Under what conditions can a minority shareholder sue the managing director on behalf of the company if the majority of shareholders do not support the motion? Should these conditions be interpreted restrictively or broadly? This article analyses the above questions in the context of a recent Supreme Court judgment.(1)
The applicant was a company which was set up in 1999 to renovate and lease fish ponds. The company's assets consisted of the fish ponds, partly owned by one of the minority shareholders and partly contributed to by the company.
Following reconstruction works, the company leased the fish ponds to a third party for the period between 2006 and 2012 (the lease agreement), which was then extended until the end of 2016.
The defendant had been the managing director (the director) of the company since 2009. In 2013 and 2016, the minority shareholder sent letters to the director, informing the company that the condition of the fish ponds was worrying, endangering their long-term utilisation. The minority shareholder requested information from the company about the preservation of the ponds and restoration for the damage resulting from improper use.
Following the lease agreement's expiration in 2016, the minority shareholder initiated a preliminary evidentiary procedure in which the expert witness determined that the ponds were in a deteriorated condition, and they estimated the cost of restoration at 130 million forints ($400,000).
Despite being previously proposed by the minority shareholder, the agenda of the company's annual general meeting on 21 November 2017 did not include the motion to enforce a claim against the director, so no resolution was made in that regard.
The proposal to enforce a claim for damages against the director was rejected at the general meeting held on 23 May 2018, only after the lawsuit had been filed.
On 7 November 2017, the minority shareholder filed a lawsuit for damages against the director on behalf of the company in accordance with the minority protection rules provided by law.(2)
He upheld his claim in the statement that he submitted in Summer 2018. In the statement, he referred to the resolution passed at the general meeting held on 23 May 2018. He stated that by a majority vote of the general meeting, the company had decided not to pursue the claim against the director complained of by the minority shareholder. The company attached the minutes of the 23 May 2018 general meeting on 27 August 2018.
The company, represented by the minority shareholder, argued in support of its claim that the director did not act in line with the company's interests in connection with the lease agreement as he did not check the condition of the fish ponds and did not take action in connection with the damages caused by the lessee. Therefore, they proposed that the director was liable for damages to the company.
In his defence, the director requested that the claim be rejected primarily on the ground that at the time of filing the application – in the absence of a resolution of the general meeting that rejected the proposal to pursue a claim of the company against the director in connection with his liability – the company had no locus standi (ie, the right to bring a legal action against a defendant) as it was being represented by the minority shareholder. This error cannot be remedied during proceedings.
The first-instance court held that the company's locus standi could be established based on the resolution of the general meeting of May 2018.
The court held that the director was liable to the company for the damage suffered as a result of his adverse business policy in relation to the lease agreement.
The court of appeal assessed the appeal submitted by the director and upheld the first-instance court judgment.
However, the second-instance court explained that the absence of the resolution of the general meeting to hold the director liable meant that the minority shareholder had no right to pursue a claim on behalf of the company, which could lead to the dismissal of the action by a judgment.
Although at the time of filing the application there was no decision of the general meeting that rejected the proposal to hold the director liable, the company later attached a decision made during the lawsuit, according to which the minority shareholder had locus standi at the time when the first-instance court brought its judgment. The director's claim that the lawsuit should have been terminated was therefore unfounded.
The director requested the judicial review of the final judgment. According to the director, as the company did not have the right to bring an action at the time of filing the application, the application should have been rejected without summoning the parties, or, at a later stage, the proceedings should have been terminated. The lawsuit could have been filed only within the 30-day limitation period following the adoption of the resolution of the general meeting of 23 May 2018.
The Supreme Court found the final judgment lawful. The Court shared the view of the lower courts that the company's application should be assessed and dismissed on the merits if the company did not prove the existence of the condition necessary for the enforcement of the claim by minority shareholders (ie, proof of the adoption of the resolution of the general meeting that rejected the claim against the director, or proof of abstaining from voting).
The absence of a resolution of the general meeting meant that the lawsuit was filed prematurely, in the absence of a decision, the minority shareholder had no legal right to sue. Although the lawsuit was initiated by the appropriate legal entity (ie, the company), it was represented by the minority shareholder, who was not authorised to do so.
Consequently, by being represented by the minority shareholder, the company did not have locus standi when it filed the application on 7 November 2017 because at that time the minority shareholder did not have the authority to initiate action in the name of the company.(3) However, the consequences of this (including the termination of the procedure) were not applied by the first-instance court when it could have done so – namely, before the company attached the resolution of the general meeting held in May 2018.
After the above, the company had locus standi. The fact that the minutes of the general meeting were annexed by the company at a later date did not mean that the minority shareholder had failed to exercise its right to sue in a lawful and timely manner.
Enforcement of claims by minority shareholders
The legal instruments for the protection of minority shareholders are generally available in the company law of the countries of the continental legal system,(4) in order to protect the interests of the company as an independent operator if it is jeopardised by the undesirable will of the majority. The protection of the company's interests also means the protection of minority's interests.
An important instrument for the protection of minority shareholders is the minority's right to enforce company claims. In this context, the Civil Code explicitly authorises minority shareholders to "take over" the representation of the company if the majority impedes the enforcement of the claim by the company's bodies:
[I]f the supreme body of the company rejected or did not submit for adoption the proposal to enforce a claim of the company against a member, executive officer, supervisory board member or the auditor, the claim may be enforced on behalf and to the benefit of the company by members holding at least five per cent of the voting rights, within a term of preclusion of thirty days following the meeting of the supreme body.(5)
In case of "derivative litigation", the minority shareholder acts as the company's representative on behalf of and for the benefit of the company.(6)
Therefore, this legal instrument provides the minority shareholder with an exceptional procedural opportunity to initiate legal proceedings on behalf of the company, as the minority shareholder is not otherwise entitled to do so. The exceptional nature of the minority protection instrument is shown by the fact that its exercise is subject to strict formal conditions, so that the minority shareholder can initiate litigation only:
- if the general meeting obstructed their proposal; and
- within one month of the obstructions.
Form versus substance
The precondition for the enforcement of minority shareholder claims is that the general meeting of the company must have, in some way, hindered the enforcement of the minority shareholder's will. This could include through the rejection of the minority shareholder's motion or the omission of decision making. A minority shareholder may bring an action on behalf of the company only if this precondition is met; from a procedural point of view, the company's locus standi is based on this fact.
In the examined case, it was not disputed that at the time that the lawsuit was filed, the company, being represented by the minority shareholder, lacked the right to sue as at that time, there was no resolution of the general meeting that had rejected his proposal to pursue a claim against the director.
The first-instance court could have dismissed the action for lack of formal conditions, but it took into account the general meeting resolution of May 2018, which was subsequently attached, and finally ruled on the merits.
Precedent-setting interpretation by Supreme Court
Based on the above, the Supreme Court had to decide whether to take a formalistic approach and examine the locus standi solely on the facts that already existed at the beginning of the proceedings, or to allow the party to subsequently refer to circumstances that did not exist at the beginning of the lawsuit – allowing the court to rule on the merits of the case.
According to the Supreme Court's interpretation, by maintaining the claim during the lawsuit after the occurrence of the condition that created the locus standi, the applicant had in fact presented his claim with locus standi, after which, the lack of the locus standi at the beginning of the lawsuit could no longer be considered.
Thus, instead of a strict formal investigation, the Court gave a legal interpretation that better served the interests of the minority shareholder, and thus the company, providing an opportunity to remedy the missing formal requirements during the lawsuit.
Due to this approach, it was possible for the court to rule on the merits of the case instead of terminating the lawsuit.
In the apparent absence of similar case law brought by higher courts, the Supreme Court has set a precedent with the examined decision, supporting the enforcement of minority shareholders' rights. The decision is a binding precedent under the "limited precedent system"(7) introduced in Hungary in 2020, which means that lower courts can deviate from this precedent only in justified cases. In such cases, a special legal remedy is available to establish whether the deviation was justified.
For further information on this topic please contact Richard Schmidt or Peter Gritta at SMARTLEGAL Schmidt & Partners by telephone (+36 1 490 09 49) or email ([email protected] or [email protected]). The SMARTLEGAL Schmidt & Partners website can be accessed at smartlegal.hu.
(1) Judicial decision BH 2021.10.284.
(2) Pursuant to section 49(5) of the Act IV of 2006 on business associations, the rules of which are currently incorporated in section 3:105 of the Civil Code, with essentially the same content.
(4) "Európai társasági jog" (Péter Miskolczi Bodnár, KJK-KERSZÖV, Jogi és Üzleti Kiadó, Budapest , 2004) section 2.10.
(5) Section 3:105 of the Act V of 2013 on the Civil Code.
(6) Explanatory memorandum of Chapter XVIII of the Civil Code.
(7) Introduced by Act CXXVII of 2019 on the amendment of certain acts in relation to the single-instance administrative procedures of district offices.