The Hong Kong Court of Final Appeal (the “CFA”) clarified in Waddington Limited v Chan Chun Hoo Thomas and Others (FACV No. 15 of 2007) that a shareholder of a parent company may sue on behalf of its subsidiary in respect of wrongdoings committed against the subsidiary.  This is the first reasoned decision on multiple derivative actions in a common law jurisdiction outside the USA.

“On the well established thinking as to why a single derivative action is maintainable, there is no reason why a multiple derivative action is not.” Per Mr Justice Bokhary PJ and Mr Justice Chan PJ in the CFA

Shareholder May Sue on Behalf of the Company Under Limited Circumstances

As mentioned in our previous newsletter: Can a Shareholder Sue on Behalf of a Company (posted at www.onc.hk/pub/oncfile/publication/litigation/0808_EN_Statutory_Derivative_Action.pdf), shareholders may under limited circumstances sue for wrongs done to their company on the company’s behalf by way of derivative action.  However, it has not been clear in the past whether a person who is not a shareholder in the company but a shareholder in its parent or ultimate holding company can bring a derivative action.  Such an action has been described, conveniently but somewhat misleading, as a double or multiple derivative action.  In this article, the expression “multiple derivative action” is used to embrace both double and multiple derivative actions.

No Multiple Derivative Action under the Existing Statutory Regime

In 2005, a statutory derivative action  (“SDA”) was introduced in Hong Kong.  Under the newly added section 168BC of the Companies Ordinance (Cap. 32) (the “Ordinance”), an SDA only applies to proceedings brought by a member of a company.  The statutory regime hence does not provide for a multiple derivative action.  However, one’s right to bring a derivative action at common law (“CDA”), which is expressly preserved in the introduction of SDA, remains a venue to argue for a multiple derivative action.

Waddidgton Limited v Chan Chun Hoo Thomas and Others (FACV No. 15 of 2007)

The proceeding of this case was commenced in 2003, hence the SDA was not applicable.  The Plaintiff Waddington Ltd (“Waddington”) is a minority shareholder of Playmates Holdings Limited (“Playmates”), of which Playmates International Limited (“Playmates International”) is its wholly-owned subsidiary.  Playmates International has two wholly-owned subsidiaries: Profit Point Limited (“Profit Point”) and Autoestate Properties Limited (“Autoestate”).   The primary issue in this case is whether Waddington may bring a derivative action on behalf of Profit Point and Autoestate regarding alleged wrongs inflicted on them.  The alleged wrongdoer, Thomas Chan, has been effectively in control at every level of the corporate chain, and allegedly he would not allow the companies to sue himself.

The CFA, having regard to the potential injustice which would result if a derivative action were not available where the company is controlled by the alleged wrongdoers, unanimously held that a multiple derivative action is in fact available at common law.

Double Recovery Precluded by Reflective Loss Doctrine

In the Court of First Instance, Waddington had formulated its action solely as a derivative action on behalf of Playmates.  As the claims advanced were merely reflective of the alleged losses of Playmate’s subsidiaries Profit Point and Autoestate, they were precluded by the reflective loss doctrine and liable to be struck out.  Nevertheless, since a derivative action on behalf of Profit Point was in principle available and was prima facie sustainable on the facts pleaded, Barma J granted Waddington an opportunity to reconstitute its pleading to accord with the principle.  CFA upheld Barma J’s finding and allowed Waddington to continue the proceedings as a multiple derivative action on behalf of Profit Point.

CFA Clarifies Threshold Requirement in CDA

In addition, while minority shareholders are required to seek leave of the Court to bring a SDA, leave is not required for a CDA.  However, the CFA has clarified that in either case, the minority shareholders have to show a prima facie case before they could proceed, reversing the finding of the Court of Appeal that at common law a plaintiff in a derivative action is not required to establish a prima facie case.

CFA Recommends Changes to Law

The CFA’s judgment does not extend the SDA to multiple derivative action.  Minority shareholders who wish to bring a multiple derivative action must do so at common law.   However, they cannot enjoy the new statutory right to inspect the company's record, nor can they bring a claim if the alleged wrongdoing does not fall within the narrow meaning of “fraud on minority”.  The CFA opined in Waddington that the co-existence of SDA and CDA is merely a source of confusion and complication.  It is hoped that there will be legislative change in due course creating a statutory mechanism for multiple derivative actions.  The legislature is also invited to reconsider whether it is really sensible to maintain two parallel regimes with different threshold tests, one requiring leave and the other not.