Second Order Derivative Action for Damage to Subsidiary
In Batya Holding Properties v. Tukatli the Jerusalem District Court approved a second order derivative action filed by shareholders of a parent company against a board member of a subsidiary for failure to promote the business of the subsidiary.
Under the standard doctrine of derivative actions, a director or shareholder of a company may initiate a derivative action against a third party on behalf of the company in certain circumstances if the company fails to take such action. The derivative action allows a shareholder to protect his derivative right as a shareholder (the direct right belongs to the company) if the company fails to protect such direct right.
The precedence of the ruling by Hon. Judge Solberg, is that in Batya Holdings the plaintiffs were shareholders only in the parent company, and therefore had no direct standing in the wholly owned subsidiary (since they were neither shareholders nor directors in the subsidiary).
Batya Holdings dealt with an anomaly – the plaintiffs were the owners of 99.7% of the parent company, but had the right to appoint only one of the two directors. The minority shareholders had the right to appoint the second director. The structure of the board of the subsidiary reflected the same arrangement. The director appointed by the minority (to the board of both the parent and the subsidiary) refused to act until her demand for management fees from the subsidiary was settled. The refusal led to a dead-lock that endangered the main asset of the subsidiary.
Allowing the derivative action Judge Solberg reasoned that since the failure to act would have caused damage to the subsidiary, and the parent is the sole owner of the subsidiary, the parent had a cause of action against the director. Therefore, the shareholders of the parent had a derivative cause of action against the director of the subsidiary on behalf of the parent.
Since the cause of action of the parent was a derivative cause (as a shareholder of the subsidiary), the de facto the ruling in Batya Holdings permits a derivative action from a second order (the shareholders’ derivative action, enforcing the parent’s derivative cause of action).
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