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IJLMA
51,4
Minority shareholders and
corporate governance
Reflections on the derivative action in
206 the UK, the USA and in China
James Kirkbride and Steve Letza
Liverpool John Moores University,
Liverpool, UK, and
Clive Smallman
Lincoln University, Canterbury, New Zealand
Abstract
Purpose – The purpose of this paper is to compare the response in the UK, the USA and China to
the need to provide effective protection in law to disgruntled minority shareholders.
Design/methodology/approach – The study draws upon official comment and case law across the
three jurisdictions in order to assess the scope and availability of minority actions.
Findings – The importance of shareholder rights through alternative actions is an important aspect
of controlling the behaviour and actions of the Board of Directors and an important part of corporate
governance. This paper seeks to compare the development and scope of derivative rights in the UK,
the USA and in China and provides an assessment and insight into the differences in approach and in
the political and legal structures with the consequent likely impact on the role and contribution of
derivative claims in the control and governance of Boards in the different jurisdictions.
Originality/value – The study should prove of interest to scholars of comparative corporate law.
Keywords Stakeholder analysis, Corporate governance, United Kingdom, China,
United States of America, Shareholders
Paper type Research paper

International Journal of Law and
Management
Vol. 51 No. 4, 2009
pp. 206-219
# Emerald Group Publishing Limited
1754-243X
DOI 10.1108/17542430910974031
Introduction
Over recent years debate and discussion over the scope and extent of directors duties
has taken place in many jurisdictions, including in the UK and China. In China, the
statutory formulation of directors’ duties has reflected the UK common law position of
seeking to explain the boundaries of directors’ behaviours through the application of
Directors’ fiduciary principles and duties of care and skill (management). It is correctly
stated that while director duties exist, if they are to perform an effective function then a
realistic prospect of enforcement must also exist which would be largely dependent
upon shareholder actions (Parkinson, 2000). This is supported by Boyle who also
argues that effective derivative actions for shareholders are necessary to provide a
sanction for directors’ duties and to play a role within Corporate Governance (Boyle,
1997). Fishel and Bradley also support the view that derivative actions play a
fundamental role in aligning the interests of Directors and Shareholders (Fischel and
Bradley, 1986). Pistor and Xu warn that simply transplanting different rules such as
fiduciary duties from one country to another might not always lead to the intended
consequences (Pistor and Xu, 2002). To ensure that substantive rules are effective,
This paper is the periodic achievement of project ‘‘Research on Finance Law and Cultivation of
Talents under the Background of Financial Reform and Innovation’’ by Shanghai Municipal
Education Commission.
procedural rules need also be designed in such a way that minority shareholders would Shareholders and
have a standing in court to seek compensation of damages (Wei-Qi and Lawton, 2005).
While this paper is not intended to represent a study of the convergence or
corporate
otherwise of corporate governance rules, an often over generalised debate (Toms and governance
Wright, 2005), nevertheless its content does support the view that in respect of the
protection of shareholder interests, differences in regulatory approaches exist within
the common law world itself, and challenge any assumptions of a seamless progression
towards a uniform model of corporate governance; and certainly not an example of
207
convergence to a superior common law position (Jordan, 2005). This paper seeks to
consider the extent to which derivative actions and regulatory frameworks have been
developed as possibly effective contributors to Corporate Governance through the
regulation of directors’ duties and behaviours in the UK, the USA and in China.
Derivative actions and their scope represent an important element in any model of
corporate governance. The extent of their importance and contribution must reflect the
collibratory approach (Kirkbride and Letza, 2000) of balancing the full range of
regulatory responses. In the immediate instance of derivative claims, the suggested
counter-balances are market control through permissive takeover controls, and the
existence of personal statutory rights in circumstances of ‘‘oppressive’’, ‘‘unfairly
prejudicial’’ and ‘‘unfairly discriminatory’’ behaviours of the board or individual
directors. La Porta et al. support the view that minority shareholder protection is vital
to Corporate Governance in stating that ‘‘Corporate Governance is, to a large extent, a
set of mechanisms through which outside investors protect themselves against
expropriation by insiders’ (La Porta et al., 1999, p. 4).
La Porta et al. further suggest that the inclusion and development of effective
minority protection rules within the legal and corporate governance framework of any
country will add to investor confidence and encourage, or is even a pre-requisite for, an
environment of dispersed ownership. Supporting this claim, a study was completed in
1999 (La Porta et al.) showing evidence of higher valuations attached to firms in
countries with clear and advanced forms of derivative actions and minority protection
(the suggested narrative subtext was that common law protections were superior to
those found in civil law systems (Hill, 2000)).
Other studies have sought to identify the value of derivative suits. One suggesting
that the level of affirmative relief for shareholders demonstrated the effectiveness and
success of this form of ‘‘protection’’ Thompson and Thomas (2004); others, suggesting
that the deterrent effect was substantial and primary in its role (Choo, 2001).
Despite these claims and studies, some commentators question the suggested
agency-cost benefits of a derivative suit (Fishel and Bradley, 1986) and also, as we shall
see later, claim that the real beneficiaries are the lawyers and that these are outside of
any agency-cost model.
Some might question why jurisdictions should move towards increasing minority
protection, or at least the facilitation of derivative actions and shareholder actions. The
theory, supported by research from La Porta et al. suggests that it would facilitate the
confidence of shareholder protection and wide and disbursed investment required in
advanced economies. The La Porta et al. study in 1999 showed evidence of higher
valuation of firms in countries with better and advanced protection for minority
shareholders. One can also point to, the pre-credit crunch position of the marked trend
towards cross-listing of foreign firms in the USA during the 1990s. It has been
suggested (Coffee, 2005) that this is evidence of regulatory competition whereby
companies incorporated in jurisdictions with weak minority shareholder protection
IJLMA would voluntarily adopt higher standards and thus attract a significant valuation
51,4 premium (Coffee, 2007)

The UK position
It has been suggested that historically the UK position toward minority protection and
derivative lawsuits represents a dour attitude (Miller, 1998). The general rule in the UK
208 is suggested as stemming from a case of Foss v. Harbottle which held that only the
company not shareholders may sue to remedy the wrong done to the company. This
replicates and respects the separate corporate personality of the company albeit there
is some suggestion that this is an exaggeration of the actual position in Foss vs
Harbottle itself (Talbot, 2008). It is often expressed as being a corporate plaintiff rule
recognising that the proper action belongs to the company and not the shareholder.
Exceptions to the rule developed during the latter half of the nineteenth century. Those
exceptions permitted a derivative action if the company was not in a position to take a
proper decision on enforcement of its rights because the wrongdoers were in effective
control.
In essence the common law, rule has allowed shareholders to sue to obtain redress
for wrongs done to the company when
. the corporation or the company is in the control of the wrongdoers and (control);
and
. that the breach complained of is not a breach ratifiable by the shareholders
themselves. (a ‘‘fraud’’).
The non-ratifiable breach developed to include misappropriation of company assets or
similar illegal conduct, but not negligent mismanagement per se. It is suggested that a
derivative action would not ordinarily lie in the UK for breach of the duty of care owed
by directors or at least without other aspects of self dealing not being present Megarry
V.C clearly stated that the core wrong was in the form of misuse of power not
negligence.
[. . .] apart from the benefit to themselves at the companies expense, the essence of the matter
seems to be an abuse on issues of power. Fraud in the phrase ‘‘fraud in the minority’’ seems to
be used as comprising not only fraud at common law but also fraud in the wider equitable
sense of that term, as in the equitable concept of a fraud on a power (Estmanco (Kilner House)
Ltd v. Greater London Council (1982) 1 WLR 2, p. 12)
The meaning and extent of ‘‘wrongdoer control’’ has challenged the UK courts. A
simple majority vote would support a position of simplicity but this is not a realistic
demand for a large industrial corporation because wrongdoers can effectively control a
public company with far less of the majority shares. Vinelott, J. in Prudential Assurance
Co Ltd v. Newman Industries Ltd ((1980) 2 WLR 339) considered control to be a
procedural issue and one that was flexible in it meaning, once fraud had been
established. He suggested that justice would be thwarted if the approach was to allow
the de jure control to be the only basis upon which to pursue a derivative action in
courts. He suggested that courts should have the flexibility to consider de facto control.
Adopting a ‘‘justice in the case’’ principle, Vinelott, J. suggested that control should be
flexibly approached to include those in a position to influence as well as those with
actual control. It has been suggested this ‘‘rescued the derivative suit from oblivion as
applied to large scale corporations’’ (Miller, 1998).
 Vinelott, J. argued that the notions of interest of justice have consistently insisted Shareholders and
that issues of control should be flexibly approached to include those in a position to corporate
influence as well of those with actual control. Thus, in this instance control was
permitted and established, although it should be noted that the Court of Appeal did governance
consider control in this area to be perhaps too wide and too difficult to apply except
when a Judge was determining the preliminary issue of whether a shareholder had a
right to bring a derivative action at all. Perhaps, reflecting the courts’ reluctance to
permit consideration of minority claims, particularly around mismanagement, the
209
court held that the question whether the rule in Foss v. Harbottle applied to any
particular set of circumstance should, where possible be decided as a preliminary issue
and not left for determination at the trial.
The position in the UK is noted for including further problems or barriers beyond the
restrictive nature and interpretation of control: it is suggested that the ‘‘loser pays’’
principle exacerbates the situation. In the UK the derivative plaintiff may have to pay the
defendant Directors fees in the event that the suit is unsuccessful. Given the substantial
evidential uncertainties and impediments to the derivative action the ‘‘loser pays’’
principle significantly increases the riskiness of this type of litigation for any potential
plaintiff. The UK does not recognise, like the USA, contingency fee rules. In the USA
there is an enormous incentive to bring shareholder derivative suits on the basis of the
prospect of a generous fee award for the lawyer or attorney who represents the plaintiff
and obtains a fund for the benefit of the corporation. This is absent in the UK. Because
there is no realistic prospect of a fee award from the judgement, derivative litigation
normally occurs when there exists a plaintiff with sufficient funding and motivation to
support litigation, himself or herself. Perhaps, this is a explanation as to why the level of
derivative claims in the UK have been so low and certainly much lower than those found
in the USA. Similarly, there is no incentive or action on behalf of the institutional
investors in the UK. Institutional investors clearly do not want to incur the cost and
inconvenience of derivative litigation which would tie up there senior fund managers
time and result in costs that cannot either be passed on to clients and invite freeloading
by other shareholders who do not contribute to the litigation (Miller, 1998). Even in the
Prudential Assurance case where an institution did act as a the champion of the
corporation in pursuing a derivative action the Court was not impressed and stated:
We were invited to give judicial approval to the public spirit of the Plaintiffs who, it was said,
were pioneering a method of controlling companies in the public interest without involving
regulation by statutory bodies. In our view voluntary regulation of Companies is a matter for
the City. The compulsory regulation of Companies is a matter for Parliament (Miller, 1998).
Perhaps the spirit of that attitude and statement is a reflection of the passion and desire
behind the reform debate that has taken place in the UK resulting in the statutory
derivative action being introduced through the Companies Act 2006. The Companies
Act 2006 was preceded by a Company Law review over a number of years and also in
this area a Law Commission report and recommendations. Significantly the Law
Commission Report recommended that there should be ‘‘a new derivative procedure
with more modern, flexible and accessible criteria for determining whether a
shareholder can pursue an action’’ (Report, but emphasizing that any modernized
position should retain a balance of regulation in favour of the Company’s Management
by insisting that any derivative action should be ‘‘exceptional’’. (Report, para 6.5) 6.15.
The Companies Act 2006 took on board those recommendations and introduced a
statutory right to bring a derivative claim for breach of the duty to exercise reasonable
IJLMA care, skill and diligence, even if the director or wrongdoers had not personally
51,4 benefited from that breach. The applicant will not have to prove that the wrongdoing
directors, controlled the majority of shares. Thus on the face of it the statutory
derivative action is much broader in scope and extent that the former common law rule
of Foss v. Harbottle. The final report of the Company Law Review Steering Group
stated that the recommendations in respect of derivative actions would be ‘‘an
210 important mechanism by which shareholders can hold directors to account for the
proper exercise of their duties in pursuit of their company’s short and long term
interest’’: (CLR, 2005); clearly identifying that this is a key factor in the regulatory
regime of seeking to encourage and achieve effective corporate governance. The
revised approach was one of seeking to remove the difficulties of needing to demolish
‘‘wrongdoer control’’, and one of seeking to retain the ability of the Courts to dismiss
inmeritorious claims. Barriers still exist however, in that the revised statutory
framework provides a two stage procedure for ‘‘permission’’ to pursue a derivative
action.
At stage one the applicant must make a prima facie case for the claim, providing
evidence to support this claim. If no prima facie case is proven at this point, then the
court must dismiss the application. The Court can also, through dismissing the
application, make any consequential order that it considers appropriate for example a
cost order or civil restraint order against the application. If the application is not
dismissed the Court, on hearing the application may grant permission, refuse
permission and dismiss the claim, or adjourn the proceedings and give such directions
as it thinks fit. The suggestion is that this will enable the Court to dismiss any
inmeritorious claims at an early stage without involving the defendant or the company
(note to the Companies Act 2006, Section 261, p. 75). At the second stage, but before the
substantive action begins, the Court may require evidence from the company (the
Defendants). The Court is bound to consider a number of factors when deciding
whether to give permission to continue and it may refuse permission according to
other factors set out in legislation. For example section 262 states that:
. The Court may consider the manner in which the company commenced or
continued the claim may amount to an abuse of process;
. The company may fail to prosecute the claim diligently; and
. It may be appropriate for a member to continue a claim of derivative action.
Section 263 identifies the matters that the Court must take into account. These include
matters such as:
(1) Whether the member is acting in good faith in seeking to continue the claim.
(2) The importance that a person acting in accordance with Section 172 (duty to
promote the success of the company) would attach to continuing it.
(3) Where the cause of action results from an act or omission that is yet to occur,
whether the act or omissions could be, and in the circumstances would be likely
to be:
. authorised by the company before it occurs; and
. ratified by the company after it occurs.
 (4) Where the cause of action arises from an act or omission that has already Shareholders and
occurred, whether the act or omission could be, and in circumstances would be
likely to be, ratified by the company.
corporate
governance
(5) Whether the company has decided not to pursue the claim.
(6) Whether the act or omission in respect of which the claim is brought gives rise
to course of action that a member could pursue in his own right rather than on
behalf of the company. 211
In considering whether to give permission (or leave) the court shall have particular
regard to any evidence before it, including the views of members of the company who
have no personal interest, direct or indirect, in the matter.
The statutory definition of a derivative action through Section 260 provides an
interesting extension to the current scope for derivative action. It includes actions that
may be bought by a Director or third party or both, albeit the Guidance Notes suggest
that derivative claims by third parties would be permitted only in very narrow
circumstances where the damage suffered by the Company involved a breach of duty
on the part of a Director; for example for knowing receipt of money or property
transferred in breach of trust or for knowingly assisting in a breach of trust. Section
260 also suggests that derivative claims may now be brought by members in respect of
those wrongs committed prior to becoming a member. This reflects the fact that the
rights enforced are those of the company rather than those of the member. Section 260
also confirms that a Director in this section includes former Directors and shadow
Directors.
It will be interesting to observe over the coming years the extent to which this
extended scope through statutory definition will result in more lawsuits and minority
actions. In particular it will be interesting to observe the nature of any Plaintiffs
particularly whether those include institutional investors who have hitherto shyed
away from the challenges and uncertainties of the common law exceptions to the rule
in Foss v. Harbottle. Whether we reach the dizzy heights of minority claims in the
United States is something that is unlikely to be achieved. In the UK context, the
Attorney General, Lord Goldsmith, stated that he did not expect there to be a
significant increase in the number of derivative claims on a statutory footing. (Hansard
HL. Vol. 679 (Official Report) (27 February 2006) Cols GC4-5.) Despite this the
Companies (Audit, Investigations and Community Enterprise) Act 2004, extended the
ability of companies to indemnify directors against any liability incurred in respect of
such actions, even if judgement is given against the director (now see the Companies
Act 2006, ch 7 pt 10). Commentators have suggested that there are substantial
differences in the political and legal structures of the USA and the UK that would
account for these differences. The statutory amendments do not directly address those
areas of substantial difference albeit the revised statutory position places the courts in
the position they had hitherto sought to avoid. The Courts under the statutory regime
will be required through its permissive role to analyse and consider the corporate
benefits in a more explicit and more directed manner. To many this will be a positive
development. Interestingly, however, it might deepen the differences within common
law jurisdictions and remove even further claims of an international convergence of
governance rules in this area based upon a misplaced perception of a common and
superior set of agreed common law principles. For example, the statutory reforms in
the UK, under a European influence, have adopted an ‘‘enlightened shareholder’’
approach thus recognising a wider range of shareholders with corporate interests.
IJLMA Hence, the broad interests to be considered under s 263 when considering the
‘‘permission’’ question. Such a broader stakeholder approach has been rejected in other
51,4 common law countries, including both the USA and Australia. In Australia the
Parliamentary Joint Committee Report on Corporate Responsibility in 2006 was critical
of the UK approach suggesting that it was overly prescriptive and would result in
confusion. In the same year, the Corporations and Markets Advisory Committee
considered that a comparable statutory amendment in Australia would provide ‘‘no
212 worthwhile benefit’’.

Common law – convergence?

It has been suggested that Corporate Law in the UK and in the USA enjoy many
similarities, more similarities than many legal systems. Unlike for example in Germany
with its two tier board system and worker participation in management, English and
American corporations operation under a unitary board system and do not favour
employee co-determination. Similarly, or perhaps more significantly, is the degree to
which UK and US companies turn to the securities market for financing rather than to
banks. Yet, in one area of Corporate Law which has a direct impact on the governance
of organisations and management decision taking, the UK and US approaches appear
to differ substantially. This is in the balance between accessible minority protection
and restrictive takeover controls. Some suggest that this is simply a different approach
to the governance issue of poorly performing management as opposed to any
fundamental differences. The suggestion is that the different regulatory positions can
be adopted for takeover and merger controls based upon the availability or otherwise of
minority protection claims through permissive derivative actions. A more proactive
permissive takeover action regime should encompass a control on poorly performing
directors over and above the view of minority action to prevent fraudulent and
wrongful dealings of individuals or the board itself. But where such an action and
flexible regime is not present then a more permissive and flexible takeover and merger
regulatory system would enable the market itself, through acquisitions, to respond to
poorly performing boards and poorly performing companies. The theory sounds
simple and it is suggested reflects alternative approaches to controlling the Bearle and
Means agency costs (Miller, 1998). The simplicity of this approach to balancing the
agency-costs of incorporation has been challenged. Miller suggests that the UK and
USA are similar in their substantive approach to derivative actions when dealing with
mismanagement. In both system, fraud or illegality overwhelmingly support
successful derivative claims whereas poor or weak managerial performance claims per
se overwhelmingly fail (albeit the new UK statutory action now permits such claims).
Thus, they may not be clear substitutes in governance and regulatory terms as was
originally thought and suggested. In search for another explanation as to the
differences, some have suggested it is more likely to be based upon political structures
and political dynamics rather than any dedicated and directed approach to deal with
the same issue of poor management.
In the UK the position in relation to takeovers is remarkably open, particularly to
hostile takeovers. Court decisions in the UK have favoured the free play market forces
in a take-over context. Some regulation does exist through the self regulatory approach
of the City Code on takeovers and mergers. Generally however, the takeover position in
the UK has been one that is decided by market forces. The liberal takeover regime in
the UK, facilitating the highest number of takeovers and acquisitions in Europe,
nevertheless may be disturbed in the future by the increasing layers of EU
membership. The political structure in the USA, where corporate law is dominated by Shareholders and
state governments, permits strong alignment against hostile takeover activity. Miller
suggests that the political structure in the USA has enabled the delivery of legislation
corporate
and judicial decision that have surpressed takeover activity. This thesis is illustrated governance
by the benign federal approach of the Williams Act which has remained, through non-
amendment, ‘‘neutral’’ between the position of the ‘‘incumbent Managers and that of
bidders. It is at state level where the lobbying of incumbent managers has been
successful in developing legal principle and practice to defeat hostile ‘‘takeover bids’’.
213
For example the ‘‘poison pill’’ provision was successfully developed and received
approval by the Delaware Supreme Court. Under such provisions a simple board
resolution could be passed whereby an ‘‘acquirer’’ suffers a devastating decline in its
ownership position in the event that it obtains certain acquisition thresholds without
the prior approval of the target’s Management.
This and other examples support the view that the state political context is one of
protecting firms incorporated in one state from inter-state hostile takeover activity. The
political reality of intensive inter-state lobbying by incumbent managers is permitted
by the political structure.
More significant are the differences towards derivative litigation and the political
dynamics and structures that facilitate those differences. As we have seen within the UK
there are particular barriers that exist in advance of the recent statutory reform statutory
changes towards derivative litigation. Those barriers supported the view of many that
the UK rules and UK opportunities in this area were essentially minimal and particularly
supported by a legal system that adopts the ‘‘loser pays’’ system and one that does not
enjoy a contingent fee element as an inducement to commencing such litigation.
Compare that with the USA, where there is an entrepreneurial class of attorneys that
specialise in class action and derivative litigation. This has created a strong financial
incentive for attorneys to encourage derivative actions not only in an attempt to protect
management, but also to increase their own financial rewards. This creates substantial
problems if one looks at those actions from a Corporate Governance prospective,
particularly if one is seeking to align shareholder interests through the derivative claim.
Essentially, the interest that it is suggested exists behind the high level of derivative
claims in the USA is the interests of entrepreneurial and enterprising attorneys. Those
interests may not, and often do not, coincide with the shareholders interest. (Romano,
1991). It has been further suggested that the attorneys incentives are the key factor in
shareholder litigation and encourage settlement (Cofter, 1985). They are also strongly
represented on State bar associations unlike in the UK where the unitary system
weakens legal lobbying and it is difficult to identify any influential champions of reform
in this area. It must however be noted that in the USA in this area most lawsuits are
settled, but retaining rewards for the enterprising attorneys. Shareholder plaintiffs have
an abysmal record in Court, and that this is around 6 per cent of adjudicated cases.
Whereas the level of settlement rate outside the court is around 63 per cent (Romano,
1991). There exists opinion that derivative actions and the level of settlement, should be
viewed in a favourable light. The extent and level of change caused to Directors
Contracts and behaviours indicate that derivative suits do deter rather than compensate;
compensation being confined to class actions (Schwartz, 1986)
It is suggested that the political environment and political structure that enables the
lawyers to be the proponents of derivative suits in the USA and the predominant
winners or at least financial winners of such actions is the Federal State arrangement
that enables on a very localised basis State Bars to negotiate and place pressure on
IJLMA authorities to permit and facilitate derivate actions, including contingency fee and
class base actions. The contrary exists in the UK where no such class rights and
51,4 contingency rights exist. The unitary system of one bar in the UK weakens and lessens
the impact of negotiations and discussions with authorities. It is interesting to note that
the Statutory Derivative Action introduced through the Companies Action 2006 in the
UK bears a strong resemblance to the Federal Rule 23.1 in the USA. Notably not only
do they both contain Statutory Rights of action but both permit derivative actions to be
214 bought for mismanagement. Similarly within the Companies Act 2006 amendments the
Court has a particular role to play in granting permission and in doing so needs to
consider the views of independent members. In the Federal Rules procedure in the US
permission of the Court is similarly required and there is a requirement that suggests
that the action and permission may not be granted where the plaintiff does not
adequately represent the interest of the shareholders. There exist substantial structural
similarities between the UK position and the Federal Rule 23.1. The UK insistence of
‘‘wrongdoer control’’ is replicated in a ‘‘demand requirement’’ in rule 23.1 The ‘‘demand
requirement’’ requires that shareholders seeking to redress wrongs done to the
company must first make a demand on the directors to rectify the harm themselves. In
practice the requirement is often overcome and does act as a barrier to action. The
courts in the USA, particularly in Delaware, remove this requirement if it is shown that
a ‘‘demand’’ would be futile – that a reasonable doubt is created as to the disinterest of
directors and the propriety of the challenged action. (Arunson vs Lewis) The
permissive and flexible approach of the courts in the USA to the interpretations and
application of the legislation requirements encourages further the enterprising
attorney, and consolidates and embeds the political process of state-bar lobbying.

The position and reform in China

It is clear that the development of a derivative action and flexibility or otherwise of the
availability of such an action is a balancing act recognising the need to protect minority
shareholders from unwanted abuse while at the same time recognising the economic
requirements of not permitting a unnecessary multiple range of actions threatening
and removing the discretion and function of the Board of Directors. The point is often
made that an appropriate balance varies from jurisdiction to jurisdiction depending
among other things on the corporate governance requirements of the underlying
market. Within the context of China, the absence of takeover activity as an effective
mechanism of monitoring management of Corporations suggests that any need for
managerial accountability might support a proactive approach to the development of a
derivative action. Similarly unlike many common law countries China does not have a
statutory oppression remedy for shareholders who complain that the affairs of their
Company have been conducted in an oppressive manner. This remedy is usually
couched in very broad terms such as oppressive, unfair prejudicial, and unfair
discriminatory conduct with the Court being empowered with a wide range of orders to
remedy that matter (Huang, 2007). Although in the developed common law
jurisdictions ‘‘oppression claims’’ are based on personal rights it does overlap with
derivative claims and provides some degree of managerial accountability. These two
major omission or absences in the Chinese legal structure support the need to enact and
develop a flexible and effective derivative right of action. In fact it has been suggested
that in China the derivative action can expected to play a more important role that it
counterparts in other jurisdictions (Huang, 2007). Outwith the legal framework there is
an organisational framework in China that suggests that corporate governance is
becoming acutely serious. Those measures include the fact that in the Chinese Shareholders and
securities market non-tradeable State owned companies have previously represented
more than 60 per cent of all the shareholdings in listed companies. Thus, providing
corporate
ample opportunities for the majority shareholders to abuse their powers by voting at governance
the General Meeting or by controlling the Board of Directors. Similarly, China has been
making efforts to encourage the practice of independent Directors on the Board, albeit
their independence and effectiveness has been subject to criticism. The response has
been the introduction for the first time of a statutory derivative action through a 215
comprehensive Corporate Law reform in 2005. This action came into effect on the
1 January 2006 and is contained within chapter 6 of the Company Law of the Peoples
Republic of China. Article 150 of the Company Law provides that ‘‘if a Director,
Supervisor or Senior Manager causes a loss to the Company in violation of the law,
administrative regulation, or the Articles of Association during the course of
performing their duties, he or she shall be liable’’. In this situation, it is expected that
the Company itself will usually bring legal proceeding to recover damages. Where the
company does not bring legal proceedings, then a derivative action becomes a
possibility. Under Article 152, if the Director, Supervisor or Senior Manager, is in a
situation as referred to in Article 150, the right to bring a derivative suit is given to the
following persons:
. The shareholders of the Limited Liability Company (LLC).
. The shareholders of the Joint Stock Limited Company ( JSLC) who separately or
aggregately hold 1 per cent or more of the total shares in the company for more
than 180 consecutive days.
Innovatively within this approach, the issue of standing is treated differently
depending on the type of company involved. In the case of the LLC, any shareholder
has standing to sue while with the JSLC stock ownership requirements are imposed.
The law takes a more restrict approach to derivative actions being available to those
involved in the performance of JSLC. It is interesting to note that very few jurisdictions
take such an approach on the issue of standing (Choo, 2001). The merits of this
approach in China reflect the local circumstance. In particular it should be noted that
the plight of minority shareholders in LLC is generally graver than of their
counterparts in the JSLC. Any disgruntled shareholders of the JSLC have the avenue to
leave the company by selling their shares on the stock market, members of the LLC do
not have a liquid market for their shares. This situation is exacerbated by the legal
requirement that a member must obtain the consent of at least half of all other
shareholders prior to the members selling their shares. Furthermore the JSLC are
already closely monitored by various regulatory bodies such as the Chinese Securities
Regulatory Committee and relevant Stock Exchanges. Consequently corporate
governance of the JSLC is generally better than that of the LLC. For example it is
required that listed companies have independent Directors. At first it appears that the
greater need for legal rights to pursue managerial accountability exist in the LLC
rather than the JSLC albeit any conclusion to that effect would depend upon some
assessment of the effectiveness of the existing governance arrangements within the
JSLC. It has been suggested that in the JSLC with its relatively dispersed ownership,
shareholders with more than 1 per cent of holding are mostly institutional investors.
Thus, the ownership requirements for standing effectively limits the right of action to
institutional investors. This can nurture institutional investors in China, encouraging
investors to play a more active role in China’s corporate governance. This is consistent
IJLMA with some findings and suggestions that in the developed common law systems of
governance, including derivative actions that there is room to open the door further for
51,4 institutional investors to utilise derivative actions further to police corporate
misconduct (Thompson and Thomas, 2001).
There exist further preconditions in China to the bringing of derivative actions.
These are found in Article 152 and essentially require that a shareholder wishing to
bring a derivative action needs to make a demand on the board of directors to bring a
216 suit to remedy the alleged harm, or demonstrate that any delay in instigating the action
would be prejudicial to the interests of the company.
In other words, the plaintiff shareholder is required to exhaust all intra-company
remedies before bringing a derivative action. This is consistent with the approach in
other Common Law Countries which seek to recognise the legal status of the company
and the practical advantage of offering the Corporate Management an opportunity to
remedy the action without the expense, publicity and delay of litigation. It also permits
the Board of Directors, should they decide to, bring an action to retain control of the
litigation on behalf of the Company and also acts as a sifting mechanism for vexatious
and unnecessary actions and litigants. This is similar to the position in the USA where
90 days are given to the Company to respond to the demand and in the UK where
similarly under the Companies Act 2006 permission or leave from the Court must also
be granted. In all instances it permits a wider consideration of interests and recognises
the legal personality of the corporate form. However in the context of China it has been
suggested that this precondition is rather stricter in the sense that it can only be waved
in cases of emergencies. There is no room for dispensation from the notice
requirements as in other jurisdictions. Having said that it is not completely clear when
the demand can be excused unlike jurisdictions such as in the USA where the plaintiff
shareholder can bypass the demand requirement by alleging that the demand would be
‘‘futile’’ because the majority of Directors and interested parties are incapable of
reaching an impartial decision. The extent of the evidential requirement of establishing
an ‘‘emergency’’ of a level that failure to lodge an action immediately will cause
irreparable ‘‘injury’’ to the interests of the company might create a substantial barrier
to claims.
A further point of interest within the Chinese legal context is that Chinese corporate
governance is traditionally a two tier board structure with a Supervisory Board
independent from the Board of Directors. This feature was taken into consideration
when the Chinese Derivative Action was developed. In Article 152, it is clear if the
Directors have caused harm to the Company a demand is to be made on the
Supervisory Board rather than the Board of Directors. In the context of China’s
corporate governance, the Supervisory Board is independent of the Board of Directors
and is specifically charged with a task of monitoring the later. In the context of the
powers and rights given to the Supervisory Board the precondition of seeking a
demand of the supervisors appears sensible and appropriate. In governance terms this
structure and avenue of complaint is positive. Independent monitoring and control
exercised by a supervisory board who need to respond satisfactorily to the complaint
within 30 days, facilitates an avenue for aggrieved minority shareholders to complain,
without the uncertainty and associated costs of individual action. One suspects that
any personal ‘‘oppressive’’ remedy, as found in common law countries, would disturb
motivations and corporate citizenship in this area.
The Chinese position has not been without criticism. Firstly, the fact that the
derivative actions are given only to current shareholders to the exclusion of former
members. Some jurisdictions particularly in Australia and Canada enable Plaintiffs to Shareholders and
be broad enough to include former members. This is an attempt to recognise a broad
range of interests in rendering management accountable for actions including those
corporate
who have left in circumstances where they feel they were forced to leave and governance
nevertheless still wish to complain. Of course, the scope of the potential plaintiff is
counted by the fact that in Australia ‘‘leave’’ of Court is required. There is no automatic
right for the complainant to pursue a derivative action. Second There exist concerns
about whether an automatic green light is given to the plaintiffs to pursue a derivative
217
action if, having raised the matter before the Supervisory Board or others, that Board
decides not to bring an action. Haung makes the point that the wording of the provision
suggests that as long as the Company itself refuses to bring an action the Shareholders
will be able to bring a derivative action regardless of the reason behind the Company’s
decision. This is inconsistent with the need to balance the interests of the shareholders
in obtaining a derivative action and of the Company dismissing detrimental litigation.
It contrasts to the position in the UK and Australia for example where leave of the
court must be obtained before bringing a derivative action. Such a leave process is
essentially a filtering process. Such a process enables the Court to consider on
mandates the court to consider broader range of shareholder and or stakeholder
interests.
Third, a major gap within the statutory action in China is the omission to refer to the
costs situation. The cost of litigation has traditionally been a key issue in any
derivative action. In general if the derivative action is successful, the company receives
the award. The position in common law countries differ. For a long time the UK
adopted the ‘‘loser-pays’’ principle whereas in Canada and Australia the Courts have
wide order powers. This can include the order for the Company to pay the applicant,
reasonable legal costs. It is widely believed that one of the key reasons why derivative
actions are much more popular in the USA than any other common law jurisdictions is
because of the contingency fee arrangements. These arrangements provide an
incentive for the creation of the entrepreneurial lawyers. Some have argued that the
contingency fee model is suitable for China because it would not only encourage the
bringing of derivative actions, which is the primary objective of Chinese law, but also
because the model of a leave requirement would be consistent with the structure of the
legislation.
Thus, it appears that the call for a need for managers to be accountable through
derivative actions has been heeded. For example Liu stated that ‘‘it is urgent to deal
with the loopholes in the current legislation and corporate responsibility of Directors
and Managers through various means, in particular the shareholder derivative actions’’
(Liu, 1999).

Conclusion
With the increasing concerns over the transparency and openness of director actions,
and the effective or otherwise; Legal controls on managerial behaviour and
accountability, the existence of shareholder rights is an essential part of the governance
regime. The extent and accessibility of those rights has always been a matter of
concern; accessibility not aided by judicial attitudes and the erection of legal and
practical barriers. In constructing such rights, different jurisdictions have
demonstrated a consistent acceptance of principle, namely the right to remedy the
wrong, or at least to decide whether they accept the wrong and the need for remedy,
belongs to the company. The mores and behaviours of the corporate world and the
IJLMA exposure of wrongdoing directors and ineffective auditing regimes have damaged the
51,4 acceptance of that principle. If we look to the UK as the founding father of this
principle, through Foss v. Harbottle, we find that the decision as to whether the matter
should remain one for the company to deal with has been explicitly given to the Courts
who must, significantly now consider a wider range of interests beyond the company
and the aggrieved shareholder. It is one where personal shareholder rights become
societal rights – a very different position to the individual trust and contract of 1843
218 when the Vice Chancellor declared in Foss that ‘‘. . . . . . every individual company must
be taken to have come into the corporation upon the terms of being so bound’’. (1843)
2 Hare 461, 67 ER 189, p. 195

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Further reading
Coffee, J.C. (1985), ‘‘The unfaithful champion: the plaintiff as monitor in shareholder litigation’’,
Law and Contemporary Problems, Vol. 48, pp. 5-46.
La Porta, R., Lopez de Silenes, F. and Shleifer, A. (1999), ‘‘Corporate ownership around the world’’,
Journal of Finance, Vol. 54, pp. 471-517.

Corresponding author
James Kirkbride can be contacted at: j.kirkbride@ljmu.ac.uk

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