[2015] KECA 356 (KLR)

IN THE COURT OF APPEAL

AT NAIROBI

(CORAM: WAKI, G.B.M. KARIUKI & OUKO, JJ.A.)

CIVIL APPEAL NO. 101 OF 2004

AMIN AKBERALI MANJI ………………..................……..1STAPPELLANT

HEMANTH KUMAR …………………………….....….......2NDAPPELLANT

MUSIKLAND MILLENIUM LIMITED ……….................3RDAPPELLANT

VERSUS

ALTAF ABDULRASUL DADANI ……………....…............1STRESPONDENT

MUSIKLAND LIMITED (Under Receivership) ….............2NDRESPONDENT

(An appeal from the ruling of the High Court of Kenya at Nairobi (Milimani Commercial Court) (Mwera, J-as he then was)dated 5thFebruary, 2004 in

HCCC NO 913 OF 2002)

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JUDGMENT OF THE COURT

Introduction

1. What is the law on derivative action by a member of a limited liability company? Is a Company under receivership amenable to derivative action by its member? What is the procedure for invoking derivative action? The answers to those questions, among others, lie at the heart of the appeal before us. Incidental to those questions is whether the suit filed in the High Court was validly filed and whether the High Court properly granted various prayers made in the main suit at an interlocutory stage.

2. The appellants before us are Amin Akberali Manji (Manji), Hemanth Kumar (Kumar) and Musikland Millenium Limited (MML). They are represented before us, as they were in the High Court, by learned counsel

Mr. Ochieng Oduol, instructed by M/s Ochieng, Onyango, Kibet and Ohaga Advocates. The 1st respondent is Altaf Abdulrasul Dadani (Dadani) represented by learned counsel Mr. Desterio Oyatsi instructed by M/s Shapley Barret & Co Advocates, while the 2nd respondent, Musikland Limited (In receivership) (ML or ‘the Company’) was initially represented by the Firm of Theuri Wanjohi & Co Advocates in the High Court but they fizzled out of the picture leaving Mr. Oyatsi to speak for ML.

Background

3. At the centre of the dispute is the 2nd respondent, ML. It is common ground that ML was formed by Dadani and Manji in 1993 for the main object of importing and selling musical instruments. The two paid the share capital of Sh.7 million in equal shares and therefore had 50% shareholding and directorship in the company. Business commenced in 1995 at the registered business premises in Cambrian House on Moi Avenue Nairobi, with Dadanicontrolling the day to day operations while Manji took charge of financial matters. There was an argument advanced by Dadani that the company was no more than a glorified partnership while Manji maintained it was a limited liability company, but the latter argument was upheld, in our view correctly, by the trial court.

4. All was well with the company thereafter following its incorporation and commencement of trading when it accumulated considerable assets and made profits. The turning point was in 1999 when Manji resigned from the office of director and his place was taken up by his nominee, Kumar, the financial controller. In the same year, Manji also nominated one Madhani to whom he transferred all his shares to hold in trust. He nevertheless continued to participate actively in the management of the company’s affairs.

5. Matters came to a head in May 2000, when Manji allegedly refused to release money for purposes of replenishing stock and payment of creditors thereby paralyzing the company’s business. Dadani felt frustrated and the operations of the company ground to a halt. As the company teetered on the brink of collapse, and was placed in receivership by a secured creditor, Dadani claims that Manji incorporated MML which had a deceptively similar name as ML, expropriated the stock and assets of ML, and started operations of similar business in the premises of ML in conjunction withKumar. It was clear to Dadani that Manji was acting contrary to his fiduciary duty towards ML and that, in cahoots with Kumar, they intended to defraud, not only ML, but also the creditors of ML and Dadani himself as a shareholder. That is when he went to court on 22ndJuly 2002 and filed suit.

6. He gave particulars of the fraud as he saw it, including: closure of ML’s business without the valid consent of ML; expropriation, concealment and removal of ML’s property; making false entries in the company's financial statements relating to its property and its affairs; transferring the company's assets at gross undervalue or for no consideration at all so as to conceal the true nature of the transaction; attempting to account for part of the said company's property by making fictitious losses or expenses or credits in the financial statements of the company and making material omissions in the company's financial statements.

As against MML: acquiring or obtaining ML's property by deception and/or acquiring or obtaining ML's property at gross undervalue or concealing the company's property; and finally passing-off ML’s goods.

7. He made a host of prayers which we only reproduce in extenso because some of them were granted at an interlocutory stage and are at the centre of the appeal before us. The prayers are slightly rephrased:

“(a) A declaration that the closure ofML’sbusiness byManjiandKumarand the acquisition of the said business byMMLwas wrongful and/or unlawful.

(b)A declaration that all the business transacted by MML in

ML’s premises at Cambrian Building, Moi Avenue, Nairobi and the revenue thereby generated belongs to ML and MML do account to ML and this Honourable Court for all the said revenue in the said premises.

(c)A permanent injunction restraining MML from carrying on business under the name 'Musikland Millenium Limited' in the said premises.

(d)A mandatory injunction compelling MML to produce and deliver to ML all ML's equipment, documents or assets acquired by MML.

(e)A mandatory injunction compelling Manji and Kumar to produce and deliver to ML a true and accurate record of all the financial affairs of the company from 1995 to the date of judgment and to pay to ML all the sums of money found not to have been previously accounted for.

(f)A mandatory injunction compelling Manji and Kumar to produce and deliver to ML all its property, assets, books, records and documents.

(g)General damages against the Manji, Kumar and MML jointly and severally.

(h)A declaration that the Manji and Kumar are jointly and severally liable to personally pay all ML's creditors.

(i)Kshs 75,000,000/- against Manji and Kumar jointly and severally payable to ML.

(j)Dadani's and ML’s costs of this suit be paid by the Manji,Kumar and MML jointly and severally.

(k)Interest on damages and costs.

(l)Any other or further reliefs that this Honourable Court may deem just to grant”.

8. Contemporaneously with the filing of the suit, Dadani took out an ex parte notice of motion invoking Section 3A of the Civil Procedure Act. He sought two orders :

i). leave to prosecute the suit as a derivative action on behalf of ML and its creditors;

ii) indemnity by ML for all the costs and expenses reasonably incurred in prosecuting the suit.

9. The basis for that application was that: a receiver had taken over the management of ML after closure of the company; that ML, which would have instituted the suit was incapable of prosecuting it because it was under the control of the wrong doers themselves who had deliberately paralyzed it by misappropriating its money and property; and that ML, the receiver and all creditors would suffer irreparable loss if the company was left in the hands of Manji, Kumar and MML. The ex parte motion was placed before Mwera J.(as he then was) and he granted the two orders as sought.

10. The reaction by Manji, Kumar and MML came thick and fast as soon as the orders and pleadings were served. In their 42-paragraph defence, they denied any role in any alleged fraud, unlawful acts or illegalities against ML or any creditor. They contended that the affairs of ML were lawfully conducted by its Board of Directors of which Dadani was a participating member throughout and assented to all resolutions and financial statements issued by the company. Instead, they accused Dadani and his wife of fleecing the Company when they were incharge of operations. They further contended that the suit was a fraud on the court because it was based on undisclosed information. In particular they asserted that the suit could not be a derivative one on behalf of ML and raised five issues of law which they sought to have decidedin limine.

11. The issues (paraphrased) were as follows:-

· “Dadani is not the proper Plaintiff in Law.

· Dadani has not brought himself within the exceptions to the rule in Foss v. Harbottle.

· Dadani is not a minority shareholder within the meaning of the Companies Act, Chapter 486 of the Laws of Kenya.

· Dadani is not the proper plaintiff in light of the fact that ML iscurrently under receivership. The Receivers and Managers....having been appointed by The Imperial Bank Limited on the 28thof March 2002.

· No cause of action accrues to ML and therefore no cause of action can accrue to Dadani.”

12. Dadani was not impressed by that defence because, in his view, it did not dispute the crucial facts pleaded by him that the three appellants had closed the business of ML, taken over and misappropriated its assets and premises, sold its stock at an undervalue, compromised its debt, and committed serious fraud on the company and its creditors--- all without any form of resolution from the Board of Directors. For that reason, he filed a chamber summons underOrder 6 rules 13(1) (b)of theCivil Procedure Ruleson 26th November 2002 seeking to have more than 30 paragraphs of the defence struck out for being scandalous, frivolous and vexatious and for judgment on liability to be entered, pending formal proof. He also sought final judgment on prayers(a), (b), (c), (e), (f), (h), (j), and (k)as listed in the plaint above.

13. Manji, Kumar and MML reacted to the application by raising the same issues of law made in their defence contending in a ‘Preliminary Objection’ and ‘Grounds of opposition’ that Dadani had no locus standi and/or capacity to bring the application. They also placed on record a 47-paragraph

“Replying Affidavit” sworn by Kumar, which, as we shall see shortly, became contentious.

14. They went further and filed their own notice of motion on 14th May 2003 under Section 3A of the Civil Procedure Act seeking the following substantive orders:-

“1. That the Honourable Court be pleased to set aside the Order Number 1 granting leave to plaintiff to file a derivative claim on behalf of the Fourth Defendant herein in the Order dated the 22ndof July 2002.

2. That the Honourable Court be pleased to set aside the Order Number 2 allowing the plaintiff to be indemnified for all the expenses reasonably incurred in respect of prosecuting the suit herein.

3. That the Honourable Court be pleased to strike out the plaint dated the 22ndof July 2002 with costs.”

15. Those are the two applications that came before Mwera, J for hearing and determination which gave rise to this appeal.

Decision of the High Court.

16. With the benefit of extensive research and incisive submissions made for several days in Nairobi and Mombasa, by two seasoned counsel, the trial court acknowledged that there were many and diverse issues raised on both sides of the argument which the Ruling would not cover, but framed four substantive issues for determination which it answered as follows:-

i) Whether the HIgh Court had jurisdiction to determine the dispute:

Yes; the court’s jurisdiction was original and unlimited under Section 60of the formerConstitution.

17. ii) Whether the suit was a proper derivative one with Dadani at the helm:

Yes; the suit fell within the exceptions set in the case of Foss vs. Harbottle(1843) 2 Hare 461in that Dadani had established aprima faciecase that thesuit was principally for the benefit of the company; that MML was trading in the premises of ML and was using the plant, equipment and stock in trade of ML without any formal resolution or transfer; that those averments were not controverted by affidavit since the replying affidavit on record sworn by Kumar, who was neither an officer, director or shareholder of MML, could not purport to do so; that the failure by Manji and MML to respond to the averments in Dadani’s affidavit in support of the motion for striking out amounted to admission of those averments; that Dadani had not participated in the illegalities relating to alleged adulterated annual accounts of ML as he protested their accuracy and never signed them; that in a 50/50 shareholding, it was not feasible that Dadani could successfully move a board resolution for the company to sue in its name for wrongs committed against it; that a 50/50 situation cannot be described as one where one party is in control, but is a stalemate; that the receivership ( though lifted after the filing of the suit) did not disentitle Dadani from filing a derivative action; and finally that the suit cannot be struck out since it was not shown that there were alternative ways or remedies available to Dadani or ML.

18. iii). Whether leave to institute the suit ought to be sought before or may be sought after the filing of the suit and , either way, whether it should be ex parte:

“There is no approved pre-action protocol in relation to derivative claim.”-see Joffeon“Minority Shareholders: Law Practice and Procedure.”The process is entirely procedural and no minimum tests or hurdles are set for the claimant to satisfy. A claimant who has not established a prima facie case for derivative action before filing the suit may seek permission to continue after the filing of the suit.

Ex parteorinter partes?- The application must be served and heardinter partes. SeeJoffe. Nevertheless, in the circumstances of this case where the parties had extensively acted on the pleadings and fully made submissions on interlocutory matters, there was no prejudice to either of them and the ex parteorders for leave would not be set aside. The prayer for indemnity for costs may be made ex parte and was also properly granted in this case.

19. iv).What prayers, if any, may issue pursuant to the application for strikingout several paragraphs of the defence?

· The main pleadings on both sides shall be left intact to form the basis for a trial where the witnesses will be cross examined.

· Despite an unacceptable replying affidavit sworn by Kumar which amounted to no reply to the matters stated by Dadani, there was a joint defence of all three defendants who must be accorded an opportunity to argue what they deny about the plaint.

· At this point the court was not inclined to grant the striking out of parts of the defence to pave way for judgment on liability followed by assessment of damages. The plaint would not be struck out either.

· In sum,the main pleadings remain for the basis of a trial, amended or otherwise, and no party gets summary judgment.

20. Despite those findings, the trial court went ahead and granted the following four orders in relation to the main suit, thus obviating a trial thereon:

a) A declaration that the closure of ML’s premises was wrongful and unlawful because there was no consent or resolution of ML to sanction it.

c). A temporary injunction to issue to restrain MML from carrying on business in ML’s premises pending hearing of the suit.

e). A mandatory injunction to compel Manji and Kumar to furnish ML with duly audited and certified accounts from 1998 to 2001 within 30 days.

f) All the property, assets, stock, books and records of ML be delivered by Manji and Kumar to ML within 60 days.

The Appeal and Issues for determination.

21. The appellants were aggrieved by the rejection of their main prayer to strike out the plaint on the basis that the action was not a derivative one and that it was filed without leave of the court. They were also dissatisfied with the issuance of final orders in four of the twelve prayers made in the plaint before the hearing of the suit. They laid out 27 grounds of appeal but in the written and oral submissions before us, Mr. Ochieng reduced them to four substantive issues which may be paraphrased as follows:

“a) Whether Dadani had locus standi and/or was competent in law to institute a derivative action on behalf of the Company?

b) Whether Dadani brought himself within the exceptions to the Rule in Foss-v-Harbottle?

c)Whether Dadani's suit before the High Court was properly instituted?

d)Whether the exparte proceedings and resultant order issued on 22ndJuly, 2002 were proper in law and ought not to be set aside?

e)Whether there were alternative remedies available toDadani herein to pursue?”

22. On the other hand, Mr. Oyatsi was of the view that the central issues for determination are three as follows:

i)“Whether the present case meets the legal threshold of a derivative action, and if so;

ii)Whether the High Court erred in granting prayer (2) in the application dated 26thNovember, 2002 in the derivative suit;

iii)Whether the commencement of the case prior to obtaining leave of the Court was fatal to the case.”

23. We think for our part, as we stated in the opening paragraph of this judgement, that the appeal stands or falls on two issues.Firstly, whether or not the suit filed by Dadani was a ‘derivative action’, either because Dadani had no capacity to institute the suit or because there was no leave of court tofile it. If the suit was not properly instituted as a derivative one, then it would attract a striking- out order as sought by the appellants and that would be the end of the matter.Secondly, if the suit was properly filed, the second question will be whether the High Court acted judiciously in the exercise of its discretion to issue the four orders it did at an interlocutory stage.

Those are the two main issues both learned counsel, in their usual industry, expended considerable time submitting on. The issues are easily distilled from the two sets of issues proposed on either side. Both counsel laid before us numerous authorities for consideration and if we do not refer to them all, it is not out of disrespect for their extensive research.

Was the suit procedurally filed?

24. That is the first issue. There is no divergence of opinion from both counsel on the legal personality of a limited liability company which acquires its own property, rights and liabilities separate from its members upon incorporation. The centuries-old case of Salomon vs. Salomon Company Limited [1895-99] All ER 33laid that principle to rest. There is also no argument that the proper plaintiff in any proceedings or action in respect of a wrong done to the company, is the company itself. Again that was established over 160 years ago in Foss vs. Harbottle (1843) 67 ER 189 (the Foss case),popularly referred to in company law as “the rule in Foss v.Harbottle”(the rule). The rule was restated by Jenkins L. J. in the case of

Edwards vs. Halliwell (1950) All ER 1064 as follows:-

“The rule in Foss-v-Harbottle, as I understand it, comes to no more than this. First, the proper Plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself. Secondly, where the alleged wrong is a transaction which might be made binding on the company or association and on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that if a mere majority of the members of the company or association is in favour of what has been done, then cadit quaestio; or if the simple majority challenges the transaction, there is no valid reason why the company should not sue.”

25. In essence the rule established two principles. The first is the "proper plaintiff principle"and the second is"the majority principle”.Through the former, a wrong done to the company may be vindicated by the company alone. On the second principle, if the alleged wrong can be confirmed or ratified by a simple majority then a shareholder is barred from bringing an action. The principal effect in the rule is to bar actions by minority shareholders.

26. This Court and others in this country have indeed cited and followed the Foss caseand others which came after it, as good law. The cases ofRai and Others vs. Rai and Others [2002] 2 EA 537andGrace WanjiruMunyinyi & Another vs. Gedion Waweru Githunguri & 5 others [2011]eKLRwere cited before us to confirm that the rule inFoss casestill standsin Kenya. In a recent case,Arthi Highway Developers Ltd vs. WestendButchery Ltd & 6 Others Civil appeal No. 246 of 2013this Courtfollowed the summing up of the rule by Lord Denning M.R inMoirvs.Wallerstainer [1975] 1 All ER 849at pg 857,thus:-

“It is a fundamental principle of our law that a company is a legal person with its own corporate identity, separate from the directors or shareholders and with its own property rights and interests to which alone it is entitled. If it is defrauded by a wrongdoer, the company itself is the one person to sue for the damage. Such is the rule in Foss V. Harbottle (1843) 2 Hane 461. The rule is easy enough to apply when the company is defrauded by outsiders. The company itself is the only one who can sue. Likewise, when it is defrauded by insiders of the minor kind, once again the company is the only person who can sue.”

27. The divergence of view in this matter centers on the exceptions to the rule which were stated in the Foss case itself and in other cases that came after it, especially Edwards v Halliwell (supra) which is regarded as the locus classicusthat laid out the exceptions and where Jenkins L. J. emphasized that:-

“..the rule(in Foss v. Harbottle) is not an inflexible rule and it will be relaxed where necessary in the interests of justice”.

28. Lord Denning in theMoir case (supra)posed the appropriate question:-

“.........But suppose (the company) is defrauded by insiders

who control its affairs – by directors who hold a majority of the shares – who then can sue for damages? Those directors are themselves the wrongdoers. If a board meeting is held, they will not authorize the proceedings to be taken by the company against themselves. If a general meeting is called, they will vote down any suggestion that the company should sue themselves. Yet, the company is the one person who is indemnified. It is the one person who should sue. In one way or another some means must be found for the company to sue. Otherwise the law would fail in its purpose. Injustice would be done without redress......”

29. Some of the exceptions to the rule may be taken from this court’s decision in theRai case(supra), citing the House of Lords inPrudential AssuranceCompany Limited v Newman Industries Limited and Others [ 1982] 1ALL ER 364 at page 357thus:-

“(a)There is no room for the operation of the rule if the alleged wrong is ultra vires the corporation, because the majority shareholders cannot confirm the transaction;

(b)There is also no room for the operation of the rule if the transaction complained of could be validly sanctioned only by special resolution or the like because a simple majority cannot confront a transaction which requires the concurrence of a greater majority; and

(c)There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company.”

30. L.C.B Gower, in his textbook,The Principles of Modern Company Law, 3rdEdition, has referred to those exceptions and added two more as follows :-

·“Where it is alleged that the personal rights of the plaintiff shareholder have been or are about to be infringed.

Such individual rights include the right to attend meetings the right to receive dividends; the right to insist in strict observance of the legal rules; statutory provisions in the memorandum and articles. If such a right is in question, a single shareholder can on principle, defy a majority consisting of all other shareholders.

·Any other case where the interests of justice require that the general rule, requiring suit by the company, should be disregarded”.

31. In his submissions, Mr Ochieng emphasized that the protection in those exceptions is only available to a minority shareholder, defined as one who “owns less than half the total shares.”In his view, Dadani who held half or 50% of the shares of ML was not a minority shareholder. Conversely, he submitted, Manji was not a majority shareholder and was not therefore in control of the company even assuming he was a wrong doer. He held 50% too and had equal voting rights with Dadani. On both counts, he concluded, it was not open for Dadani to purport to institute a derivative suit citing Manji or Kumar who succeeded Manji as Director, as if they were in control of the company. Dadani simply had nolocus standiin the matter. He cited for support of that conclusion the case ofTitus Musyoki Nzioka vs. JohnKimanthi Maingi & Another [2003] eKLRwhere two shareholders heldequal shares and this court held that neither of them could file a derivativesuit.

32. Furthermore, Mr. Ochieng submitted, Dadani fits nowhere among the exceptions to the rule in Foss v. Harbottle. That was so because all the particulars stated in the plaint, and summarized above (paragraph 6), were effectively traversed in the defence and controverted in affidavits in reply placed on record. There was thus a joinder of issues which can only be determined at a full hearing, where Dadani would have a heavy burden of proving fraud beyond a balance of probability. Even if there were suspicions about the accuracy of the accounts, records, other irregularities or voidable actions, counsel submitted, it was solely an internal matter which the members of the company could resolve or ratify in a general meeting. See Bamford vs. Bamford [1969] 1 All ER 969.

33. Finally Mr. Ochieng submitted that even assuming, arguendo, that the suit was a derivative one, it required leave but none was sought or granted before the suit was filed. The procedure was not spelt out in the Companies Act Cap 486 but the common law of England extant as at 1987 which requires that a prima facie case be established before leave is granted applied. The Rai case(supra) also stated so, as did Musinga J. (as he then was) inIn the matter of CMC Holdings Limited [2012]eKLR.In counsel’s view, it was not permissible to file the suit and then seek leave subsequently. At any rate,he added, no orders could be issuedex parte,as the High Court did, in theabsence of any threat of irreparable or serious mischief. It was the height of irregularity therefore for the court to refuse to set aside theex parteorderexdebito justitiaeafter making a finding that the procedure was wrong.

All in all, he concluded the derivative action taken out by Dadani was an abuse of court process and ought to be rejected.

34. In response to those submissions, Mr. Oyatsi contended that ‘derivative action’ was an American term amounting to no more than a ‘representative suit’ filed on behalf of a plaintiff under disability, like a minor or person of unsound mind. In this context, it is a suit instituted by a shareholder on behalf of the company as its representative when the company itself cannot sue. He submitted that there were three legal thresholds which must be met in order to obtain leave of the court to sue on behalf of the company:

Firstly, that the aggrieved company has a cause of action, that is, a“legal right that has been violated.”Secondly, that it is impossible for the company to sue in its own name to redress the wrong or breach. This would arise if the wrongdoers themselves are the directors or majority shareholders in the company and will not allow it to file suit against themselves. Similarly, where there was no majority shareholding which could overule the directors, it would be impossible to institute the suit in the name of the company, if the directors fail to do so. Thirdly, that the representative has locus standi, or legal standing as a shareholder, but not a majorityshareholder, to commence the suit.

35. In this case, submitted counsel, there were clear breaches of the rights of the company which were particularized in the plaint, and which the trial court appreciated upon examination of the record, raised a valid cause of action. The impossibility to take action in the name of the company arose because, as the trial court correctly found, a 50/50 shareholding was a stalemate and a resolution by the Board to allow the company to sue in its name was next to impossible to achieve. Lastly, on locus standi, Dadani was a shareholder, not a majority shareholder, there was a stalemate in the Board of Directors, and the situation was akin to that described by Lord Denning M.R in the Moir case (supra). All three thresholds were thus satisfied.

36. Mr. Oyatsi referred to the extensive submissions by Mr. Ochieng on the issue of locus standi, contending that there was undue concentration by the latter on the distinction between minority and majority shareholders. This distinction, in his view, was only useful in derivative actions for the purpose of addressing the issue of impossibility of the company to sue in its own name. A majority shareholder cannot institute a derivative action to redress wrongs committed against the company because he has thealternative remedy of overuling the directors or replacing them.

37. As regards leave to commence the action, counsel submitted that there was no law, either in the Companies Act, Cap 486 or the 1948 English Companies Acton which the Kenyan Act was modelled, or theCivil Procedure Act, Cap 21, which referred to derivative action, let alone provide a procedure for it. Derivative actions were a creation of the common law and it was not until 2006 that England changed its Companies Act and Supreme Court Rules to provide expressly for derivative actions. The applicable law in Kenya was therefore the common law before 2006 and it allowed for an “application to continue with a derivative action”which is what Dadani did the same day he filed the suit. As to whether leave should have been granted ex parte, Mr. Oyatsi submitted that the trial court gave cogent and valid reasons for the refusal to set aside the leave, and in any event, no party suffered any prejudice as they will have an opportunity to contest the main suit.

38. We have anxiously considered the first issue and in the end we have formed the following firm view on the matter. Firstly, on the procedure for granting leave to mount a derivative action, it is common ground that there are no express provisions in Kenyan company laws to govern the procedure. Musinga J. (as he then was) was right in lamenting that stateof affairs in theCMC Holdings case (supra)stating:

“I think time has come to enact a new Companies Act which will, inter alia, shed light on the grey areas of company law practice, including derivative claims….”

The nearest we come to an express provision is in Rule 3 of the Companies(High Court) Ruleswhich states:-

“Any proceedings brought under these Rules shall be deemed to be a suit within the meaning of the Civil Procedure Act and any Rules made thereunder, and the general practice of the Court, including the course of procedure and practice in chambers, shall apply in so far as the Act or these Rules otherwise provide”.

39. The procedure therefore remains the English common law, and it matters not whether it is the common law extant as at 1987, as submitted by Mr. Ochieng or before 2006, as contended by Mr. Oyatsi. Leave of court shall be obtained before filing a derivative suit, but may also be obtained to continue with the suit once filed. On this, the trial court was right in adopting the exposition of the procedure in the treatise “Minority Shareholders: Law, Practice and Procedure”byJoffethat‘there is no approved pre-action protocol in relation to derivative action’and that

“..after the claim form has been issued, the claimant is required to make an application - which must be supported by written evidence- for permission to continue with the claim.”It is our view that at whatever stage leave is sought, the crucial requirement is for the applicant to establish aprima faciecase demonstrating that he haslocus standito institute such action, the company is entitled to the intended relief and that the action falls within any of the exceptions tothe rule in Foss vs.Harbottle.

40. Where no application for leave is filed or where one is filed long after the suit is filed, different considerations would, of course, apply. The application for leave to continue with the suit filed in this matter was not made long after the suit was filed. Both were filed contemporaneously and were placed before a judge on the same day under a ‘certificate of urgency’. In the circumstances of this case, we find no impropriety in the procedure. It is correct to say, as it is the procedure under common law and the trial Judge found as much, that such application ought to be heard inter partes.But he heard and granted itex parteas it was under certificate of urgency. In his view, the matter lay in the discretion of the court and equitable principles were applicable. It is indeed so, that the matter lies in the discretion of the court which ought to be exercised judiciously and in the circumstances of this case the discretion was justifiable on the basis that the case was prima facie a derivative one and it was necessary to come to the rescue of the company if it was truly inthe distress portrayed in the application for leave. There was apparent threat and mischief. There was nothing to prevent any party cited in the application from making an application to have theex parteorders set aside for good reasons immediately thereafter, but instead the three appellants here waited to raise the matter in their extensive defence in August 2002 which attracted an application for striking out parts of it in November 2002. That application was strongly resisted in volumes of documents and there were skirmishes about the propriety of sworn affidavits which were determined by the court. It was not until May 2003, almost one year later, that an application for setting aside the leave grantedex partewas filed. We think in the circumstances, the trial judge was right in exercising the discretion to maintain the leave granted and to give the parties the opportunity to contest the real issues in controversy in the main suit.

41. Secondly, on the question whether the suit was a derivative one, we find it was. The company was in the peculiar and unique position of having only two members who were equal in power and glory in relation to the company. There was no majority or minority shareholder. The two shareholders/directors had reached a stalemate until one left the directorship as the other migrated to Canada while the company wassinking into extinction. Proof of a stalemate in the boardroom was that there are no resolutions of the Board exhibited in the record on the matters complained of. On the face of it, the property of the company was disappearing or being taken over by a third party but the company was doing nothing about it. Did any of all this fit anywhere in the exceptions to the rule inFoss vs.Harbottle?The trial court found it did and we think it was right. From earlier learning on the principles which both counsel broadly agree on except for their application, we think the following exceptions, which we take from theRai caseandGower, would easily justify a derivative suit in this matter:-

“(i) There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company.

ii) Where it is alleged that the personal rights of the plaintiff shareholder have been or are about to be infringed.

(iii) Any other case where the interests of justice require that the general rule, requiring suit by the company, should be disregarded.”

The suit ought to be agitated at a full hearing as it is largely for the benefit of the company. Should some of the issues be left out at the trial on the basis that summary judgment was entered in favour of the company at the interlocutory stage? That leads us to the second and final issue.

Final orders granted in interlocutory application

42. Mr. Ochieng submitted that there was no basis for granting the four prayers in the plaint that the court did, as there was a full answer to the allegations made. The answers were not only in the defence filed, but also in the affidavit in reply to the motion for striking out which the trial court erroneously ignored or rejected. On the other hand, Mr Oyatsi submitted that the replying affidavit was properly rejected since it was sworn by someone who had no authority to do so and therefore the averments made in the affidavit in support of the application for striking out were uncontroverted and therefore admitted.

43. It is indeed the case, that the only reason the trial court granted the contentious prayers was because, in its view, the affidavit sworn in response to the application was of no probative value as no authority was given for stating the matters the deponent did. With respect, that view was not entirely correct and we differ. The affidavit in issue was sworn by Kumar on 15th May 2003 and he expressly stated in paragraph 3:

“THAT I have been authorized by the first and third defendants to make this affidavit on their behalf. I further make this affidavit on my own behalf in reply to the matters and issues raised in the application and Dadani’s affidavit.”

He then proceeded to respond in 47 paragraphs and to annex numerous documents in support. At no time was any challenge made to that authority and it was therefore erroneous to reject it outright.

44. Furthermore the rejection of the affidavit did not ipso facto amount to admission and therefore automatic acceptance of the applicant’s evidence.

In the case of Hon. Daniel Toritich arap Moi vs. Mwangi Stephen Muriithi [2014]eKLRthis court stated as follows:-

“It is a firmly settled procedure that even where a defendant has not denied the claim by filing of defence or an affidavit or even where the defendant did not appear, formal proof proceedings are conducted. The claimant lays on the table evidence of facts contended against the defendant. And the trial court has a duty to examine that evidence to satisfy itself that indeed the claim has been proved. If the evidence falls short of the required standard of proof, the claim is and must be dismissed. The standard of proof in a civil case, on a balance of probabilities, does not change even in the absence of a rebuttal by the other side. (Emphasis added)

45. Even without the affidavit in reply, the trial court was able, in its discretion, to reject the main prayer for striking out numerous paragraphs of the joint defence and to pronounce emphatically that :

“But at the end of the day this Court was satisfied that both main pleadings be left intact and may they form a basis of a trial with evidence (orally) and the same subjected to the rigours of examination. First, it is not usual that derivative suits feature in litigation in this country. Second, where claims are laid and denials returned, normally proof is better

left to the outcome after a trial. Sometimes affidavit evidence may appear extremely attractive as the case was here. ...........Nonetheless there is a joint defence and the 3 defendants must be accorded an opportunity to argue or testify about what they deny as per the plaint. Affidavit evidence is good; but oral evidence is better and unless it is in the clearest of cases to strike out a pleading and as it were, shut out a party from being heard on the particular aspect of a case, let him be heard.”

46. Equally emphatically, the Court concluded:

“In sum, the main pleadings remain for the basis of a trial, amended or otherwise, and no party gets

“summary judgment” at this point.”

That, in our view, should have been the final order. The court reached that conclusion without the benefit of the replying affidavit which it had rejected. We do not know what conclusion the court would have made if the affidavit had been considered but, in our view, it would have made a more compelling case for rejecting the whole application for ‘summary judgment’ on parts of the plaint. We now find and hold that the trial court was in error in proceeding further to grant the four prayers it did, after finding, correctly so in the circumstances of the case, that no party should get summary judgment at the interlocutory stage.

47. The upshot in the appeal is that it succeeds in part as stated above. The orders made by the High Court on the application dated 26th November 2002 are hereby set aside and substituted with an order dismissing that application. The Ruling and other orders of the High Court made on 5th April 2004 are otherwise upheld. Each party shall bear its own costs of the appeal and of the motions before the High Court. Orders accordingly.

Dated and delivered at Nairobi this 25thday of September, 2015.

P. N. WAKI

………………………………

JUDGE OF APPEAL

G. B. M. KARIUKI

……………………………

JUDGE OF APPEAL

W. OUKO

………………………………

JUDGE OF APPEAL

I certify that this is

a true copy of the original.

DEPUTY REGISTRAR