The Proper Plaintiff Rule is one of the most critical foundational principles in company law. It dictates who has the legal right (locus standi) to initiate a lawsuit when a corporate entity has suffered a legal injury.
Derived from the landmark English case of Foss v. Harbottle (1843) 2 Hare 461, this rule states that if a wrong has been done to a company, the company itself is prima facie the proper plaintiff (claimant) in an action brought to remedy that injury.
1. The Core Principle: Separate Legal Entity
The rule is fundamentally rooted in the concept that a company is a legal person, separate and distinct from its directors or shareholders.
This principle establishes that the company holds its own property rights and interests, and therefore, only the company can sue for damage suffered by the corporate entity.
The necessary implication is that:
“The proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself.” per Jenkins LJ in Edwards v. Halliwell [1950] 2 All ER 1064, 1066.
This means individual shareholders cannot generally bypass the company to file a suit, even if they hold a majority of the shares.
2. The Bar Against Reflective Loss
A direct consequence of the proper plaintiff rule is the prohibition against recovering “reflective loss.” A shareholder cannot recover damages measured by the diminution in the value of their shares or dividends, because this loss is considered merely a reflection of the loss suffered by the company itself.
This rule is enforced to ensure that the recovery proceeds are returned to the company, thus safeguarding the interests of all shareholders and creditors.
In Foo Toon Yeong & Ors v. Jonah Wong Ching Hang 4 MLRA 509 CA, the Court of Appeal reinforced this boundary, stating that shareholders are:
“[29] As a general rule, the company is the proper claimant in an action to recover the loss that itself has suffered. A shareholder cannot in substance avoid that rule by bringing a personal claim to recover damages for loss in the value of his shares merely because the company in which he is interested has suffered damage, even if the conduct of which he complains gave him personally, and not the company alone, a cause of action.”
This distinction is also vital in preventing a shareholder (even a holding company) from suing for wrongs done to its subsidiary, as demonstrated in Ageson Berhad v. Dato’ Foo Chu Jong & Ors MLRHU 3068 HC, where the court clearly stated:
“[16] The Plaintiff’s suit against these Defendants is contrary to the legal principle of separate legal entities. Injury or harm if any to the subsidiary is actionable by the subsidiary company and not the holding company.”
3. The Mandatory Exception: Derivative Action
The strictness of the Proper Plaintiff Rule led to the recognition of exceptions, primarily the derivative action, designed to prevent injustice when wrongdoers control the company.
A derivative action is fundamentally different from a personal claim. It is used in situations where the company is incapacitated from enforcing its rights because the alleged wrongdoers are themselves in control of the decision-making processes.
Under the current statutory regime, the common law right to bring a derivative action has been abrogated by provisions like Section 347(3) of the Companies Act 2016. Instead, a complainant (a member or director) must obtain leave of the court (under Section 348) to initiate the suit in the company’s name for the company’s benefit.
4. The Deadlock Scenario (Perak Integrated)
The necessity of the derivative action is particularly highlighted in cases involving corporate deadlocks.
In Perak Integrated Networks Services Sdn Bhd v. Urban Domain Sdn Bhd & Anor [2018] 3 MLRA 249 FC, the Federal Court addressed a situation where the shareholders held equal (50-50) stakes, creating a deadlock. The court affirmed that whether a party is a majority or minority shareholder is not a conclusive test for bringing a derivative action.
The relevant criterion is “wrongdoer control”—that is, whether the alleged wrongdoer prevents the company from suing. The court noted that this test is satisfied in a deadlock situation where the aggrieved member is unable to move the company to take action against the other shareholder (the wrongdoer):
“The requirement of ‘wrongdoer control‘ may be satisfied where the aggrieved member and the alleged wrongdoer are in 50-50 control such that either may prevent the company from suing.”
The Federal Court concluded that in a deadlock situation, “there is no objection in principle to a shareholder bringing a derivative action on behalf of the company”. This action must be proved on a prima facie basis to be in the best interest of the company.
CONCLUSION
The proper plaintiff rule, originating from Foss v. Harbottle, establishes that the company itself is prima facie the proper claimant in an action to redress a corporate wrong, a necessity rooted in the principle that a corporation is a separate legal entity distinct from its members. This rule prohibits shareholders from recovering damages for reflective loss, such as diminution in share value, maintaining that the company’s creditors and shareholders must benefit collectively from any recovery of lost corporate assets. However, where wrongdoers are in effective control, creating a deadlock situation (as recognized in cases like Perak Integrated Networks Services), the law permits a shareholder to seek leave to bring a statutory derivative action, allowing them to sue in the company’s name and for its benefit to ensure justice is achieved.
Disclaimer: This post is for informational purposes only and does not constitute legal advice. Please consult a qualified lawyer for your specific legal needs.
