Minority Shareholder Protection I- The Rule in Foss v Harbottle PDF

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This lecture explores minority shareholder protection and Foss v Harbottle....

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Minority Shareholder Protection I: The Rule in Foss v Harbottle A. I nt r oduct i on I.

Basic Principles 1. What is a minority shareholding o may be as much as 50% (to exercise a minimum level of control 50%+ is needed) Barrett v Duckett [1995] BCLC 243 CA 2. The company is a separate legal person o can sue to enforce legal rights and be sued for breach of them o if a wrong is done to the company it is the company who should be the claimant, not the members 3. The company is run by the board o management of the company and exercise of all its powers is delegated to the board (see article 3 Model Articles, CA 2006) o if a wrong is done to a company, the board is the appropriate organ to decide to initiate proceedings 4. Members’ decisions are made by a majority of votes and such decisions bind all the members o ‘The provisions of the constitution bind the company and its members to the same extent as if there were covenants on the part of the com pany and of each member to observe these provisions’. (s 33(1) CA 2006) o all members are therefore contractually bound by the constitution o consequently, decisions taken by a majority in general meetings bind all members including those who abstained from voting or voted against the resolution Note that members can generally vote for their own advantage-Gower ‘the position of the shareholder is in striking contrast with that of the director’. 5. This situation can lead to abuse

o Someone in control of the board and general meetings might: -fail to remedy a wrong done to the company -oppress the minority of members -if a minority shareholder disagrees with decisions in the com pany he may wish to exit the company by selling his shares and may have to sell to a majority shareholder. He could be at a disadvantage when negotiating a sale price (unless a fair price or its determination is set out in the articles) OR member may wish to retain shares and take action against management 6. A balance must be struck between management efficiency and the possibility of abuse of power

before

o But law should not be too indulgent of minorities who: -should know the disadvantages of being a minority shareholder purchasing their shares; and -could obstruct the management of the company o So law needs to strike an appropriate balance between democracy and management efficiency on the one hand and protection of minority shareholders on the other hand 7. Courts’ non-intervention policy Carlen v Drury (1812) 1 Ves & B per Lord Eldon: The court is not required on every Occasion to take management of every playhouse and brewhouse in the Kingdom.

NB 1: Directors’ power may be unrestrained by members. Eg if the director is also a majority shareholder (de facto or de jure) or if the shareholding is dispersed. NB 2: If a minority member disagrees with decisions in the company and want to sell his/her shares they will have to usually sell to a majority shareholder and will be at a disadvantage negotiating a sale price. Such a member may want to keep his/her shares.

II.

‘Inbuilt’ Protections and Court Remedies

Some protection built into CA. Includes: o 75% majority required for various issues (e.g. change of name); o court’s consent required for other issues, e.g. reduction of capital; o right given to apply to court to have resolutions cancelled in certain circumstances; o law on directors’ duties;

o shareholders must act bona fide when altering articles and varying class rights.

B. TheRul ei nFossvHar bot t l e Normally, a minority shareholder cannot sue in the name of a company for a wrong done to the company: ‘the court will not ordinarily intervene in a matter which it is competent for the company to settle itself or, in the case of an irregularity, to ratify or condone by its own internal procedure. Where it is alleged that a wrong has been done to a company, prima facie the only proper [claimant] is the company itself’ (Sealy). This is a logical consequence of the doctrine of separate legal personality: see CA judgment in Prudential Assurance (Cumming Bruce, Templeman and Brightman LJJ): A cannot, as a general rule, bring an action against B to recover damages or secure other relief on behalf of C for an injury done by B to C. C is the proper plaintiff because C is the party injured, and, therefore, the person in whom the cause of action is vested. This is sometimes referred to as the rule in Foss v. Harbottle (1843) 2 Hare 461 when applied to corporations, but it has a wider scope and is fundamental to any rational system of jurisprudence. (Emphasis added.) Principles of constitutional contract and majority rule (continuing above passage): o The rule in Foss v. Harbottle also embraces a related principle, that an individual shareholder cannot bring an action in the courts to complain of an irregularity (as distinct from an illegality) in the conduct of the company's internal affairs if the irregularity is one which can be cured by a vote of the company in general meeting. o Foss v Harbottle is therefore a rule of procedure. Foss v Harbottle (1843) 2 Hare 461 Jenkins LJ explained the two parts of the rule in Edwards v Halliwell [1950] 2 All ER 1064 Firstly, the proper plaintiff in respect of a wrong alleged to be done to a com pany or an association of persons is prima facie the company or the association of persons itself. Secondly, where the alleged wrong is a transaction which might be made binding on the company or association and on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the sim ple reason that, if a mere majority of the members of the company or association is in favour of what has been done, then cadit quaestio.1 See also Mozley v Alston (1847) 1 Ph 790 1 Literally ‘the issue falls’, in other words there is no issue left.

Facts Directors should have retired in rotation under articles. They did not do so. Two shareholders tried to stop them acting as directors. Held Simple majority of members could have ratified the acts of the directors. See also MacDougall v Gardiner (1875) 1 Ch D 13, CA at 25, per Mellish LJ: …if the thing complained of is a thing which in substance the majority of the company are entitled to do … there can be no use in having litigation about it, the ultimate end of which is only that a meeting has to be called, and then ultimately the majority gets its wishes. and Johnson v Gore Wood & Co [2001] 2 WLR 72, [2001] 1 All ER 481, where it was found that the shareholders’ reflective loss could not be claimed in a liquidation Advantages of the rule: o more convenient for company to sue; o avoids wasteful litigation (majority will just ratify acts - no point in suing); o prevents harassing litigation by members unjustifiably aggrieved.

C. Whent heRul ei nFossvHar bot t l eDoesNotAppl y Edwards v Halliwell: Jenkins LJ’s four sets of circumstances where the rule does not apply: 1. Where a member’s personal rights have been infringed; 2. Where the act is illegal or ultra vires the company; 3. Where the matter in issue requires the sanction of a special majority or there has been non-compliance with a special procedure; 4. Under previous law: where a fraud has been perpetrated against the company and the wrongdoers are in control (a ‘fraud on the minority’) a derivative action could be bought by a shareholder for a wrong done to the company The company would receive any award for damages. Replaced by the statutory derivative claim in Part 11 CA 2006. NB Categorisation of these four sets of circumstances is disputed as it can be argued that the first three ‘exceptions’ are not real exceptions as they are based on different areas of law. The fourth exception is therefore arguably the only real exception to the rule. Remember that there are also the statutory remedies in Part 30 CA 2006 (‘unfair prejudice’, ss 994-999) and s 122 (1) (g) IA 1986 (‘winding up on the just and equitable ground’) both of which are the subjects of the next lecture.

Where the Rule does not apply 1. A Member’s Personal Rights o Members have certain contractual/tortious rights which are personal to them, eg the right to be paid a dividend after a dividend has been declared is a con tractual right enjoyed by the member. A member can sue concerning such a right in a personal action. o The right is personal to the member, so it is not an exception to the rule in Foss v Harbottle: the member is not trying to claim on behalf of the company, but on behalf of him/herself. Which rights are personal? o If there has been a case on it, then we know one way or the other. If not, much more difficult to say. o Rights deriving from the Articles, which form a contract between members (s 33 CA 2006) are particularly important. Rights recognised as personal in case-law include rights: o to have vote counted ie included (Pender v Lushington (1877) 6 Ch D 70); o to have dividend paid in cash if specified in Articles (Wood v Odessa Waterworks (1889) 42 Ch D 636); o to have a particular procedure followed (Edwards v Halliwell). Rights not so recognised include rights: o to have accounts prepared in accordance with CA (Devlin v Slough Estates Limited [1983] BCLC 497); o to have directors retire in rotation as provided by Articles (Mozley v Alston (1847) 41 ER 833; o to recover damages because company has suffered loss (Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, at 222223). 2.

Illegality and Ultra Vires

Two categories: a) act is illegal, therefore ultra vires; b) act is not illegal, just ultra vires. Act is Illegal, Therefore ultra vires

Smith v Croft (No 2) [1988] Ch 114 Facts The company provided financial assistance to a purchaser of shares to buy shares in itself. This was then illegal under company legislation and therefore also ultra vires. Held An individual shareholder could bring a personal action to restrain the company from so acting because it infringed his personal right to have the business conducted in accordance with the Constitution. Act is ‘pure’ ultra vires o But note CA 2006, s 40(4): ‘[no ultra vires] proceedings lie in respect of an act to be done in fulfilment of a legal obligation arising from a previous act of the company.’ o General meetings can ratify ultra vires act: CA 2006, s 239. 3. Special Majority Required and Not Obtained, or Non-compliance with a Special Procedure o Where the matter in issue requires the sanction of a special majority or there has been non-compliance with a special procedure. o If the approval of a special majority of members is required but not obtained, then a minority shareholder will have the right to sue the company. Edwards v Halliwell Facts Trade union (same principles apply). Meeting of delegates tried to in crease members’ subscriptions. Such a resolution required a two-thirds majority of members and this was not obtained. Two members (a minority) asked the court for a declaration that the resolution was invalid. Held The resolution was invalid, otherwise the company would be in breach of the company’s own regulations and could ignore them at will. NB It is the company which has done something wrong rather than be wronged, so is governed by principles other than principles applied in the rule in Foss v Harbottle, therefore this is not an exception to the rule. See also Quin and Axtens Limited v Salomon [1909] AC 442 Facts Consent of both managing directors needed for some transactions. One director refused to give consent for transaction; shareholders tried to authorise transaction. Held Not possible to do this. Shareholder granted an injunction prohibiting the majority’s action.

IV. A Derivative Claim (Part 11, ss 260-264 CA 2006 which came into force on 1st October, 2007) o New statutory right based on derivative actions developed by common law o A derivative action was a claim which a shareholder ‘derived’ from the company. It enabled him to bring an action in his own name against someone (usually but not necessarily, a director) who had done a wrong to the company. The claimant joined in the company as a third party and if the claim was successful it was the company which received the monies payable pursuant to the judgement o In a derivative action a shareholder had to prove ‘fraud on the minority’ and to show that the alleged wrongdoers were in control. Difficult to prove and there was little judicial guidance as to what the courts took into consideration in deciding the cases o Derivative actions were limited in scope and excluded for example the right to bring such an action in respect of a director’s negligence if it had not benefited the director personally see Palvides v Jensen [1956] 2 All ER 518) o Current statutory derivative claim is still a claim which a shareholder ‘derives’ from the company. It still enables him to bring an action in his own name against someone (usually but not necessarily, a director) who has done a wrong to the company o BUT it is no longer necessary to show ‘fraud on the minority’ and to show that the alleged wrongdoers were in control. Statutory provisions clearly set out the grounds for any claim which has been widened to include eg negligent acts of directors even when there has been no personal benefit to such director o The claimant still has to join in the company as a third party and as before, if the claim is successful it is the company which receives the monies payable pursuant to the judgement claim o Statutory provisions set out situations where courts must not give permission for a derivative claim to be bought as well as matters they will consider in all other cases o Expected to become commoner in its statutory re-incarnation but concerns about ‘opening the floodgates of litigation’ and acting as a deterrent to potential directors have not materialised o To what extent will the old law remain relevant? See Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch) (also a useful use generally as a demonstration of the way in which the new provisions work – see also Bridge v Daley [2015] EWHC 2121 (Ch), [2015] All ER (D) 97 (Aug)). See also Universal Project Management Services Limited v Fort Gilkicker Limited [2013] EWHC 348 (Ch) (common law ‘multiple derivative actions’, ie in which a member of holding

company can sue if the wrong takes place at the subsidiary level) not abolished. o Note s 260 (2): a derivative claim may also be sought and granted in unfair prejudice proceedings. 1.

Grounds for the claim (initiated by claimant shareholder) o Grounds for derivative claim are ‘an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.’ (s 260(3)): o Claim against whom? - ‘The cause of action may be against the director or another person (or both).’ (s 260(3)). Unlikely to bring an action against someone other than a director (‘director’ includes former director and shadow director, s 260(5)).

o Who may bring the claim? - any member who can bring proceedings in respect of wrongs committed even before he/she became a member (s 260(4)). NB 1: a member may, with permission of the court, continue a derivative claim started by another member (s 264). NB 2: a member may, with the permission of the court, continue a derivative action started by the company (s 262) 2.

Costs o Since the claimant, ie the shareholder, brings the claim he is prima facie responsible for costs. But the court has the power to make a pre-emptive order requiring the company to indemnify the claimant’s costs (Civil Procedure Rules 1998 r 19.9(7) derived from the decision made in Wallersteiner v Moir (No 2) [1975] QB 373).

3.

Procedure o Claimant must show prima facie case for permission to be given (s 261). Other criteria (not related to prima facie case) set out in s 263. o If no prima facie case made to court the court must dismiss the application (s 261(2)) o See s 263 for guidance which states that permission must be refused if the court is satisfied— (a) that a person acting in accordance with section 172 (duty to promote the success of the company) would not seek to continue the claim, or (b) where the cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorised by the company, or

(c) where the cause of action arises from an act or omission that has already occurred, that the act or omission— (i) was authorised by the company before it occurred, or (ii) has been ratified by the company since it occurred (s 263(2)) o In all other cases in considering whether to give permission the court must take into account, in particular (ie may consider other factors); (a) whether the member is acting in good faith in seeking to continue the claim; (b) the importance that a person acting in accordance with section 172 (duty to promote the success of the company) would attach to continuing it; (c) where the cause of action results from an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be— (i) authorised by the company before it occurs, or (ii) ratified by the company after it occurs (d) where the cause of action arises from an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company; (e)

whether the company has decided not to pursue the claim; (f) whether the act or omission in respect of which the claim is bought gives rise to a cause of action that the member could pursue in his own right rather than on behalf of the company (see (a)-(f) s 263(3))

Note: ‘In considering whether to give permission the court shall have particular regard to any evidence before it as to the views of members of the company who have no personal interest, direct or indirect, in the matter’. (s 263 (4)) A good example is Zavahir & anor v Shankleman & ors [2016] EWHC 2772 (Ch) 4. Application for permission to continue a claim bought by a company, as a derivative claim (s 262) o Applies where a company has bought a claim, the cause of action of which could be pursued as a statutory derivative claim; AND -The manner in which the company commenced or continued the action amounts to an abuse of the process of the court; OR -The company has failed to prosecute the claim diligently (s 262(2)) o Then provided the court is of the opinion that it is appropriate for the member to continue the action as a derivative claim then it may do so following the usual procedure ie by proving a prima facie case

5. Application for permission to continue a derivative claim bought by another member (s 264) o If a member has already commenced a derivative claim or taken over from the company an action in respect of a wrong done to the company, AND the same criteria in s 262(2) (in respect of taking over a company’s claim) are met o Then if a prima facie case can be made claim may be continued by another member

V. Cl ai msf orReflect i veLoss Where a wrong results in a loss to the company but the only alleged loss to the shareholder is a reduction in the value in his shares (ie a reflected loss only) then the courts will not permit an action by the shareholder against the company or the person who has done the wrong to the company. Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 at 219, CA; Stein v Blake (No.2) [1998] 1 All ER 724.

VI . Repr esent at i veAct i ons( Gr oupLi t i gat i on)( f ori nf or mat i onpur posesonl y) A shareholder can bring an action on behalf of not only himself but others who have the same right which has allegedly been ‘abused’ (usually where class rights have been ‘abused’). Avoids multiplicity of suits. Benefit of an award goes to all claimants....