When you’re navigating a separation or divorce, it is not uncommon for a situation to arise where a company run by co-directors also becomes involved in a family law dispute over the operation of a company and or the monies received. In this article Dane Thornburgh, Senior Associate at Quinn Law Group, explains what a derivative action is, when it may be suitable, and other important factors.
Many directors, shareholders and other company officers, whether involved in a family law dispute or not, are often unaware that when a dispute arises between directors and/or shareholders of the same company, they have legal standing to do something about it on behalf of the company, by way of commencing a derivative action.
What is a derivative action?
A derivative action may be required in family law proceedings when a spouse or third party (as a shareholder/director) needs to protect corporate assets from being depleted by the other spouse, and the company itself will not take action against that wrongdoing.
A derivative action is generally an action brought by the company against a director for a breach of duty, but where a company cannot or does not bring that action, the court allows the members to bring the action on behalf of the company.
This type of action is common when a company/business is part of the matrimonial assets but is controlled by one party who refuses to act in the best interests of the company.
A derivative action enables a person, typically a shareholder or officer, to bring legal proceedings in the name of the company. This action is unique as it allows a person to litigate on behalf of the corporation, even though the right to initiate such proceedings ordinarily resides with the board of directors. Notably, any benefit arising from the litigation accrues to the corporation, not the individual bringing the action.
The right to bring a derivative action is open firstly, to a director of a company who may choose to pursue a derivative action by establishing certain factors giving rise to the right to act on behalf of the company.
Alternatively, where shareholders have been oppressed by the conduct of the directors, they also have a right to bring an action against the directors on behalf of the company.
Both of the above avenues are common in family law situations, where one of the parties is also a director or shareholder of the former family company.
What are some scenarios where a derivative action may be suitable?
Some scenarios that may indicate the need to bring a derivative action include:
- Using the position as director to gain an advantage whether it be for personal benefit or for the advantage of someone else.
- Failing to avoid/manage conflicts of interest which may arise due to personal goals conflicting with what is in the best interest of the company.
- Preventing and or excluding a minority shareholder from involvement with the company and or the dealings of the company.
- Using information which was obtained in the course of carrying out a director’s role for personal benefit to the detriment of the Company.
- Manipulating of the company board by appointing additional directors or issuing shares to others or the majority.
- Directors diverting corporate opportunities in pursuit of personal profits.
- Excluding a minority shareholder from involvement with the company or dealings thereof.
- Denying a shareholder the right to remain informed about company affairs.
What key factors are considered by the Court?
When seeking a derivative action, courts primarily consider whether the lawsuit is in the company’s best interests, if the applicant is acting in good faith, and if there is a serious question to be tried.
The party seeking the derivative action must usually also demonstrate that the company itself is unlikely to bring the proceedings. Some other relevant factors the Court may consider are:
- The court assesses if the action is in the best interests of the company and if it will benefit the company, rather than just the individual shareholder.
- The applying party must be acting in good faith, honestly and with the purpose of protecting the company, not for personal gain or tactical advantage.
- It must be shown by the party seeking the relief, that there is a serious question to be tried, which is legitimate and contains an arguable case.
- Evidence must show likelihood of company action in that the company is unlikely to initiate proceedings itself.
- Whether there are other alternative remedies, including less disruptive ways to resolve the issue.
- Courts evaluate if the costs of the litigation are a prudent use of resources and not a waste of company assets.
These actions are typically governed by statutory provisions (e.g., s 237 of the Corporations Act 2001 in Australia), which exist to prevent frivolous or purely personal lawsuits.
How Quinn Law Group help?
If you’re having a dispute with a business partner or shareholder and require assistance, contact us and ask to speak to Dane Thornburgh to see if we can help. Dane Thornburgh is a Senior Associate at Quinn Law Group, contributing over 23 years of substantial legal expertise as a Solicitor and previously as a Barrister. His distinguished career spans family law and commercial litigation, complemented by a strong background in several related practice areas.
This blending of advocacy and legal knowledge provides clients with significantly lower legal costs, effectively combining a seasoned advocate and an experienced Solicitor in the one practitioner. Read more on Dane’s experience by visiting our About page.