Derivative lawsuit in Ukraine: the issue of improving legal regulation
The concepts of the preventive derivative lawsuit and a derivative lawsuit for the invalidation of a company's transaction and possible issues regarding them are analysed. The necessity for implementing a "business judgement rule" is emphasised.
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Derivative lawsuit in Ukraine: the issue of improving legal regulation
Smirnov Heorhif
Summary
1. Introduction. - 2. A Plaintiff under the Derivative Lawsuit. - 2.1. General status of a plaintiff. - 2.2. Exercise of procedural rights and obligations. - 2.3. Persons that can file a derivative lawsuit on behalf of a legal entity. - 3. Preventive Mechanisms for Abuse of the Right to File a Derivative Lawsuit. - 4. Other Types of Derivative Lawsuit. - 4.1. Preventive derivative lawsuit. - 4.2. Derivative lawsuit for invalidation of a company's transaction. - 5. Defendants in a Derivative Lawsuit - 5.1. The issue of financial (civil) and employment (material) liability of a company's officials. - 6. Business Judgement Rule. - 7. Conclusions.
Keywords: derivative lawsuit, property qualification, locus standi, business judgement rule, preventive derivative lawsuit, derivative lawsuit for invalidation of a company's transaction
Abstract
Background: Some jurisdictions provide for the right of members of a corporation to sue on its behalf and in its interests. This remedy is called a derivative action (derivative lawsuit), and the right to file such a lawsuit is granted to a company's members in case the wrongdoers are in its control, preventing the company from taking actions to protect its rights and interests - which is detrimental to the interests and rights of minority shareholders. However, derivative lawsuit's regulation differs in each jurisdiction despite sharing common features, raising a variety of issues to be resolved.
Methods: In this article, the author points out several issues and their possible solutions, which could be implemented in Ukrainian legislation: property qualification by itself cannot prevent abuse in filing a derivative lawsuit - extended `locus standi' has to be implemented; holders of preferred shares have to be granted the right to file a derivative lawsuit; property qualification has to be substituted with a representation quota for members of non-entrepreneurial corporations; the circle of defendants should include major members (majority of members) and third parties, etc.
Results and Conclusions: The concepts of a preventive derivative lawsuit and a derivative lawsuit for the invalidation of a company's transaction and possible issues regarding them are analysed. Additionally, the necessity for implementing a `business judgement rule' is emphasised.
Introduction
The institute of derivative action originated from common law countries, namely the United Kingdom, as an exception to the precedent-based `proper plaintiff rule' in the case of Foss v. Harbottle, which is worded as follows: `In any action in which a wrong is alleged to have been done to a company, the proper claimant (plaintiff) is the company itself'.1 LA Ostrovska `Indirect (derivative) lawsuits: international experience and legislation of Ukraine'
This means that the plaintiff may be the person that has the financial claim against the defendant. At the same time, there are frequent circumstances in corporate (membership) relations where the legal entity's ability to defend its violated rights on its own is ruled out due to a defect of its will: the offender is also the person who forms and (or) expresses the legal entity's will. Such persons can be a majority member (shareholder), a majority of members (shareholders), or an official. In due course, these circumstances resulted in the exception to the `proper plaintiff rule': members of a corporation may bring a claim for and on behalf of the legal entity if a wrong has been done to the latter by the persons who manage it (both majority members and officials). This opportunity of the persons affiliated with the corporation with membership constitutes the content of a derivative action as a remedy.
A derivative lawsuit is defined as a legal remedy used to defend a legal entity's rights, which enables its members to bring and affirm claims for the legal entity if the latter does not initiate the lawsuit on its own due to the interests of its controllers.(abstract of PhD (Law) Thesis, National University `Odessa Law Academy' 2008) 4-5. A derivative action is generally used to indirectly defend the interests of members (shareholders) in connection with the value of their stock (shares) and payment of dividends or liquidation quota rather than their rights. As O. V. Bihniak rightly states:
regarding the use of the term “indirect” and “derivative”, it comes down to the fact that the participant (shareholder) who initiated the lawsuit is not a direct beneficiary in the dispute, such a person is the company itself, but the rights (interests) of the participant are protected by protecting the interests of the company. OV Bihniak OV, `Derivative action and corporate contract as means of corporate rights protection: experience of Ukraine' (2018) 5 (3) European Political and Law Discourse 231-232.
It is essential to note that pecuniary equity rights (not to be confused with the equity rights of binding nature - such as the right to demand payment of declared dividends or right to demand payment of the liquidation quota) are not violated since their idea is to establish the holder's capability of having a property interest in the results of the corporation's activity. They do not enable the person to claim the specific volume of property: it is only a proportional interest in the future distribution of property results. At the same time, the above does not mean that a derivative action cannot be used as a remedy to defend the rights of members (shareholders) of the corporation. We agree with the opinion that a derivative lawsuit may be filed in order to indirectly protect not only the interests but also the rights of a legal entity's members.54 In particular, indirect protection of a shareholders' rights takes place when the company's losses, resulting from the actions (inaction) of officials or a majority of members or even transactions conducted by the executive body, prevent the exercise of equity rights of a binding nature - payment of dividends or liquidation quota. Given the specific volume of dividends or liquidation quota that the shareholder is entitled to, the corporation's inability to make payments in the prescribed volumes violates the shareholders' rights.
However, a derivative action is not limited to damages. Officials (or a majority member or majority of members) are usually not able to fully pay damages caused by their actions (or inaction). In addition, there are many cases of concluding fraudulent transactions to the detriment of the interests of a minority of members of the corporation. In such cases, when the corporation cannot defend its violated rights, the rights and interests of the corporation (as well as the rights and interests of its members) are protected by invalidating the transaction on the claim of a minority participant (or participants) of the corporation, which is also a derivative claim. Regarding this type of derivative lawsuit, another instance of indirect protection of the shareholder's specific right may be presented - namely, when a transaction was concluded in breach of the preliminary approval procedure, filing a lawsuit for rendering it void will indirectly protect the shareholder's right to manage the company.
It should be noted that a derivative action is a form for implementing the doctrine of `piercing the corporate veil' due to transferring the right to bring an action for damages held by the legal entity to its members (shareholders), even though their rights have not been directly violated. In the case of Agrotexim Hellas SA and others v. Greece (1995), deciding whether the shareholders could bring an action on the company's behalf and could be recognised `victims' instead of the company in the meaning of the Convention on Protection of Human Rights and Fundamental Freedoms (hereinafter `the Convention'), the European Court of Human Rights (ECtHR) reiterated that
...the piercing of the “corporate veil” or the disregarding of a company's legal personality will be justified only in exceptional circumstances, in particular where it is clearly established that it is impossible for the company to apply to the Convention institutions through the organs set up under its articles of incorporation or - in the event of liquidation - through its liquidators. SO Koroed, VM Mahinchuk, `Derivative (indirect) lawsuits of the founders of legal entities as a form of implementation of the doctrine of piercing the corporate veil' (2020) 44 Scientific Bulletin of the International Humanities University. Series: Jurisprudence 75.
In its judgement, the ECtHR repeats the equivalent stance of the UN International Court of Justice, which was presented in Paragraphs 56-583 and 664 of its judgement in the case of Barcelona Traction, Light and Power Company Limited dated 5 February 1970. In its judgement, the court emphasised that the independent existence of the legal entity could not be treated as an absolute, and the economic realities sometimes required protective measures and remedies in the interests of those within the corporate entity, as well as of those outside who have dealings with it, and there could be `lifting of the corporate veil' Case concerning Barcelona Traction, Light and Power Company, Limited, (Belgium v Spain) [1970] I.C.J. Rep 1970 p. 3, paras 56-58, 66. (in cases of protection of rights and interests of members, a derivative action, as noted by H. Yu.).
1. A plaintiff under derivative lawsuit
1.1 General status of a plaintiff
In Ukrainian law, a derivative action is prescribed in Art. 54 of the Commercial Procedural Code of Ukraine (hereinafter `the CPC of Ukraine'). According to this article, the right to bring an action is granted to the person (member, shareholder, owner) that holds 10% or more of the authorised capital or property of the legal entity. Commercial Procedure Code of Ukraine (as amended of 5 July 2021) <https://zakon.rada.gov.ua/laws/ show/1798-12#Text> accessed 8 August 2021. According to the Draft Law of Ukraine `On Joint-Stock Companies', namely Clause 9 of Section XIX, the right to bring a derivative action is granted to the person (member, shareholder, owner) that personally or jointly holds 5% or more of the authorised capital or property of the legal entity. Draft Law of Ukraine `On Joint-Stock Companies' register No 2493 of 25 November 2019 <http://w1.c1. rada.gov.ua/pls/zweb2/webproc4_1?pf351i=67468> accessed 8 August 2021. According to Part 2 of Art. 54 of the CPC of Ukraine (which the legislator is not planning to amend), the procedural status of a plaintiff is granted to the legal entity, while its members (shareholders) act as persons, who by law are entitled to file a lawsuit in the interests of the others. Such members (shareholders) are granted the same procedural rights and obligations as a plaintiff - a legal entity. CPC of Ukraine (n 7). They are not the legal entity's representatives, as found in Art. 54-55, which regulates their procedural status, located before the subsection dedicated to the regulation of representatives in litigation procedure. The official against whom the claim for compensation for the losses incurred is filed may not act on behalf of such a legal entity.
Regarding the issue of who must be granted the status of a plaintiff, there is no consensus among scholars. O. R. Kovalyshyn argues that members of a corporation must be given the status of a plaintiff, while the corporation itself has to act as a third party who does not make independent claims. OR Kovalyshyn, `Indirect (derivative) lawsuits as a legal remedy for participants in corporate relations' (2010) 17 Bulletin of the Academy of Advocacy of Ukraine 65. Ye. Talykin is convinced that under a derivative lawsuit, the main emphasis should be on the conflict between members of the corporation and the management - thus, members are to be deemed as plaintiffs. Ye Talykin, `Derivative lawsuit in commercial litigation of Ukraine: general principles of procedural construction' (2014) 4 Law Herald 164. M. K. Bogush claims that it is the corporation that has to be given the status of a plaintiff. MK Bogush, `Protection of the rights and interests of the subjects of corporate legal relations' (PhD (Law) Thesis, Taras Shevchenko National University of Kyiv 2018) 186-188.
In our opinion, the status of a plaintiff under the derivative action must be indeed granted to the legal entity whose rights and interests have been directly violated by the official's actions (or inaction). We are inclined to agree with the opinion that the legal relationship regarding the liability of officials or members of collective bodies (majority of shareholders included) arise from the material legal relationship between these persons and the legal entity (regarding the authority to act on its behalf, make its decisions, etc.). SO Koroed, VM Mahinchuk, `Derivative (indirect) lawsuits of the founders of legal entities as a form of implementation of the doctrine of piercing the corporate veil' (2020) 44 Scientific Bulletin of the International Humanities University. Series: Jurisprudence 23-24. The wrongdoing in question was committed against the corporation in the first place, not against a minority of its members. Therefore, a corporation must be given the procedural status of a plaintiff under a derivative lawsuit. The fact that, given the defect of will, the action is brought to court by the minority members (shareholders) rather than the legal entity itself does not contradict our statement since it is fully consistent with the definition of a plaintiff. According to Part 3 of Art. 45 of the CPC of Ukraine, plaintiffs are persons that have brought an action, or for the benefit of whom an action has been brought, to defend the right that has been violated, has not been recognised, has been challenged, or whose legally protected interest has been violated. Ibid. Under a derivative action, a legal entity acts as a plaintiff in the United Kingdom (Art. 206 of the Companies Act), Companies Act of United Kingdom of 2006 <https://www.legislation.gov.uk/ukpga/2006/46/contents> accessed 8 August 2021. in Canada (Art. 239 of the Business Corporations Act), etc. Business Corporations Act of Canada of 1985 (as amended 1 January 2020) <https://laws-lois.justice. gc.ca/eng/acts/C-44/index.html> accessed 8 August 2021. At the same time, the legal entity's members (shareholders) act as plaintiffs under derivative actions in the USA (Rule 23.1 of the Federal Rules of Civil Procedure), Federal Rules of Civil Procedure of United States of America of 1938 (as amended 12 January 2021) <https://www.uscourts.gov/rules-policies/current-rules-practice-procedure/federal-rules-civil- procedure> accessed 8 August 2021. Germany (Art. 148 of the Joint-stock Companies Act), Act of Germany `On Joint-Stock Companies' of 1965 (as amended 3 June 2021) <https://www.gesetze- im-internet.de/englisch_aktg/index.html> accessed 8 August 2021. and Spain (Art. 239 Corporate Enterprises Act). Corporate Enterprises Act of Spain of 30 August 2010 (as amended 2015) <https://www.mjusticia.gob. es/es/AreaTematica/DocumentacionPublicaciones/Documents/Corporate_Enterprises_Act_2015_-_ Ley_de_Sociedades_de_Capital.PDF> accessed 8 August 2021.
1.2 Exercise of procedural rights and obligations
In Ukrainian legislation, the members of a corporation act as its procedural representatives. According to Art. 54 of the CPC of Ukraine, the legal entity exercises its procedural rights and fulfils its procedural obligations only upon consent of the members that have brought a derivative action and gives the latter, pursuant to Art. 55 of the CPC of Ukraine, the procedural rights and obligations of the entity for the benefit of which they have brought the action. In our opinion, however, this model is doubtful and must be reconsidered. Commercial Procedure Code of Ukraine (n 7).
Since the members will just approve resolutions of the legal entity, the latter will be adopted as a result of the traditional process of formation and expression of the company's will (via governing bodies and the majority of shareholders who committed wrongdoing or prevented the company from protecting itself) against the background of the defect of will. We believe that since the offenders control the legal entity, it would be better if the procedural legal capacity of the legal entity in this category of actions were exercised in another manner. The law already conditions the commission of any procedural action of a legal entity by the need to obtain the consent of minority participants (shareholders) who filed a lawsuit on its behalf. We suggest that members (shareholders), due to wrongdoers being in control, act on behalf of a legal entity during the litigation itself, exercising the management of the legal entity instead of its majority members (shareholders) or officials. The legal entity's ability to act via its members (shareholders) is already provided for by Part 6 of Art. 44 of the CPC of Ukraine, Ibid. although it is ultimately derived from Part 2 of Art. 92 of the Civil Code of Ukraine Civil Code of Ukraine of 16 January 2003 (as amended 1 August 2021) <https://zakon'rada'goV'Ua/laws/ show/435-15#Text> accessed 8 August 2021. Act of Germany `On Joint-Stock Companies' (n 16). and is first and foremost related to a general and limited partnership. Thus, we suggest amending Part 2 of Art. 54 of the CPC of Ukraine as follows:
When case proceedings based on such an action are instituted, the legal entity acquires the status of a plaintiff, and its procedural rights and obligations shall be exercised for and on behalf of that legal entity by its members and (or) shareholders that have brought the action.
In suggesting such amendments, we understand that it is highly probable that the persons that have brought the action will try to prevent the defendant from obtaining relevant evidence and hinder the adversarial nature of proceedings in general. However, its procedural status is balanced by the plaintiff's burden of proof, the capability of claiming evidence, preventive mechanisms of the derivative action itself (which will be discussed later in this article - H. Yu.), and the concept of the `business judgement rule'. The latter is the refutable presumption of the lawful nature of actions (refusal to take them) and decisions of the officials, provided that they have acted in good faith, reasonably, and for the benefit of the legal entity. We will examine this issue separately in more detail later in this article. lawsuit preventive judgement
1.3 Persons that can file a derivative lawsuit on behalf of a legal entity
According to Art. 54 of the CPC of Ukraine, the right to file a derivative lawsuit may be granted to members of the company.2323 Usually, the right to file a derivative lawsuit is granted to minority shareholders under the circumstances of the corporation's inability to protect itself. Ukrainian legislation does not contain a direct ban on the use of this right by a majority shareholder, establishing the minimum property quota for the right to be exercised. The same approach is used in Art. 260 of Companies Act in United Kingdom. UK Companies Act 2006 (n 13). O. A. Chaban, studying the institute of a derivative lawsuit in the United Kingdom, aptly notes that despite there being no direct prohibition on filing a derivative lawsuit by a majority shareholder, other types of remedies are available to such a person, and thus the court will most likely dismiss the claim of such a plaintiff. OA Chaban, `Institute of derivative action in England and Wales' (2020) 27 Scientific Papers of National University `Odessa Law Academy' 21-22. As a majority shareholder, such a person can decide that a corporation will file a lawsuit directly.
It should be emphasised that the provisions of Art. 54 of the CPC of Ukraine do not provide a clear answer to the question of whether a derivative action can be brought by a person that was not a company member when losses were sustained by the company. Commercial Procedure Code of Ukraine (n 7).
For example, according to Clause 1 of Part 1 of Art. 148 of the Joint-stock Companies Act of the Federal Republic of Germany, the person bringing a derivative action, or, in case of universal legal succession, its legal predecessor, must hold shares before the moment they knew or could have known about the damages inflicted upon the joint-stock company. Act of Germany `On Joint-Stock Companies' (n 16).
Usually, such a requirement is due to the need to prevent abuse of the right to bring a derivative action: i.e., the purchase of shares (stock) in order to engage the legal entity in prolonged litigation based on minor claims and to make the latter `buy off' the unconscientious applicant, who files a lawsuit on behalf of the legal entity and therefore gains the benefits.
However, such abuse may also be enacted by a current member (shareholder) of the legal entity. We believe that it is expedient to grant the right to bring a derivative action to members (shareholders) that did not have that status as of the date of damages inflicted upon the legal entity. There are several reasons for this:
1) the right to claim damages is held by the legal entity rather than its member;
2) the losses inflicted by the official indirectly influence the rights and interests of such a member (possibility and volume of payment of dividends, whether the goals of a corporation are to be achieved, etc.) - such a person's rights and interests, having been indirectly violated, also deserve protection;
3) the abuse of the right to bring a derivative action is prevented by the expanded locus standi model and examination of conformity of the decision not to take action to protect the violated right to the business judgement rule.
The stance above is reflected in Part 4 of Art. 260 of the UK Companies Act, according to which it is immaterial whether the cause of action arose before or after the person seeking to bring or continue the derivative claim became a member of the company. 28 UK Companies Act 2006 (n 13). In the Explanatory Note to Art. 260 of the Law, the drafters explained their approach with the fact that a derivative action is used to defend the rights of the company rather than its members. 29 Explanatory Note to Section 260 of Companies Act of United Kingdom <https://wwW'legislation' gov.uk/ukpga/2006/46/notes/division/9/2/1/1> accessed 8 August 2021.
Another aspect that should be taken into consideration is that upon the alienation of shares (stock) by members (shareholders) of a corporation, there is a singular succession in the rights and obligations owned by the previous owner as a member of the corporation. For example, Part 4 of Art. 260 of the UK Companies act was developed by taking into account the recommendation by the Law Commission of England and Wales, which had noted in its Shareholder Remedies Report, dated 24 October 1997, that the right to bring a derivative action was a part of the `bundle of rights represented by a share', so it could be transferred to third parties upon the alienation of the share. 30 Shareholder Remedies Report of Law Commission of England and Wales as of 24 October 1997, p. 101 <https://wwW'lawcom'goV'Uk/project/shareholder-remedies/> accessed 8 August 2021.
While studying the institute of a derivative action, we should mention that the current legislation contains the absolute ban on the use of this remedy by holders of preference shares (Part 1 of Art. 54 of the CPC). Commercial Procedure Code of Ukraine (n 7). This approach has been preserved in Clause 9 of Section XIX of the Draft Law of Ukraine `On JSCs'. Draft Law of Ukraine `On Joint-Stock Companies' (n 8). In our opinion, such a ban is unreasonable due to the following reasons.
Firstly, the legal status of holders of preference shares is indeed somewhat limited compared to the status of holders of ordinary shares in terms of management. For example, according to Part 5 of Art. 28 of the Act of Ukraine `On Joint-Stock Companies (hereinafter - Act of Ukraine `On JSCs'), their right to participate in management is limited by specific issues they are allowed to vote on. Act of Ukraine `On Joint-Stock Companies' of 17 September 2008 (as amended 1 July 2021) <https:// za^n^ada^^^/laws/show^^^^ex^ accessed 8 August 2021. However, the same article provides for the expanded list of issues on which holders of preference shares may vote.
Secondly, in addition to protection of the legal entity's rights, the purpose of a derivative action is to protect the violated rights and interests of the shareholder. In that regard, it should be emphasised that the right to claim payment of dividends, which is held by holders of preference shares, is of priority (Clause 2 of Part 2 of Art. 31 of the Act of Ukraine `On JSCs') compared to the same right of holders of ordinary shares. Ibid.
Thirdly, that the comparative legal analysis of this issue has found no examples of situations where holders of preference shares have been deprived of their right to bring a derivative action in any other country. For example, Part 1-1 of Art. 63 of the Act of Kazakhstan `On Joint-stock Companies' gives the right to bring the action both to holders of ordinary shares and preference shares. Act of Kazakhstan `On Joint-Stock Companies' of 13 May 2003 (as amended 8 June 2021) <https:// online.zakon.kz/Document/?doc_id=1039594> accessed 08 August 2021. This issue is similarly regulated by Art. 148 of the German Joint- stock Companies Act. Act of Germany `On Joint-Stock Companies' (n 16). Art. 261 of the UK Companies Act uses the concept of `a member of a company', and there are no limitations as to persons that may bring the claim based on the criterion of a proper type of shares. UK Companies Act 2006 (n 13).
Fourthly, if holders of preference shares are forbidden to bring a derivative action, it might be detrimental to the legal entity's interests since about a quarter of the shareholders potentially cannot defend their rights either personally or jointly. Moreover, it is easier for the offenders to arrange with the other shareholders so that they will not exercise their right to bring a derivative action.
Therefore, we believe that the ban on a derivative action brought by holders of preference shares must be lifted in Ukrainian legislation.
2. Mechanisms to prevent the abuse of the right to file a derivative lawsuit
Prevention of the abuse of the right to file a derivative lawsuit is provided through locus standi - a procedure that establishes a person's right to bring a derivative action to court, during which conformity of submission of the derivative action to the criteria established by the law or case law is assessed. Locus standi itself is comprised of a set of preventive mechanisms. In common law countries, the locus standi criteria are established for the cases in which a derivative action may be brought, whereas it is typical of the civil law countries that the criteria are aimed at determining the group of persons entitled to bring a derivative action. Z Zhang, `The Shareholder Derivative Action and Good Corporate Governance in China: Why the Excitement is Actually for Nothing' (2020) 28 (2) Pacific Basin Law Journal 183-189. For example, according to Art. 263 of the UK Companies Act, the court considers the following facts for permission to continue the claim as a derivative claim: 1) whether the act or omission of the officials has been ratified by the company; 2) whether the act or omission gives rise to a cause of action that the member could pursue in his or her own right rather than on behalf of the legal entity (whose rights have been violated); 3) whether the company has decided not to bring an action (pursue the claim). UK Companies Act 2006 (n 13). Moreover, the court also finds out whether the offenders control the company's operations and whether a derivative action will be in the best interests of the company.
The classic locus standi criterion in civil law is the property qualification in holding the interest in the authorised capital or the stock as a precondition to bringing a derivative action.
Thus, Part 1 of Art. R225-169 of the Commercial Code of France establishes the property qualification of 5% of personal or joint holding of shares. Also, this property qualification is progressive: it decreases along with the size of the authorised capital. According to Part 2 of Art. R225-169 of the Commercial Code of France, if the authorised capital of the company exceeds 750,000 euros, for the first 750,000 euros of surplus, the property qualification is 4%, for 750,000-7,500,000 euros, it is 2.5%, and for 7,500,000-15,000,000, it is 1%. Commercial Code of France as amended 2 August 2021 <https://www.legifrance.gouv.fr/codes/texte_ lc/LEGITEXT000005634379> accessed 8 August 2021. In Germany, according to Ar. 148 of the Joint-stock Companies Act, the property qualification is established at the level of personal or joint holding of 1% of the company's share or under the condition of holding the shares with the value of at least 100,000 euros. Act of Germany `On Joint-Stock Companies' (n 16). According to Clauses 1-2 of Art. 2393-bis of the Civil Code of Italy, the property qualification to bring a derivative action is 2.5% of the authorised capital for public joint-stock companies and 20% of the authorised capital for private joint-stock companies (unless otherwise stipulated in the articles of association). Civil Code of Italy of 16 March 1942 (as amended26 October 2020) <https://www.altalex.com/ documents/codici-altalex/2015/01/02/codice-civile> accessed 08 August 2021. As for members of limited liability companies, the right to bring a derivative action under Art. 2476 of the Civil Code of Italy is granted to each member of the company. Ibid. The same rule is stipulated in Part 1 of Art. 157 of the Czech Act `On Commercial companies and cooperatives (Business Corporations Act)' (hereinafter - Czech Business Corporations Act). Czech Act `On Commercial companies and cooperatives (Business Corporations Act)' of 25 January 2012 <http://obcanskyzakonik.justice.cz/images/pdf/Business-Corporations-Act.pdf> accessed 8 August 2021.
According to Art. 847 of the Companies Act of Japan, a person must own one share, i.e., be the company's shareholder, to have the right to bring a derivative action. This rule also requires continuous ownership of shares for six months to bring a derivative action. Companies Act of Japan of 26 July 2005 (as amended 2014) <http://www.japaneselawtranslation.go.jp/ law/detail/?ft=2&re=2&dn=1&yo=companies+act&x=0&y=0&ia=03&ja=04&ph=&ky=&page=3> accessed 8 July 2021. To our mind, such a requirement is inefficient since it makes the person wait for a certain period despite losses having been incurred, thus depriving a member (shareholder) of an opportunity to respond to the event promptly. Therefore, we believe that such a preventive mechanism should not be introduced into Ukrainian law.
It should be emphasised that scholars have various standpoints regarding property qualification for bringing derivative lawsuits. Yu. Popov believes that this matter should be established by considering the specific features of each legal entity. For instance, in his opinion, since shares in the authorised capital of limited and additional liability companies are not suited for quick turnover, it is inexpedient to establish the property qualification in their respect to prevent abuse of the right to bring the action. As for joint-stock companies, Yu. Popov believes that such qualification is necessary. 46 Yu Popov `Derivative (indirect) lawsuits: foreign experience and Ukrainian prospects' (2012) 12 Ukrainian Commercial Law 55-65. O. O. Kot notes the member's right to bring the respective derivative action should be found reasonable in case its equity rights as a member are also violated, regardless of the interest. 47 OO Kot, `Implementation and protection of subjective civil rights: problems of theory and judicial practice' (Alerta 2017) 382.
The advantage of property qualifications in most countries of the world is the necessity for the preventive mechanism against abuse by minor shareholders (members). However, the property qualification must be reasonable. According to M. Gelter, if it is relatively large, it will be a factor restraining a derivative action rather than a tool preventing abuse. M Gelter, `Why do Shareholder Derivative Suits Remain Rare in Continental Europe?' (2012) 37 Brooklyn Journal of International Law 857. On the other hand, in their research regarding the lack of popularity of derivative actions in Europe, M. Sekyra and K. Grechenig referred to the obvious connection between the property qualification giving the right to bring such claim and the level of risk of potential such a member, acting on behalf of the legal entity, being bribed by senior executives: the higher the percentage threshold for a derivative action is, the higher the risk of potential members (shareholders), who bring a derivative action, being bribed (given the small number of the latter). K Grechenig, M Sekyra, `No Derivative Shareholder Suits in Europe - A Model of Percentage Limits and Collusion' (2010) 15 Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 1-3. Therefore, the optimum qualification is the one that would concurrently prevent abuse by members (shareholders) and unlawful arrangements with officials and create no unreasonable hindrance in the exercise of this right. The property qualification at 5% of the authorised capital (property of the legal entity), prescribed by Clause 9 of Section XIX of the Draft Law of Ukraine `On Joint-Stock Companies', 50 Draft Law of Ukraine `On Joint-Stock Companies' (n 8). is much more reasonable than the 10% prescribed by Art. 54 of the CPC of Ukraine, 51 Commercial Procedure Code of Ukraine (n 7). and, taking into account the comparative study above, it conforms with the foreign practices. Such a size is optimal since it is capable of preventing abuse of the right to bring a derivative action by minor members (shareholders) and does not create major obstacles to exercising this right. If it was established at the level of participatory share 1%, it would be of a formal nature and perform no preventive function.
At the same time, we believe that the legislative focus on property qualification as the only mechanism to prevent abuse of a derivative action is somewhat excessive.
Firstly, it is insufficient for effective prevention of abuse since it only prevents abuse by minor members (shareholders) and fails to cover quite a wide range of participatory shares that will be held by members (shareholders) who can file a derivative lawsuit. Awareness of this fact is reflected by the case law of the Supreme Court. In its Resolution dated 17 February 2021 in case No. 910/13643/19, the court did not limit itself to establishing the existence of the property qualification and emphasised that a derivative action could only be brought in the exceptional circumstances that justify the need of the company's member to file a claim on the company's behalf if the legal entity's inability to defend its rights on its own if proven. Resolution of Supreme Court in case 910/17602/19 of 17 February 2021 <https://reyestr.court.gov.ua/ Review/95170089> accessed 8 August 2021. Commercial Procedure Code of Ukraine (n 7).
Secondly, by using the property qualification, the legislator unreasonably deprives members of the legal entities without participation shares (condominiums, public associations, charitable organisations, etc.) of the right to bring a derivative action. The nature of this remedy is preconditioned by the tortious act of the officials or majority of the members participating in management when the legal entity cannot file a claim to court to defend its right on its own. Since there is no participation share, another criterion should be used: per cent of the total number of members. Therefore, Part 1 of Art. 54 of the CPC of Ukraine5353 should be supplemented with para. 2 as follows:
In the legal entities where members have no share in authorised capital (stock, shares, equity interest, etc.) or property of the company, the right to bring an action is granted to the persons that jointly represent 1/20 of the total number of members.
Bringing a derivative action is traditionally preconditioned by the obligation of the legal entity's member to file a demand to the legal entity to act as an element of expanded locus standi. Such a requirement exists in the legislations of a few foreign states: Clause 2 of Part 1 of Art. 148 of the German Joint-stock Companies Act, Act of Germany `On Joint-Stock Companies' (n 16). Art. 158 of the Czech Business Corporations Act, Czech Business Corporations Act (n 43). Rule 23.1 of the Federal Rules of Civil Procedure in the USA, etc. Federal Rules of Civil Procedure of United States of America (n 15). It is necessary to introduce such a locus standi element because it will perform a preventive function (prevent the members (shareholders) acting in bad faith from bringing a derivative action where there are no grounds) and the function of proving that the officials (majority of members) have failed to take action to defend the legal entity's rights. The necessity for the implementation of an obligation to file a demand was introduced by Ye. Talykin. Ye Talykin, `Derivative lawsuit in commercial litigation of Ukraine: general principles of procedural construction' (2014) 4 Law Herald 21-22. To prevent minority shareholders from any abuse in the form of deliberate determination of the shortest possible period of time, the law should provide for a reasonable period of time within which the majority of shareholders (corporation's officials) may decide on the filed demand. In our opinion, this period should be one month from the day of the receipt of a demand.
Given the above, the model of expanded locus standi is proposed to be introduced into Ukrainian law. In addition to a property qualification, a derivative action should be preconditioned by the following requirements: 1) the person holds a required volume of share in authorised capital or property of the company or represents 1/20 of members of a non-entrepreneurial company; 2) the person has already demanded the legal entity to take action to defend the legal entity's rights and interests that have been violated (have not been recognised, have been challenged); 3) the legal entity, contrary to its interests, has failed to take any action to defend its rights and interests for one month, or has rejected the person's demand (is unable to defend its rights and interests on its own); 4) there are no other grounds that would prevent a derivative action from being brought.
3. Other types of derivative lawsuit
3.1 Preventive derivative lawsuit
A traditional derivative lawsuit is not without its own shortcomings. For example, the losses may not have been inflicted by the official's actions (omission) yet, or, as M. O. Sukhanov aptly notes, such a legal remedy may be ineffective in Ukraine in cases where the director's property is insufficient to enforce the court's decision to satisfy the claim. MO Sukhanov, Analysis of the practice of the supreme court regarding judicial protection of corporate rights of members of a limited liability company' (2020) 6 Law and Society 21-24. In cases when the losses have not yet been inflicted, the point at issue is the so-called `preventive derivative action' - the ability to eliminate the real threat of causing damages - the need for which was first emphasised by M. K. Bogush. MK Bogush `Protection of the rights and interests of the subjects of corporate legal relations' (PhD (Law) Thesis, Taras Shevchenko National University of Kyiv 2018) 95-97. In suggesting this remedy, Bogush foresaw the risk of abuse of the right to bring a preventive derivative action, so she found it necessary to introduce the obligation of the members of the corporation to deposit some money (make a pledge) to the judicial saving account as counter security.
In our opinion, such a proposal is somewhat ambiguous. Despite being aimed at preventing the abuse of the right to file a derivative lawsuit, the obligation to deposit money will constitute an additional property qualification (alongside the qualification of holding stock, shares, or equity interest in a certain volume), so it will equally (or even further) prevent both abuse and the capability of bringing a derivative action itself. We believe that introduction of such a preventive mechanism is unlikely to positively influence the already rare practice of derivative actions.
On the other hand, Bogush reasonably notes that reduced term for hearing of the cases based on preventive derivative actions would be expedient. She suggests that the hearing of such cases should be limited to one month `since the prompt application of respective remedies to eliminate the threat of violation of the subjective corporate right/interest itself is a precondition for a preventive derivative lawsuit to be effective'.6060 In general, we agree with her suggestion since, for instance, economic operations, both entrepreneurial and non-entrepreneurial ones, are associated with the need to promptly respond to changes in the economic environment to efficiently reach the goals in full (to increase profit, to perform statutory tasks, etc.). If our purpose is to prevent the corporations losses, the court must also promptly respond to the existing threat by ruling to cease the action/obliging to act as soon as possible. The need above also exists in respect of derivative actions in general: the legal entity that has sustained losses because of the official's actions (omission) or majority shareholder's decision must receive the compensation as soon as possible, to replenish its property on time at least to a certain extent and to use it for statutory objectives/ business development, etc.
Therefore, we consider it necessary to improve the suggestion by Bogush: the reduced term for hearing should be introduced not only for preventive derivative actions but also derivative actions in general. To our mind, the above-mentioned term of one month is reasonable.
3.2 Derivative lawsuit to challenge company transactions
A claim filed by the member of the corporation for and on behalf of the latter for challenging the transaction conducted by the executive body of the corporation is deemed to be another type of derivative lawsuit. The logic of the concept is quite simple: just as a defect in the will of a corporation to protect its rights by compensating it for damages is a ground for filing a derivative lawsuit by its members, in the same way, the protection of the corporation's rights, violated through a transaction being conducted contrary to its interests, may require bringing a derivative action when a defect of corporation's will precludes it from filing a lawsuit by itself. Moreover, when it comes to the prevention of losses, an offence can be terminated by invalidating the transaction and terminating the legal relationship before the parties start to take the actions that might result in losses by the corporation. Additionally, an official is not always able to compensate for the losses resulting from his or her actions (omission), whereas restitution will enable the protection of the corporation's rights and interests to a larger extent. In other words, a classic derivative action for claiming damages is imperfect in the above-mentioned cases. The proposals to introduce such a concept of a derivative action in the national law have been made by O. S. Dotsenko Ibid 95-97. OP Dotsenko `Invalidation of a transaction committed by the executive body of a business company in excess of its powers as a way to protect corporate rights' (2020) 3 Entrepreneurship, Economy and Law 74. and Yu. Popov. Yu Popov, `Derivative (indirect) lawsuits: foreign experience and Ukrainian prospects' (n 45) 10-11. M. K. Bogush rightly treats the claim filed by the member (shareholder) of the corporation for invalidation of the transaction conducted by the latter as a kind of a derivative action. MK Bogush `Protection of the rights and interests of the subjects of corporate legal relations' (n 56) 162. For example, the shareholder's right to challenge an interested party transaction is prescribed by Part 12 of Art. 72 of the Law of Ukraine `On JSCs'. However, not only does the law not mention anything about it being possible only when a legal entity cannot file such a lawsuit by itself, it also does not contain such a provision regarding major transactions.
In Ukraine, when it comes to major transactions, analysis of Parts 1 and 2 of Art. 46 of the Law of Ukraine `On LLCs' Act of Ukraine `On Limited Liability and Additional Liability Companies' of 16 February 2018 (as amended 16 July 2020) <https://zakon'rada'goV'Ua/laws/show/2275-l9#Text> accessed 8 August 2021. and Parts 1-2 of Art. 72 of the Law of Ukraine `On JSCs' Act of Ukraine `On Joint-Stock Companies' (n 32). shows that a major transaction and an interested party transaction, concluded in violation of the procedure established by law - without a resolution to grant consent for its conclusion - creates, changes, and terminates civil rights and obligations of a joint-stock company and limited and additional liability companies only in cases where the transaction is approved by the company thereafter. Due to the imperfection of the legal drafting, the wording above may drive the interpreting entity to the conclusion that such a transaction is void. However, the rules contain no direct indication that the transaction is invalid, so it is impossible to state the voidness of major transactions and interested party transactions. It appears that the legislator provided for voidability of such transactions in the way: for instance, it is done in respect of approval of transactions by the minors conducted beyond their legal capacity or transactions conducted by representative ultra vires (Arts. 221 and 222; Art. 241 of the Civil Code of Ukraine). Civil Code of Ukraine (n 23). This conclusion can also be drawn based on the analysis of the Explanatory Note to the Draft Law of Ukraine `On Limited Liability and Superadded Liability Companies'. The authors note that Art. 46 of the Draft Law prescribes non-conclusion of the major transaction in case the procedure for approval thereof has been breached. Explanatory Note to the Draft Law of Ukraine `On Limited Liability and Additional Liability Companies' <http://w1'Cl'rada'goV'Ua/pls/zweb2/webproc4_1?pf3511=59093> accessed 8 August 2021. However, in the authors' opinion, the transaction will be concluded by virtue of Clause 2 of Part 3 of Art. 92 of the Civil Code of Ukraine. It should be remembered that, according to Part 1 of Art. 638 of the Civil Code of Ukraine, a contract is deemed to be concluded if parties thereto have agreed upon all the materials terms and conditions. Civil Code of Ukraine (n 23). Accordingly, if the provisions of Part 1 of Art. 638 are not fulfilled - the parties have not agreed on the essential terms - only then should the contract be deemed not concluded. The director's transaction concluded ultra vires does not comply with Part 2 of Art. 203 of the Civil Code of Ukraine. Thus, there are grounds for invalidating it and deeming it voidable. This approach is used in Part 1 of Art. 74 of the Law of Kazakhstan `On Joint-stock Companies'. Act of Kazakhstan `On Joint-Stock Companies' of 13 May 2003 (as amended 8 June 2021) <https:// online'Zakon'kz/Document/?doc_id=1039594> accessed 8 August 2021. It allows for the defence not only of rights and interests of the legal entity (and its members) but also the turnover of goods, rights, and interests of third parties acting in good faith.
However, it should be noted that the director's transaction concluded ultra vires violates, first, the rights and obligations of the corporation, rather than its members (their interests are also violated, but indirectly). Thus, bringing a direct action in this case seems to be erroneous. The opposite approach will undermine the concept of a legal entity as an independent subject of the legal relationship, different from its members. The same stance is expressed by the ECtHR in the case of Feldman and Bank Slavyansky v Ukraine, which reiterated that the shareholder could not be considered a proper plaintiff if the legal entity's rights had been violated: it required exceptional circumstances of the legal entity's inability to claim defence of its rights via the governing bodies. Feldman and Slovyanskyy Bank v Ukraine App No 42758/05 (ECtHR, 21 December 2017) <https:// hudocechncoednt/eng# {%22f ullte xt%22: [%22slovyanskyy%22] ,%22documentcollectionid2% 22:[%22GRANDCHAMBER%22,%22CHAMBER%22],%22itemid%22:[%22001-179557%22]}> accessed 8 August 2021. In Ukraine, such an opinion was first expressed by the Grand Chamber of the Supreme Court in its Resolution dated 8 October 2019 in case No. 916/2084/17, where the court also permitted representation of the legal entity by its member (shareholder) if the entity was unable to defend its rights on its own Resolution of Grand Chamber of the Supreme Court in case 916/2084/17 of 8 October 2019 <https:// reyestr.court.gov.ua/Review/84911545> accessed 8 August 2021. (the court does not specify this directly, but it is regarding the concept of a derivative action - H. Yu.). Henceforth, the above-mentioned approach became the established law enforcement practice and was reflected in Resolution of the Supreme Court dated 14 May 2021 in case No. 904/9839/16 Resolution of the Supreme Court in case 904/9839/16 of 14 May 2021 <https://reyestr.court.gov.ua/ Review/96342397> accessed 8 August 2021. and Resolution of the Supreme Court dated 23 June 2021 in case No. 913/344/20. Resolution of the Supreme Court in case 913/344/20 of 23 June 2021 <https://reyestr.court.gov.ua/ Review/98170295> accessed 8 August 2021. At the same time, as we have stated before, the rights and interests of members of the corporation are violated, so it would be somewhat erroneous for the Supreme Court to deprive them of remedies in general. In this category of cases, the court should rely on somewhat different reasons.
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