There are many reasons why Cyprus courts refrain from interfering in the internal affairs of limited liability companies. At the core of the courts’ approach lies the commercial reality that these matters are better understood and applied by a company’s governing bodies (ie, its board of directors and shareholders) at the general meeting. However, as early as 1843 it was evident that there are times when court interference is required to create order in a company’s affairs and end the oppression of minority shareholders when wrongdoers are in control. The latest amendments to the Companies Law (Cap 113) in July 2015 provided clarity to the operation of companies; it is worth examining the applicable rules of derivative actions in that context.
The board of directors of a company cannot bring a claim against wrongdoers controlling the company to prevent the oppression of minority shareholders. Instead, an oppressed shareholder can bring a derivative claim (ie, a claim made by a shareholder in the name of and for the benefit of his or her company) under common law and the rule in Foss v Harbottle that has been upheld and followed since 1843. The Foss v Hartbottle rule clarifies that the right claimant for wrongdoings against a company is the company itself. However, the rule goes a step further, stipulating applicable exceptions when a company is de facto controlled by wrongdoers and cannot bring such a claim to end the oppression of minority shareholders. These exceptions include the following:
- The company is controlled by wrongdoers and this control could lead to fraud being committed that affects minority shareholders (eg, the wrongdoers have sole rights of appointment of company directors);
- An illegal act has taken place which cannot be ratified or confirmed by the company. In light of the recent amendments to the Companies Law and the adoption of a wide objects clause for commercial companies, it will be interesting to see how this exception will be practically applied in litigation;
- A derivative claim can be brought to protect aggrieved shareholders from breach, limitation or loss of their individual rights as shareholders. This is the only case in which a shareholder can sue in his or her own name, because the wrong is done to him or her as an individual and not to the company; and
- Where actions requiring a special majority have been implemented by a lesser majority contrary to companies law, a derivative action can be filed. The application of this exception in litigation will be noteworthy now that special majorities adopted in the articles of association are recognised and enforceable under the changes to the Companies Law.
Who can sue?
Any shareholder can sue a company, its directors (including former directors), controlling shareholders or third parties participating in the wrongdoing with a view to protecting their rights. A derivative action is brought by the oppressed minority or those shareholders without de facto control of the company (regardless of their share participation) to redress wrongs committed against the company or recover money or damages allegedly due to the company. However, it is not the proper action to be used for every shareholder dispute. Damages recovered under a derivate action will be paid to the company and not to the shareholder bringing the claim.
The following options are available to minority shareholders:
- A personal action can be taken against the company based on its breach of duty; or
- A derivative action can be filed, provided that there has been fraud perpetrated against the company which is controlled by wrongdoers. In this case minority shareholders file a claim on behalf of the company. The damages recovered will be awarded to the company itself.
Remedies for oppression of minority shareholders
Remedies for the oppression of the minority shareholders include a court order:
- regulating the future conduct of the company’s affairs;
- for the purchase of the shares of company members by other company members; or
- for the purchase of the shares of company members by the company itself and the respective reduction of the company’s share capital.
Cyprus civil procedure rules could benefit from an overhaul of the filing process for derivative actions similar to the two-stage test applied in the United Kingdom. In short, the applicant shareholder would be required to demonstrate 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. This preliminary step would enable the court to decide at an early stage whether the claim is vexatious or unmeritorious and merely a measure to cause imbalance to the company’s shareholders. The possibility of a costs order against the applicant shareholder could act as a deterrent for abuse of process.
For further information on this topic please contact Stella Koukounis at S Koukounis & Partners LLC – Solsidus Law by telephone (+357 99 415 708) or email ([email protected]).