Derivative actions in the name of Bermudian companies: when is judicial leave required?

From 9 July 2018, derivative actions commenced in Bermuda may not be continued without leave from the Supreme Court.  The requirement comes by way of amendments to the Rules of the Supreme Court 1985: a new rule 12A has been added within Order 15, in terms which replicate an equivalent provision in the Cayman Islands’ Grand Court Rules 1995.  Until now the right to pursue claims derivatively was governed exclusively by the common law, and in particular the various exceptions to the rule in Foss v Harbottle (1843) 2 Hare 461.  The introduction of a formal requirement of judicial leave brings Bermuda into line with other common law jurisdictions such as the Cayman Islands and BVI and should provide additional protection against frivolous or vexatious shareholder claims.

Stuart Jessup
Stuart Jessup

One question to which the new provision gives rise is whether it applies to any proceedings in the name of a Bermudian company, wherever commenced.  For example, must leave of the Bermuda Court be sought in order to continue derivative proceedings brought in Hong Kong?

This question ties into a broader debate about requirements of leave in other offshore jurisdictions, most notably the Cayman Islands and BVI.  The debate has important practical implications: on a number of occasions derivative claims in Hong Kong have been struck out because leave was not first sought elsewhere.[i] Unfortunately, the authorities have developed in a way which has made it difficult to provide clients with clear advice.  This article will consider the effect of those authorities as they relate to the provisions in BVI and Cayman, which in turn should inform the approach to be taken under Bermuda’s new Rule 12A.

The starting point: substance vs procedure

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Rule 19 in Dicey, Morris and Collins on the Conflicts of Law holds that “All matters of procedure are governed by the domestic law of the country to which the court wherein any legal proceedings are taken belongs (lex fori).”  Matters of substantive law, on the other hand, are “governed by the law to which the court is directed by its choice of law rule (lex causae)”.  In cases relating to the constitution and internal management of a company (which makes up much of the litigation in offshore jurisdictions), the lex causae is the law of the place of incorporation.

In Konamaneni v. Rolls Royce Industrial Power (India) Limited and others [2002] 1 WLR 1269 Lawrence Collins J (as he then was) discussed the nature of the exceptions to the rule in Foss v Harbottle, which form the principled basis for derivative actions:

“Although for purely English domestic purposes, the exceptions to the rule have been regarded as a procedural device, I do not consider that in the international context their real nature is procedural.  They confer a right on shareholders to protect the value of their shares by giving them a right to sue and recover on behalf of the company.  It would be very odd if that right could be conferred on the shareholders of a company incorporated in a jurisdiction which had no such rule, and under which they had acquired their shares.”

So, in an “international context” at least, the right to bring a derivative action is considered substantive.  Whether that right exists is governed by the lex causae. But is a grant of leave to bring such an action an expression of that right, or is it a merely procedural mechanism?

In Waddington Ltd v Chan Chun Hoo Thomas [2009] 2 BCLC 82 Lord Millett, sitting as a Non-Permanent Judge of Hong Kong’s Court of Final Appeal, offered the following obiter dicta while discussing the domestic regime for derivative claims:

“If the question whether a derivative action is available is a question of substantive law… then it is governed by the law of the place of incorporation. The same law also governs the company’s indoor management. Neither question is governed by the common law of Hong Kong; both are governed by the law, whether statutory or common law, of the overseas jurisdiction. The question whether the leave of the court is required is a procedural question governed by the lex fori.”

This seems clear enough, but Lord Millett’s approach has since been departed from.  We now turn to consider how that has happened, with reference to two of the most popular corporate domiciles for Asian businesses – BVI and Cayman.

Suing in the name of BVI companies

In East Asia Satellite Television (Holdings) Ltd v New Cotai LLC[2011] HKCA 128 the Hong Kong Court of Appeal considered a slightly different question: whether the lex incorporationis or the lex fori governed whether a multiple derivative action in the name of a BVI company was available.  In that context the leading judgment of Hon Tang Ag CJHC concluded that “it is not arguable that the right to bring a multiple derivative action is not governed by the law of the place of incorporation.”  The Court did not need to consider the separate question of whether a requirement that leave of the Court be obtained before bringing a derivative action was procedural or substantive.  However, in reviewing the authorities Hon Tang Ag CJHC made the following observations:

“…Konamaneni has not decided that a requirement for leave by the law of incorporation is not procedural. Nor is such a view inconsistent with Konamaneni, thus Arden LJ in Base Metal after expressing agreement with Konamaneni said at para 68:

“… The question whether a shareholder has a right to bring a derivative action may have to be distinguished in future from the question whether the shareholder has satisfied any procedural rules from bringing a derivative claim, for example by serving prior notice on the company. My provisional view is that these are matters of procedural law for the lex fori rather than the law of the place of incorporation.””

In Wong Ming Bun v Wang Ming Fan [2014] 1 HKLRD 1108a shareholder of a BVI company commenced derivative proceedings in Hong Kong without first obtaining leave from the Eastern Caribbean Supreme Court under Section 184C of BVI’s Business Companies Act 2004.  Section 184C(1) provides, in relevant part:

“…the Court may, on the application of a member of a company, grant leave to that member to

  • bring proceedings in the name and on behalf of that company; or
  • intervene in proceedings to which the company is a party for the purpose of continuing, defending or discontinuing the proceedings on behalf of the company.”

Section 184C(6) provides: “Except as provided in this section, a member is not entitled to bring or intervene in any proceedings in the name of or on behalf of a company.”

Having considered Waddington and other cases,Peter Ng J decided the claim must be struck out:

“The legal position is clear – whether a shareholder can commence a derivative action in the name and on behalf of the company is a matter of substantive law, and is governed by the law of the place of incorporation…In the present case, this question is governed by BVI law. Under BVI law, a shareholder can only commence a derivative action … with leave of the BVI Court. No leave has been obtained. The action as presently constituted is defective.”

This analysis seems to have started from the premise that the right to bring a derivative action is governed by the lex incorporation is and then inferred that a requirement of leave under that law must apply to proceedings brought elsewhere.  In other words, he did not expressly address the distinction identified by Lord Millett in Waddington.  He did cite the passage from Waddington mentioned above, but unusually left out the last two sentences, including the important final one.

Later in 2014, the same issue was considered in Novatrust Limited v Kea Investments Limited[2014] EWHC 4061 (Ch).  English proceedings were commenced in the name of a BVI company, and the claimant sought leave from the English Court to continue them.  The defendants alleged that the Court did not have jurisdiction over such a claim unless permission was first obtained from the BVI Court.  Judge Pelling QC said at paragraph 37:

“Whilst I fully accept that, as Arden LJ said in Base Metal Trading Limited v. Shamurin [2014] EWCA Civ 1316 at [68], the question whether a shareholder has a right to bring a derivative action may have to be distinguished from the question whether such a shareholder has satisfied any procedural rules for the bringing of such a claim, whether that is so is contextual.  As Arden LJ says, purely procedural law requirements are likely to be treated as governed by the lex fori rather than the law of the place of incorporation.  However, whether a particular requirement of the law of the place of incorporation is a purely procedural step and thus one that can in effect be ignored depends critically on the particular circumstances.  Where a step that is otherwise procedural in nature is a condition precedent to the right of a member to bring such an action then satisfaction of that condition will have to be established even if the condition concerned has the hallmarks of a procedural requirement.”

The judge went on to find thatthe requirements of Section 184C were substantive, since a member did not have the right to bring such a claim without first obtaining theleave of the Court.  He explained that decision in the following way[ii]:

“In my judgment the effect of s.184C(6) is that by BVI law a member of a company does not have the right to bring proceedings in the name of or on behalf of a company unless that member has complied with the other provisions within s.184C and that is so whether the proceedings are to be brought in the courts of the BVI or elsewhere.  Absent this provision I would have agreed that the requirement for leave from the BVI Court was procedural.  However, the effect of s.184C (6) is that before the member of a BVI company can have the right to bring derivative proceedings in respect of that company, permission has to be obtained by that member from the BVI High Court (“the Court” being defined for these purposes by s.2 of the act as meaning the BVI High Court). Obtaining that permission is a condition precedent to the ability of the member to bring such proceedings.”

The emphasis was on the nature of the provision.  A requirement of leave was not necessarily procedural; sometimes, because of its terms, it was substantive.  But this invites the question: if section 184C is substantive, what if an equivalent but differently-worded provision in the lex fori were deemed procedural?  Could this mean that leave of both courts was required?  Is Lord Millett’s formulation – that whether leave is required is always for the forum – therefore to be preferred?  The Court in Novatrust did not expressly consider that question in its reasons.  It did not suggest, for example, that once leave in BVI was obtained, a fresh application under Rule 19.9 of the English Civil Procedure Rules 1998 may be necessary.

Until these problems are resolved by an appellate court, it would appear advisable to seek leave from the BVI Court before commencing proceedings in the name of a BVI company overseas.[iii]

The position in Cayman

Similar issues have arisen in the Cayman Islands.  There, the provisions governing leave are contained in the Grand Court Rules rather than the companies legislation.  Order 15, Rule 12A (now mirrored in Bermuda) provides that where a defendant in a derivative action has given notice of intention to defend, the plaintiff must apply to the Grant Court for leave to continue the action.[iv] In other words, the application can only be made after proceedings have been issued and a notice of intention to defend filed.  This can be distinguished from BVI’s Section 184C(1), which refers to “leave… to bring proceedings”.  Further, as might be expected of a rule of court, Rule 12A contains a number of provisions which regulate the way such a claim must proceed, such as by allowing the Court hearing the application to make directions as to the joinder of parties, the filing of further evidence, discovery and cross-examination of deponents.

The Rule was considered in Charles Zhi v SRK Consulting Ltd [2015] HKCFI 1547, where a shareholder brought a common law derivative action in Hong Kong on behalf of a Cayman company.  The plaintiff did not file evidence or appear at the hearing of the defendant’s application to strike out the statement of claim.  Judge Le Pichon granted that application on the basis that leave under Rule 12A had not been obtained.  She found support for her decision in Wong Ming Bun, East Asia Satellite and Waddington.  However, none of those cases were about Rule 12A; the difficulty with Wong Ming Bun has already been noted; the Court of Appeal in East Asia Satellite expressly reserved its view on whether a requirement of leave is procedural or substantive; and in relation to Waddington, the Judge quoted Lord Millett, but like Peter Ng J in Wong Ming Bun left out the very sentence which addresses the point in issue.

Later decisions have taken a different view of the effect of Rule 12A.  In Top Jet Enterprises Limited v Sino Jet Holding Limited [FSD 106 of 2017 (NSJ)], a shareholder of a Cayman company issued derivative proceedings in Missouri and sought the Cayman Court’s permission to continue them.  The Honourable Justice Segal declared that no such permission was needed:

“[Rule 12A] clearly contemplates and presupposes that the action by the relevant company against the relevant defendant which has been commenced by the relevant shareholder is being conducted before this Court so that the application for leave to continue the action can be made within that action and the Court can make orders regulating the future conduct of such action (for example, by making an order on the application of the defendant to dismiss the action).  Furthermore, the rule contemplates that the timetable of the action will be affected by the need for an application for leave.  The procedural mechanism created by the rule only works where the derivative action has been issued in Cayman.  In my view it can have no application to a foreign derivative action.”

The same view was reached by the New York Court of Appeals in Davis v Scottish Re Group Limited, No. 111 (N.Y. Nov. 20, 2017).  At first instance and on an initial appeal it had been held that Davis did not have standing to bring the claim as he had not first obtained leave under Rule 12A.  Consistently with certain other American decisions[v], the rule was deemed to be substantive and therefore applied under New York conflicts of law principles. But the New York Court of Appeals disagreed, holding that “Rule 12A is procedural, and therefore does not apply where, as here, a plaintiff seeks to litigate his derivative claims in New York.”

This is a sensible interpretation, and one that can reasonably be expected to be adopted in Bermuda.  It remains to be seen whether it will also be adopted in Hong Kong, in spite of the decision in SRK Consulting and, to a lesser extent, the authorities considering section 184C in the BVI Act.

Stuart Jessup, Senior Associate, APPLEBY

[i] See for example Wong Ming Bun v Wang Ming Fan [2014] 1 HKLRD 1108 and Charles Zhi v SRK Consulting Ltd [2015] HKCFI 1547, both discussed below.

[ii]Novatrust Limited v Kea Investments Limited [2014] EWHC 4061 (Ch) at [38].

[iii] An example of where this was not done is Sinwa SS (HK) Co Ltd v Morten Innhaug [2010] SGHC 157, where the Singapore High Court considered a common law derivative claim in the name of a BVI company without expressly addressing whether leave of the BVI Court was required.  The defendant appears not to have raised this jurisdictional point.

[iv] Rule 12A (1) provides that the rule applies to “every action begun by writ by one or more shareholders of a company where the cause of action is vested in the company and relief is accordingly sought on its behalf”.  In Renova Resources Private Equity Limited vGilbertson and Others [2009] CILR 268, leave was given to pursue a double derivative action.

[v] See for example ARC Capital LLC v Kalra 2013 NY Slip Op 3136[U] No. 652931/2012

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