The plaintiff alleged that the defendants had breached the company’s articles of association and their fiduciary duties and had malicious intent to defraud him. He further accused the defendants of oppressive and unfair conduct, conspiring to suspend and remove him as a director without justification; advancing themselves significant sums without approval; and unfairly resolving to terminate contracts and wind up the company.

Through a cross-application, the defendants requested the striking out of the suit, arguing that the plaintiff had been legitimately removed as a director and that the current suit raised similar issues to a prior suit where the company was suing the plaintiff for misappropriation of funds and acting against the company’s interests. They contended that the plaintiff’s application was redundant and that he could raise his concerns as a defence in the existing suit.

Court’s decision

The trial court ruled in favor of the defendants, concluding that the company had adhered to the proper procedures for director removal as set out in the articles of association and the Companies Act (Chapter 486) (Act). Additionally, the court found that the defendant had failed to present sufficient evidence of oppressive conduct that would warrant judicial intervention under section 780, which allows shareholders to seek relief in cases of unfairly prejudicial conduct. On appeal, the High Court took a similar stand, dismissing the plaintiff’s application for leave to continue the suit as a derivative action and the defendants’ cross-application to strike out the suit.

Derivative action

The foundational case of Foss v Harbottle [1843] 67 ER 189 provides that a wrong alleged to have been done to a company is primarily a matter for the company itself to address through its proper organs (board of directors or shareholders in a general meeting). However, the Act provides the statutory framework for derivative claims.

A derivative action is one in which a shareholder seeks to bring proceedings on behalf of the company in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty, or breach of trust by a director of the company or any other person. It is immaterial if the cause of action arose before or after the applicant became a shareholder of the company.

In determining such an application, the court will consider factors such as the applicant’s good faith, the importance a dutiful director would place on the claim, the likelihood of future authorisation or ratification, whether the company has decided against pursuing the claim, and if the shareholder has a direct personal cause of action. The court will also consider the views of shareholders who have no personal interest in the derivative claim. These legal provisions ensure derivative actions are reserved for genuine cases of misconduct by directors or other persons and to prevent frivolous or self-serving suits.

The High Court applied these principles when determining whether to grant the plaintiff leave to continue his suit as a derivative action. The court found that the plaintiff’s claims were not substantiated and did not present a demonstrable prima facie case against the defendants.

Specifically, the court held that the defendants’ decision to wind up the company and terminate employment contracts could not, in itself, be termed unfair or oppressive conduct, as it is within the ordinary duties of directors to make such decisions. Furthermore, in dismissing the claim, the court noted that the plaintiff had not demonstrated any effort to bring the alleged breaches to the attention of the defendants or made a demand for action.

In contrast, the court in Isaiah Waweru Ngumi and Two Others v Muturi Ndung’u KBU HCCC No. 6 of 2016 [2016] eKLR permitted the minority shareholders to file a derivative claim. The applicants were able to prove that they had raised specific concerns with the company’s directors and management, which went unresolved, and that they had raised concerns about the mismanagement of the company, waste of corporate assets and failure to recover company funds. The court found these claims to disclose a plausible cause of action, sufficient to establish a prima facie case warranting judicial scrutiny. It also found no evidence of bad faith or improper motive, concluding that the applicants fairly represented the company’s interests and were therefore entitled to proceed with the derivative action.

Conclusion

The High Court’s dismissal of the plaintiff’s application in the Medlink case underscores the high standards for succeeding in bringing a derivative action under the Kenyan Companies Act. A shareholder must establish a prima facie case of misconduct by directors, or any other persons causing demonstrable harm to the company and show that the derivative action serves the company’s best interests. The plaintiff failed to meet this threshold due to unsubstantiated claims and a lack of prior efforts for internal resolution. While in this instance the applicant was unsuccessful, companies should note that shareholders can take action against board members on behalf of the company where decisions are not made in the best interest of the company.

Directors should always act in good faith, adhere to the articles of the company and the Act, and ensure transparency and open communication with shareholders to minimise the risk of derivative claims. Directors should also maintain detailed records of all decisions made and approvals received from shareholders to protect themselves against misconduct allegations. Conversely, a shareholder seeking to bring a derivative action should show a clear and credible claim of misconduct causing harm to the company. They must act in good faith, represent the company’s interests and demonstrate that internal remedies have been exhausted.