[2022] KEHC 16231 (KLR)

Ayim v Multitrade Industrial Supplies Limited & 2 others; Arican Banking Corporation (Interested Party) (Commercial Case 050 of 2020) [2022] KEHC 16231 (KLR) (Commercial and Tax) (9 December 2022) (Ruling)

Neutral citation: [2022] KEHC 16231 (KLR)

Republic of Kenya

In the High Court at Nairobi (Milimani Commercial Courts Commercial and Tax Division)

Commercial and Tax

Commercial Case 050 of 2020

EC Mwita, J

December 9, 2022

Between

Prof. Dr. Emmanuel Nuwokpor Ayim

Applicant

and

Multitrade Industrial Supplies Limited

1st Respondent

Muzamil Abdul Gafur

2nd Respondent

Abdulkader Gafoor

3rd Respondent

and

Arican Banking Corporation

Interested Party

Ruling

1. This is a notice of motion dated April 14, 2020 brought by the plaintiff, a shareholder, in the 1st defendant, (the company). The application seeks leave to continue this suit as a derivative action on behalf of the company and an order indemnifying the company against costs.

2. The application is premised on the grounds on its face and the supporting affidavit sworn by the plaintiff. The plaintiff holds 400 shares while the 2nd and 3rd defendants hold 100 and 400 shares respectively, making the 2nd and 3rd defendants majority shareholders.

3. According to the plaintiff, article 11 of the company’s articles of association puts quorum for purposes of meetings of the company at 2 members present. By virtue of this provision, the 2nd and 3rd defendants form the majority and have control of the financial affairs of the company to his exclusion.

4. The plaintiff asserts that due to the 2nd and 3rd defendants’ control of the company affairs, the two have committed wrongs against the company which are incapable of being rectified in meetings and resolutions of the directors for the benefit of the interested party and other creditors.

5. The plaintiff further asserts that between 2014 and 2015, the interested party advanced a loan of Kshs 125,000,000 to the company which was disbursed through two accounts, Nos xxxxxxxx1691(loan account) and xxxxxxxx12926 (Hazina current account) respectively. The 2nd and 3rd defendants who are the sole signatories in those accounts have singularly authorized payments from the two accounts to his exclusion and have benefited in secrecy and converted the loan account for their personal use to the detriment and prejudice of the company.

6. The plaintiff states that the 2nd and 3rd defendants have refused to account for the company’s assets; there has been and continues to be material procedural irregularities in the conduct of the company affairs and the 2nd and 3rd defendants have misused and abused their control to defraud the company.

7. It is the plaintiff’s case that the interested party issued demands for repayment of the loan in May 2017 and July 2017 and served a statutory notice in August 2017 to settle the outstanding loan balance, but the loan facility remains unpaid. The 2nd and 3rd defendant have failed to repay the loan and have used his personal guarantee for blackmail and threaten to transfer his parcel of land, LR No 13872/2 to the company, thus breaching their fiduciary duty to the company.

8. The company, therefore, craves for intervention by this court to free it from the majority control by the 2nd and 3rd defendants as it cannot bring a suit in its own name for protection.

Respondents’ Response 9. The defendants have opposed the application through a replying affidavit sworn by Abdul Kader. They assert that the suit is not a derivative action as it is filed against the company, seeks relief against the company and generally the relief are not sought on behalf of the company, contrary to section 238 of the Companies Act. The defendants also state that the plaintiff holds 40% shareholding in the company and is not, therefore, a minority shareholder.

10. According to the defendants, the plaintiff actively participated or was represented in decisions made by the company; there is no evidence of specific instances of acts or conduct on their part that amount to breach of fiduciary duty; there is no evidence of the plaintiff’s exclusion from the affairs of the company and there is no evidence that the plaintiff ever called a meeting of the company but the meeting was not convened. The defendants again state that the plaintiff has not attempted to seek information or to resolve the problems complained of using the forum available under the company’s memorandum and articles of association. The defendants maintain that they have taken all necessary steps to amicably resolve the matter but the plaintiff has not been willing to participate.

Interested Party’s Response 11. The interested party has also opposed the application through a replying affidavit sworn by Kajuju Marete. The interested party asserts that the plaintiff has not disclosed all material facts to the court by suppressing information regarding the company’s true indebtedness to it.

12. The interested party states that floating debentures were created over the company’s assets and legal charges registered over the plaintiff’s parcels of land, Nairobi/Block 82/5527; Nairobi/Block 82/5529; Nairobi/Block 32/960; LR No.13872/2 and LR No 209/109473/4, after the plaintiff willfully gave the properties as security to secure loans advanced to the company. The plaintiff and 3rd defendant signed the memorandum of acceptance.

13. The interested party maintains that it is not party to the internal wrangles between the directors of the company and those wrangles, if any, do not affect its contract with the company. The interested party points out that although the suit is brought as a derivative action, prayer (e) of the suit seeks relief beneficial to the plaintiff with the sole intention of circumventing the procedure, avoid his obligations as chargor thus threatening its rights as chargee.

14. According to the interested party, due to the company’s default, it initiated the process of recovering the outstanding loan amount and issued necessary statutory notices. This is the process the plaintiff now wants to circumvent through this suit purporting it to be a derivative claim brought on behalf of the company.

Determination 15. The plaintiff seeks leave to proceed with this suit as a derivative action on behalf of the company. The application has been opposed by the defendants and the interested party. Their take is that this is not a derivative action as the plaintiff has not only named the company as a defendant, but some of the relief sought will be beneficial to the plaintiff personally and not the company. The interested party agrees with the defendants and adds that the true intention of the suit is to circumvent and defeat its right to recover the outstanding loan amount.

16. A derivative action is a claim brought or continued by a shareholder on behalf of the company in relation to a breach of duty by a director. This action is taken where the majority shareholders or directors wrongfully prevent the company from bringing or proceeding with such a claim itself and the claim is usually brought for the benefit of the company. This procedure is necessary as a director owes a duty to the company and not to the shareholders.

17. As aptly put in Ghelani Metals Limited & 3 others v Elesh Ghelani Na twarlal & another [2017] eKLR:"Derivative actions are the pillars of corporate litigation…a derivative action is a mechanism which allows shareholder(s) to litigate on behalf of the corporation often against an insider (whether a director, majority shareholder or other officer) or a third party, whose action has allegedly injured the corporation. The action is designed as a tool of accountability to ensure redress is obtained against all wrongdoers, in the form of a representative suit filed by a shareholder on behalf of the corporation."

18. Section 238 of the Act defines what a derivative action is and who may bring a derivative action. According to section 238(1), it is proceedings by a member of the company in respect of a cause of action vested in a company and is seeking relief on behalf of the company. Sub section (3) requires that the claim be brought only 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.

19. The section makes it plain that a derivative action is brought on behalf of the company and the relief sought is for the benefit of the company. In essence, a derivative action cannot be brought for the benefit of a plaintiff claiming to bring the suit as a derivative claim.

20. The questions then that arise for determination are, whether the company should have been named as a defendant and whether this is a derivative suit.

Whether The Company Should Be Named Defendant 21. The defendant’s and interested party have argued that this is not a derivative action not only because the company has been named as a defendant but also that the plaintiff seeks relief against the company. The argument that the suit should fail because it is brought against the company has no merit. The short answer to this argument, is that in a derivative action, the corporation is named as a nominal defendant as a matter of formality only since the corporation is the true plaintiff in the suit and the shareholder plaintiff sues as the corporation’s representative. The argument must therefore fail.

Whether This Is A Derivative Suit 22. The defendants and interested party have also argued that this is not a derivative suit because the relief sought will benefit the plaintiff and not the company. As already adverted to, it is the requirement of law that a derivative action be brought on behalf of and for the benefit of the corporation. Since the action is by a shareholder against officers or directors of a company, it is brought on behalf of the corporation and the shareholder sues and acts only as a representative plaintiff for the corporation. The objective of the suit is to stop actions of directors or shareholders that are destructive to the corporation’s affairs. Any damages recovered in the suit belong to the corporation and not the plaintiff as a person. In other words, the shareholder would only indirectly benefit as one of the owners of the company.

23. It is in this regard, that section 238(3) decrees that a derivative claim be brought only 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.” A derivative action will have been brought on behalf of and for the benefit of the corporation if the relief sought will be for benefit of the company. It is again for that reason that section 241(2)(a) demands that the court be satisfied that the member is acting in good faith in seeking to continue the derivative claim on behalf of the company.

24. A perusal of the pleadings and, in particular, some of the relief sought, gives a glimpse of the true intention of the plaintiff. For instance, prayer (e) seeks any other reliefs the court may deem fit to grant for “purposes of protecting the plaintiff’s proprietary rights in Land Reference Nos Nairobi/Block 32/960, Nairobi/Block 82/5227, Nairobi/Block 82/5229, Land Reference No 13872/2 and Land Reference No 209/10473/7. ” Such a relief, if granted, would not benefit the company but the plaintiff and, to that extent, the suit is not in the best interest of the company.

25. In Ghelani Metals Limited & 3 others v Elesh Ghelani Natwarlal & another (supra), the court stated that a derivative suit will be allowed if it is in the best interest of the company. A derivative action can only be for the best interest of the corporation if all the plaintiff does, is seek remedy(ies) that the company could seek but for the fraudulent acts of its officials.

26. There is no doubt that relief (e) in the suit and which is the most consequential relief, is not sought for the benefit of the company but that of the plaintiff. This is not, therefore, a case where the plaintiff is suing on behalf of and for the benefit of the company. The plaintiff will be the direct and single most beneficiary in the suit contrary to the requirements of the law on the subject. This is so because, were prayer (e) to be granted, the court would have granted relief that would protect the plaintiff’s right to property but not any right accruing to the company.

27. In Isaiah Waweru Ngumi & 2 others v Muturi Ndung’u [2016] eKLR, the court stated that among the factors the court should consider in deciding whether or not to grant permission to a plaintiff to pursue a derivative claim, is whether the shareholder is seeking to bring a derivative suit in order to pursue a personal vendetta or private claim. In other words, where it is clear to the court, like in the instant case, that the plaintiff is bringing the suit to substantially benefit from the relief sought, permission should not be granted.

28. It must be made clear, that there is a distinction between direct and derivative claims. A direct claim is based on legal rights that belong to the individual shareholder. In such a case, the individual shareholder brings his own claim in his own name to challenge the violation of legal duties to himself and seeks a legal remedy for his own benefit. In a derivative claim, on the other hand, the cause of action belongs to the corporation and the shareholder asserts the cause of action on behalf of the corporation, as a legal representative because the management of the corporation refuses to do so. The legal remedy that the court awards is for the benefit of the corporation, not the individual shareholder.

29. Even though the shareholder is the named plaintiff in a derivative action, and the corporation as a nominal defendant, this is a matter of formality only as the corporation is the true plaintiff. The shareholder, as the representative of the plaintiff, owes a fiduciary duty to the corporation and to the shareholders collectively in conducting the suit. It is for that reason that the relief sought must be for the benefit of the corporation and not the plaintiff shareholder.

30. This distinction was aptly captured in Pokoik v Norsel Realties 2017 NY Slip Op 50459(U), where Justice Oing of the New York County Commercial Division, dismissed a derivative claim brought on behalf of a corporation, holding that a shareholder lacks standing to pursue a direct cause of action to redress wrongs suffered by the corporation. The judge pointed out that such claims must be asserted derivatively, for the benefit of the corporation. He stated:"In general, a plaintiff asserting a derivative claim seeks to recover for injury to the business entity, while a plaintiff asserting a direct claim seeks redress for injury to him or herself individually. In analyzing whether a plaintiff's claim is truly direct or derivative, courts look at the nature of the harm alleged and who is principally harmed: the corporation or the individual shareholders."The judge then went on to state:"[B]ecause derivative actions bind absent interest holders, they take on the attributes of a class action and a plaintiff must therefore demonstrate that he will fairly and adequately represent the interests of the shareholders and the corporation, and that he is free of adverse personal interest or animus. If a plaintiff cannot demonstrate such representation, the derivative causes of action will be dismissed." (emphasis)

31. Applying the above principles to this case, and looking at the totality of the relief sought herein, the plaintiff has not demonstrated that he is free of adverse personal interest, and that will adequately represent interests of the company to deserve permission to pursue the suit as a derivative claim. This emerges clearly when one closely examines the relief sought in the suit. The plaintiff will be the ultimate beneficiary of the suit given that the suit is intended to safeguard his property rights and not interests of the company and the other shareholders.

Whether To Grant Leave 32. The law requires that before granting permission to pursue a derivative claim, the court be satisfied that the plaintiff has presented a prima facie case for that purpose. Section 239(2) states that an application for leave will be dismissed if the evidence adduced in support does not disclose a case for giving of permission.

33. The defendants and interested party maintain that the plaintiff has not been truthful and has not disclosed full particulars to court. The defendants even argue that the plaintiff has not shown what action he took to remedy the situation, has not shown that he called for a meeting of the company but it was not held, or that he took steps to address the matters complained of through mechanisms provided for in the memorandum and articles of association of the company before coming to court.

34. The interested party joins the defendants to argue that the plaintiff did not fully disclose other material particulars to the court. According to the interested party, the plaintiff and the 3rd defendant were the signatories to the memorandum of acknowledgement, a fact he failed to disclose to the court.

35. Although as a shareholder, the plaintiff has the derivative action in his arsenal to present a case on behalf of the company, he cannot immediately run to court to redress the alleged wrongdoing. He must first formally demand that the company’s directors (offending directors) act in the manner that he desires for purposes of remedying the situation. The requirement for a demand may, however, be waived if the plaintiff shareholder can show that such a demand would have been futile. Where a demand has been made, the directors must be allowed time to determine the proper course of action to pursue.

36. The plaintiff makes general allegations against the defendants that they have been acting in a manner that is prejudicial to the interests of the company. The plaintiff has not, however, demonstrated that he took action to demand that the 2nd and 3rd defendants resolve the issues he is complaining about, if at all there were any. That is why a plaintiff seeking permission to continue a derivative action is required to do so in good faith. He must, therefore, show that he did whatever was possible to no avail. On that score, I am not satisfied that the plaintiff has, prima facie, made a case for granting permission.

Conclusion 37. Having considered the application, the response and submissions by parties, and carefully perused the plaint and the relief sought, the conclusion I come to, is that the plaintiff has not demonstrated that he will fairly and adequately represent the interests of the shareholders and the company, and that he is free of adverse personal interest in this suit. Instead, what is plain, is that the plaintiff will eventually be the ultimate beneficiary of the award to be made if the suit succeeded.

38. The plaintiff has not, therefore, presented a prima facie case as required by law for permission to proceed with this suit as a derivative claim.

39. Regarding the argument by the defendants, supported by the interested party, that the suit could fail because it has been brought against the company, the short answer to that argument is that it is unfounded. In a derivative action, the corporation is named as a nominal defendant. This is a matter of formality only as the company is the true plaintiff in this suit since the plaintiff is only suing as its representative.

40. In the end, I find that the plaintiff has not made a case for permission to mount this suit as a derivative claim. Consequently, the application and the suit are struck out. There will be no order on costs.

DATED, SIGNED AND DELIVERED AT NAIROBI THIS 9TH DAY OF DECEMBER 2022. EC MWITAJUDGE