining entry to Packsys's premises and removing material, including cloning the hard drive on its computers, in search of evidence to support his assertions.

Section 165 of the Companies Act 1993 allows a shareholder or director of a company to take action on behalf of and in the name of the company in any situation where the company has a right to proceed that it is not exercising. The shareholder or director must first obtain the leave of the Court.

The High Court in this case made it clear that the test for the granting of leave is whether a prudent business person would be likely to commit the company to litigation, should the decision lie with that person, after considering the factors listed in section 165(2).

Section 165(2) requires consideration of:

1. the likelihood of success;



2. the likely costs in relation to the likely relief;



3. any action already taken by the company to obtain relief; and



4. the interests of the company in proceedings being commenced.

The Court observed that the threshold for granting leave under section 165 is not high, and noted an earlier case(2) in which it was said that applications such as these are not an interim trial on the merits, but require consideration of the amount at stake, the apparent strength of the case, the likely costs and the prospect of satisfaction of any judgment.

In this case, Tweedie was granted leave, although Williams J advised both parties to resolve their differences without litigation: "They should bear in mind that the evidence to date suggests the amount in issue in the case may well turn out to be of no great moment and that, at the end of the litigation unless something else occurs, they will still both be shareholders and directors of Packsys. Derivative actions are not an appropriate vehicle for leveraging increased share offers by third parties or directing share sales".

 

(1) Tweedie and others v Packsys Limited and Newcombe (CIV 2005-404-1038, High Court Auckland, 2 June 2005)

(2) Vrij v Boyle (CP31/94, High Court Auckland, 24 July 1995)

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