When companies are harmed by their own directors: The defects in the statutory derivative action and the cures (part 2)

• Jurisdiction: South Africa
• Date: 25 May 2019
• Pages: 301-322
• Published date: 25 May 2019
• Author: Maleka Femida Cassim

WHEN COMPANIES ARE HARMED BY THEIR

OWN DIRECTORS: THE DEFECTS IN THE

STATUTORY DERIVATIVE ACTION AND

THE CURES (PART 2)

MALEKA FEMIDA CASSIM*

Senior Lecturer, Department of Mercantile Law, University of Pretoria

[The f‌irst part of this article appeared in (2013) 25 SA Merc LJ

168–183.]**

IV THE FORM OF THE BOARD DECISION: THE DECISION-

MAKING PROCESS

Until the Act is amended (or failing amendment), the courts will have to

engage more intimately with the business judgment rule. As explained

above (in part 1 of this article), the business judgment rule is incorpo-

rated, in modif‌ied form, in the derivative action through the third limb

of the rebuttable presumption.

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Paragraphs IV and V of the present

article focus on the application of the business judgment rule and the

rebuttable presumption in the context of derivative actions.

* MBBCh (cum laude) LLB (cum laude) LLM (cum laude) (Witwatersrand); Attorney and

Notary Public of the High Court South Africa; Senior Lecturer, Faculty of Mercantile Law,

University of Pretoria.

** In part 1 of this article it was submitted that the Achilles heel of the new statutory

derivative action lies squarely in the rebuttable presumption in terms of s 165(7) read with (8)

of the Companies Act of 2008. For the purposes of the rebuttable presumption, wrongdoing

directors who have inf‌licted harm on the company which they are bound to serve are regarded

as ‘third parties’ to the company, with the result that miscreant directors benef‌it from the

presumption that the grant of leave by the court for derivative proceedings against them is

contrary to the best interests of the company. This serious defect has the potential to sound the

death-knell for the derivative action where it is most greatly needed. Part 1 of this article

suggested that this egregious defect in the Act must be cured by urgent legislative amendment,

in order to carve out the directors of the company from the ambit and the benef‌it of the

presumption. Until such time as the amendment to the Act is effected (or failing an

amendment), the judiciary may have to take prophylactic measures to circumvent the

presumption. These prophylactic measures that may be taken by the courts are discussed in

part 2 of this article.

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See para II above (in part 1 of this article) and, further, para V below. The third limb, very

brief‌ly, requires the directors to be in good faith, to be disinterested (that is, to have no

personal f‌inancial interest), to make a reasonable inquiry and to have a reasonable belief that

their decision is in the company’s best interests.

301

(2013) 25 SA Merc LJ 301

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The rebuttable presumption operates to protect the litigation decision

of the board of directors only if the decision-making directors comply

with the decision-making process prescribed in the third limb. The third

limb – which embraces the business judgment rule – regulates the

decision-making process or the form of the board decision (as opposed

to the substance of the decision). If the form of the board’s litigation

decision fails to meet all four of the requirements of the third limb, then

the presumption does not apply, and the board decision not to litigate

against the wrongdoer will receive no presumptive protection at all. If,

on the other hand, the form of the board decision satisf‌ies all the

requirements of the third limb, then the board decision not to sue

the wrongdoing director – that is, the substance or the merits of the

decision itself – is protected by the presumption, although this, signif‌i-

cantly, may be rebutted.

To express it more simply, a two-step inquiry is involved in the

judicial scrutiny of the board decision not to sue a miscreant director or

third-party wrongdoer:

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(i) The f‌irst step concerns the decision-making process or the form of

the board’s litigation decision. This determines whether the protec-

tive presumption operates or not. If the presumption does not

operate, that is clearly the end of the inquiry and the board’s

decision is disregarded. If, on the other hand, the presumption does

apply, one must proceed to the second step of the inquiry.

(ii) The second step concerns the merits of the board’s litigation

decision or the substance of the decision itself. It relates to the

weight of the protective presumption (or its ‘rebuttability’); in

other words, the degree of judicial deference that should be given to

the board’s decision not to sue the wrongdoer.

Paragraph V of this article addresses the second step of the inquiry, while

paragraph IV focuses on the f‌irst step. In particular, the concept of the

‘independence’ of decision-making directors is explored. This is a

valuable concept or tool that the courts may rely on to mitigate the

practical dilemmas arising in relation to directorial wrongdoing and

mismanagement of companies.

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The formulation of this two-step inquiry is based both on s 165(7) of the Companies Act

71 of 2008 (the Act) and on the US approach as expressed in the leading case Zapata Corp v

Maldonado 430 A 2d 779 (Del 1981); see also Franklin A Gevurtz Corporation Law 2 ed (2010)

294–5, 437 for a discussion of the distinction in US law between the decision-making process

and the substance of the decision itself. The relevance of US law is discussed in para V(b)

below.

(2013) 25 SA MERC LJ302

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