There are many reasons for which Cyprus courts refrain from interfering in the internal affairs of a limited liability company. At the core of the courts’ approach lies commercial reality that is deemed to be better understood and applied by the company’s governing bodies; its board of directors and its shareholders at General Meeting. However as early as early as 1843 it was evident that there will be times when the court’s interference is necessary to bring about order in the company’s affairs where order is required, and to bring an end to the oppression of the minority in a company (a “just and equitable result”) where the wrongdoers are in control. In recent times, and with the latest amendments to the Cyprus Companies Law Cap.113 in July 2015 adding clarity to companies’ operation, it is worth re-visiting the applicable rules of derivative actions.
In the absence of the possibility for the Board of directors of a company to bring a claim against wrongdoers controlling the company and to cease oppression of the minority, the ability of an oppressed shareholder to bring a derivative claim (being a claim made by a shareholder in the name of and for the benefit of his company) is governed by common law, under the rule in Foss v Harbottle upheld and followed since 1843. The rule in Foss v Hartbottle, clarifies that the right claimant for wrongdoings against the company is the company itself. However, the rule goes a step further stipulating exceptions applicable where the company is de facto controlled by the wrongdoers and cannot bring such a claim to end the oppression. Briefly, these exceptions are:
(a) The company is controlled by the wrongdoers and in fact, this control could lead to fraud being committed on the minority shareholders (as would be the case where the wrongdoers have sole rights of appointment of directors in the company for example); or
(b) An illegal act (“ultra vires”) has taken place which cannot be ratified or confirmed by the company. In light of the recent amendments to Companies Law Cap.113 in July 2015 and the adoption of a wide objects clause for commercial companies, it will be interesting to see how this exception could practically be applied in litigation; or
(c) To protect the aggrieved shareholder from breach, limitation or loss of their own individual rights as a shareholder. This is the only case where the shareholder can sue in his own name, because the wrong is done to him as an individual and not to the company; or
(d) Where actions requiring special majority have been implemented by lesser majority contrary to Companies Law; Once more interesting to note application of this exception in litigation following recent amendments to the law, now that special majorities adopted in the Articles of Association are recognized and enforceable by the law.
Who can sue
Any person being a shareholder at the time the claim is brought can sue the company and its directors (including former directors), and/or any shareholders currently in control and/or any third parties participating in the wrongdoing, with a view to protecting their rights. The derivative action is an action raised by the oppressed minority or those shareholders who are not de facto in control of the company (regardless of their share participation in the company), to redress wrongs committed against the Company or to recover money or damages alleged to be due to the Company; it is not the proper action to be used in every case of a shareholder dispute. Any damages recovered under a derivate action will be paid to the Company, and not to the shareholder bringing the claim.
In brief, there are two options available to the minority shareholders:
- A personal action against the company on the basis of a breach of duty by the company; or
- A derivative action can be filed, provided that there has been a fraud perpetrated against the company, which is controlled by the wrongdoers. In this case the minority shareholders file a claim on behalf of the company. As indicated earlier, the damages recovered will be awarded to the company itself.
Remedies for Oppression of the Minority
- Court Order regulating the future conduct of the company’s affairs;
- Court Order for the purchase of the shares of any members of the company by other members of the company;
- Court Order for the purchase of the shares of any members by the company itself and the respective decrease of the company’s share capital.
It is perhaps worth noting that Cyprus Civil procedure rules could benefit from a revamp with respect to filing derivative actions along the lines of the “two-stage” test applied in the UK. In short, the applicant shareholder would be required to show in an application for the court’s permission to hear the claim, that there is a case at first instance and to provide evidence to this effect. Such preliminary step would enable the court to decide at an early stage whether the claim is vexatious or unmeritorious and merely a step to cause imbalance among the company’s shareholders. The possibility of a costs order against the applicant shareholder could act as a deterrent for abuse of process.