Paa Brothers Company Limited v Cheruiyot & another; Muthangari Suites Management Co Ltd (Affected Party) [2023] KEHC 25441 (KLR)

Paa Brothers Company Limited v Cheruiyot & another; Muthangari Suites Management Co Ltd (Affected Party) (Commercial Cause E032 of 2023) [2023] KEHC 25441 (KLR) (Commercial and Tax) (17 November 2023) (Ruling)

Neutral citation: [2023] KEHC 25441 (KLR)

Republic of Kenya

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

Commercial and Tax

Commercial Cause E032 of 2023

FG Mugambi, J

November 17, 2023

Between

Paa Brothers Company Limited

Plaintiff

and

Jacquiline Jerotich Cheruiyot

1st Respondent

Patrick Sooma

2nd Respondent

and

Muthangari Suites Management Co Ltd

Affected Party

Ruling

Background 1. Before the court is an application dated 31st January 2023. It is brought under the provisions of sections 239, 240, 780 and 782 of the Companies Act (the Act). The only substantive prayer that is pending in the application is the one that seeks leave to continue a derivative claim seeking relief on behalf of Muthangari Suites Management Company Limited, the affected party.

2. The application was premised on the grounds stated on the face of the application as well as on the affidavit and further affidavit both sworn by Schon Ahmed Nooran, the Chairman of Paa Brothers Company Limited, which is the applicant. The applicant filed written submissions dated 20th May 2023 while the respondents’ submissions are dated 2nd June 2023.

3. It is not contested that the affected party was intended to be incorporated and structured to be a management company whose shareholders would be the purchasers of the apartments established at Muthangari Suites. This was provided for in the Agreement for Sale dated 4th June 2014, which was the constituting instrument for the Company. The Company was registered in 2014 and the respondents, who are directors of the affected party took office on 4th November 2019.

4. The applicant stated that the current structure, composition and management of the affected party contravened Clause (d) of the Agreement for Sale dated 4th June 2014 which contemplated that the affected party would be incorporated and operate as a private management company for purposes of managing the Muthangari Suites apartments. Contrary to the provisions of the said agreement, the affected party was incorporated and is currently operating as a public trading company.

5. The applicant confirmed that he was a shareholder and member of the affected party by virtue of ownership of thirteen (13) apartments in Muthangari Suites. The applicant took issue with the manner in which the company is being ran. The reasons for this are particularized as failing to hold Annual General Meetings for the shareholders/members, failing to furnish the shareholders/members of the affected party with the Annual Financial Statement of Accounts since 2019, failing to file with the Registrar of Companies annual returns from 2019 to date and also failing to file tax returns with the Kenya Revenue Authority (KRA).

6. The applicant also took issue with a purported restructuring of the affected party whereby the respondents purported to authorize a restructuring and reallocation of shares of the members of the affected party, contrary to clause (d) of the agreement. The applicant further decried the division and splitting of the allocated shares of members/shareholders for some apartment owners without any legal basis.

7. The applicant states that he had on numerous occasions requested the respondents to discharge their statutory mandate in accordance with the law to safeguard the interest of the members/shareholders of the affected party, in vain. It was therefore submitted that the state of affairs was injurious and prejudicial to not only the members/shareholders but also the smooth operation of the affected party.

8. The application was opposed by the replying affidavit and supplementary affidavit both sworn by Jacquiline Jerotich Cheruiyot. She is named as the 1st respondent and one of the directors of the affected party.

9. The respondents deny any wrong doing as alleged and particularly maintain that the affected party has never been incorporated as a public trading company nor has it operated as such, that its Memorandum and Articles of Association had not at any time been amended to alter its intended purpose and that the respondents have never participated in any public trading activities as alleged by the applicant.

10. It was further stated that under the Memorandum and Articles of Association, there was no obligation on the respondents to furnish the applicant or any other shareholder with financial statements of accounts on demand. Clause 51 allowed the directors the discretion to determine whether and to what extent the books of account could be open to the members and shareholders who were not directors. Despite this, the directors had occasionally caused the books of account to be shared with shareholders.

11. The respondents averred that the affected party does not have any VAT obligations. It was confirmed that the affected party had filed its annual financial returns for the year 2019 to date in accordance with section 620 and 705 of the Companies Act and that the affected party was tax compliant. The respondents argue that the Annual General Meetings and other meetings have been convened according to the law and that parties were notified accordingly.

12. On the question of restructuring of the company, the respondents averred that this was necessitated by the forfeiture of shares from resignation of some of the former directors. It had become necessary to assign the shares that had become available. A resolution of 9th February 2021 had given the directors the mandate to offer the shares to prospective shareholders.

13. In any case, it was averred that the restructuring was for the purpose of correcting the anomaly between the Memorandum and Articles of Association and the sale agreement. It was finally stated that the joint shareholders had consented to the split of the shares and finally that none of the shareholders had raised and complaint against the directors.

14. In its supplementary affidavit the applicant referred the court to Clause 4 of the Memorandum and Articles of Association whereby the affected party had been incorporated as a public company. The objects of the company had also been listed in Clause 3. There is no evidence that the amendments were sanctioned as required under the law. The applicant also referred the Court to Clause 53 which required that the financials be tabled before the members and shareholders.

15. The applicant argues that the statements that have been produced are not signed by the respondents and neither are they approved. The applicant opposes the submission that there is no duty to furnish the statements as a misconception. It is also noted that the KRA Certificate was only applied for in 2023 after the applicant sought court orders.

Analysis 16. I have carefully considered the pleadings, submissions and evidence placed before the court by rival parties. Whether the court should grant permission to the applicants to proceed with this suit as a derivative suit is governed by sections 238 and 239 of the Act. By dint of section 238 (1), a derivate claim is that which is brought by a member of a company in respect of a cause of action vested in the company, seeking relief on behalf of the company.

17. Of critical importance is that derivative suits are meant to protect the legal interests of the company by seeking to redress a wrong done to the company often against an insider (whether a director, majority shareholder or other officer) or a third party, whose action has allegedly injured the corporation. A derivative action is therefore an exception to the rule established under Foss V Harbottle (1843) 2 Hare 462 that a corporation should sue in its own name and in its corporate character or in the name of the person appointed by the law to be its representative.

18. Under section 238 (1) of the Act, an applicant must establish that he is a member of a company, that the cause of action is vested in the company and, the reliefs sought must be on behalf of the company for its own benefit and not for personal gain or benefit. This Court has previously held that these requirements are not independent of each other. (See for instance Ghelani Metals Limited & 3 Others V Elesh Ghelani Natwaral & Another, [2017] eKLR.)

19. Under section 239(1) of the Act, a person intending to sue on behalf of the Company is required to seek leave of the Court. The Court of Appeal held in the case of Amin Akberali Manji & 2 Others V Altaf Abdulrasul Dadani, [2015] eKLR held that:“Leave of court shall be obtained before filing a derivative suit, but may be obtained to continue with the suit once filed…. It is our view that at whatever stage leave is sought, the crucial requirement is for the applicant to establish a prima facie case demonstrating that he has locus standi to institute such action falls within any of the exceptions to the rule of Foss vs Harbottle.”

20. The essence of judicial approval under the Act is to screen out frivolous claims. The court is only to allow meritorious claims as was held in Ghelani Metals Limited [supra]. In reaching a determination on leave to proceed with the derivative action, the Court is guided by the considerations stipulated in section 241(2) of the Act. These were articulated by the Court quite comprehensively in Isaiah Waweru Njumi & 2 Ohers V Muturi Ndungu, [2016] eKLR.

21. The Court set out the following factors to be considered in such an application:i.Whether the plaintiff has pleaded particularized facts which plausibly reveal a cause of action against the proposed defendants;ii.If the pleaded cause of action is against the directors, the pleaded facts must be sufficiently particularized to create a reasonable doubt whether the board of directors’ challenged actions or omissions deserve protection under the business judgment rule in determining whether they breached their duty of care or loyalty;iii.Whether the plaintiff has made any effort to bring about the action the plaintiff desires from the directors or from the shareholders. Our courts have developed this into a demand or futility requirement where a plaintiff is required to either demonstrate that they made a demand on the board of directors or such a demand is excused;iv.Whether the plaintiff fairly and adequately represents the interests of the shareholders similarly situated or the corporation. Hence, a shareholder seeking to bring a derivative suit in order to pursue a personal vendetta or private claim should not be granted leave. In the American case of Recchion v Kirby 637 F Supp 1309 (W D Pa 1986), for example, the Court declined to let a derivative lawsuit proceed where there was evidence that it was brought for use as leverage in plaintiff’s personal lawsuit;v.Whether the Plaintiff is acting in good faith;vi.Whether the action taken by the Plaintiff is consistent with one a faithful director acting in adherence to the duty to promote the success of the Company would take;vii.The extent to which the action complained against – if the complaint is one of lack of authority by the shareholders or the Company – is likely to be authorized or ratified by the Company in the future; andviii.Whether the cause of action contemplated is one that the Plaintiff could bring as a director as opposed to a derivative action.”

22. In Ghelani Metals Limited (supra), the Court held that this is a two-stage enquiry process envisaged by the Act. In the first stage, the court must first satisfy itself that there is a prima facie case on any of the causes of action noted under section 238(3) of the Act. To surmount the first stage, an applicant only needs to establish through evidence, that he has a prima facie case without the need to show that it will succeed. (See Mrao Limited V First American Bank of Kenya Ltd & 2 Others, [2003] eKLR). The second stage entails a consideration of statutory provisions and factors which ordinarily guide judicial discretion albeit in the realm of derivative action.

23. The capacity of the applicant to bring this application is not contested. Against this background and for the avoidance of doubt, the applicant raises the following particularized claims of breach by the respondents:

(i)Breach of duty to keep proper accounting records for the Affected Party 24. The applicant states that the respondents have breached the requirements of section 635, 652 and 662 of the Companies Act as well as Clause 53 of the Memorandum and Articles of Association. This is by failing to furnish the members/shareholders of the affected party with approved and signed annual financial statements from 2019-2022.

25. The Act provides at section 635(1) that:“The directors of every company shall prepare a financial statement for the company for each of financial year of the company.”Section 652(1) in turn provides that:“As soon as practicable after a company’s annual financial statement has been prepared, the directors shall approve the statement and arrange for one or more of them to sign it.”Finally, under section 662, the law requires that:“Every company shall send a copy of its annual financial statement and reports for each financial year to—(a)every member of the company;(c)every person who is entitled to receive notice of general meetings.”

26. Turning to the Memorandum and Articles of Association, I find that although the obligation to allow the inspection of the accounts and books is at the discretion of the directors by virtue of Clause 51, the accountability of directors to the shareholders is nonetheless guaranteed. Clause 53 of the Memorandum and Articles of Association provides:“A copy of every balance sheet (including every document required by law to be annexed thereto) which is to be laid before the company in the general meeting together with a copy of the auditor’s report shall not less than twenty-one days before the date of the meeting, be sent to every member of and every holder of income notes or debentures of the company.”

27. I have looked at the financial statements that have been presented before the Court for the years 2018, 2019, 2020 and 2021. On the face of it, they are not signed as required under section 651(2). No reason has been offered by the respondents for this.

28. I further note from meeting agenda and minutes provided to the court that the financial statements and reports were meant to be placed before the shareholders at the annual meetings. It is not clear whether these were circulated within the time required by law or whether there were discussions and resolutions to adopt the statements by the shareholders.

(ii)Breach of duty to file KRA returns 29. The applicant states that the respondents have failed to diligently file annual returns of the affected party with the KRA. In their defense the respondents argue that the affected party is not a profit-making body and therefore not obliged to file returns and also that it does not have any VAT obligations. The respondents therefore maintain that the company is tax compliant.

30. I note from the record that despite having been registered in March 2014, it was not until 19th April 2023 that the affected party was issued with a KRA Pin Certificate. This can only mean that for the period in between, the respondents did not file tax returns in respect of the affected party although later, as the record shows, the tax returns for the tax periods 2018-2019, 2019-2020, 2020-2021 and 2021-2022 appear to have been filed on 26th April 2023.

31. Further, as evidenced in the minutes of the AGM of 2023 at agenda 007/1/4/2023, the issue of tax returns was discussed. In what appears to be an attempt at regularizing the matter, the meeting resolved to visit the KRA offices for confirmation as to whether the company ought to file returns. It is not clear why the same enquiry was not done earlier if the directors were not sure about the requirement to file returns. I say this noting that the company had previously engaged services of auditors who would have been in a position to advise.

32. There are also issues raised by the applicant on the accuracy of the tax returns as all the returns were nil returns.

(iii)Breach of duty to lodge company returns to the Registrar of Companies 33. Section 705 of the Companies Act provides for the duty of company to lodge annual returns with Registrar in the following terms:“Every company shall submit to the Registrar successive annual returns each of which is made up to a date not later than the date that is from time to time the company’s return date.”

34. The applicant blames the respondents for failing to lodge and file the company annual returns for the affected party on time. More particularly, the applicant blames the respondents for filing the returns for the years 2019, 2020, 2021, and 2022 on 22nd March 2023. This was after the applicant had raised the issue with the respondents.

35. The submission by the applicant is confirmed by the record showing the CR29 Annual Returns to the Registrar of Companies. These are dated 22nd March 2023 in respect of the returns for March 2019, March 2020, March 2021, March 2022 and March 2023. This means that all the returns to the Registrar of Companies had not been filed over these years and were only filed in March 2023. Again, no reason has been given by the respondents for this failure save to state that the company is compliant.

(iv) Breach of duty to hold Annual General meeting for the Affected Party 36. The applicant submits that the respondents failed to discharge their statutory duty to hold Annual General Meetings contrary to Section 275A and Section 278 of the Companies Act. This is denied by the respondents.

37. I do note that although the applicant states that the last general meeting was held in 2021, the applicant also states that the AGM held on 1st April 2023 was merely an afterthought following the institution of this suit by the Applicant.

38. Section 275A of the Act requires that every company shall convene a general meeting once a year.

39. I have perused the record. I note that there were meetings as evidenced by the notices sent out through email as well as minutes. I note that the notices relate to a Stakeholders Meeting and were sent out in respect of meetings of 18th September 2016, 14th February 2021 and 15th May 2022. Other than 2016, 2021, 2022 and 2023, it is not clear why the AGM was not held on the other years save that the respondents argue that they have held AGMs in every year that they have been in office.

(v)Subdivision of shares of members contrary to provision of Section 405 of the Companies Act 40. The Applicant submits that the exercise of subdivision of shares held by members of the affected party was ultra vires in nature as the same was never authorized by any resolution by the members of the affected party. This was in breach of section 405 (3) and (6) of the Companies Act and Clause (d) of the Agreement for Sale.

41. Section 405 (1)(a) of the Companies Act allows a company with a share capital to subdivide its shares into shares of a smaller nominal amount than the existing shares. For this to happen, section 405(1) of the Act provides that:“A company may exercise a power conferred by this section only if its members have passed an ordinary resolution authorizing it to do so.”By dint of section 405(6):“If a company contravenes any of the provisions of this section, the company, and each officer of the company who is in default, commit an offence and on conviction are each liable to a fine not exceeding one million shillings.”

42. Again, from the record availed before this court, the issue of restructuring of the shares were discussed at various meetings held on 25th September 2019, 9th Feb 2022 and 15th May 2022. These meetings discussed the issue of correcting the anomaly between the Agreement for Sale, the leases held by respective shareholders and the Memorandum and Articles of Association. The meetings also discussed the forfeiture and allotment of shares to prospective shareholders.

43. The specific point that the applicant takes issue with is the sub division of shares. I do not see any resolution approving such subdivision. All that there is on record is a statement at the AGM of 2023, by the directors that each share would be split into two, between husband and wife. There was no further discussion on the agenda item as the matter is in court.

44. It is therefore not clear how the decision to subdivide the shares was arrived at. The only justification that has been provided is that the affected parties had not raised any issue and that they had consented to the subdivision. The evidence of such consent has not been tabled before the court.

45. Besides these, it is clear from the Memorandum and Articles of Association that the affected party was registered as a public company while the Agreement for Sale clearly envisages a management company. While no evidence has been placed before the court to prove that the company was engaged in any other business beyond that of managing the apartments, the structure and objectives of the company goes to the root of its very existence and is a matter for deeper interrogation.

46. I am alive to the fact that the company may by way of a resolution vote to ratify some of the actions and inactions that have been raised by the applicant. This rule would however not apply where the act complained of is ultra vires, or contra statute. The totality of my analysis is that the applicant has established a prima facie case that demands further interrogation and production of evidence.

47. Although there is clearly hostility between the adversaries herein, the court must rise above such and look at the whole picture to satisfy itself that the suit is not brought to settle personal vendetta. The critical question ought to be whether the intended action is going to be in the interests of the company. Having looked at the reliefs sought in the plaint dated 31st January 2023, I am satisfied that they relate to the affairs of the company in which case, the final orders that may eventually be granted will have a bearing on the rights and/or obligations of the shareholders and the company.

Determination 48. Having regard to the findings and observations that I have made, I allow the application dated 31st January 2023. The costs of the application shall abide the outcome of the main suit.

DATED, SIGNED AND DELIVERED IN NAIROBI THIS 17TH DAY OF NOVEMBER 2023. F. MUGAMBIJUDGE