Company Law Case Study : Foss V. Harbottles

Author’s article involves principles of company law which emerged through Foss v. Harbottles

in which some principles were laid down by the Court of England. Issues before the court were: -

v That if the majority of share- holders have decided to act in a particular way, and then can minority share- holder oppose the decision of majority?

v Which acts of majority can be brought under the sphere of litigation?

v Whether the minority has the right to sue the company?

v Is it valid that even if a resolution which has been ratified by the majority should be left open for the minority to challenge it?

v If minority is allowed what impact it would have on the business of company?

v Will such litigation not lower down the credentials of that company in the market?

Court observed that yes, the minority will have the right to sue the majority but: -

• Minority will have to prove that the majority has done an act which is “Ultra Vires” according to the AOA or MOA of a company.
• Or that the majority has played fraud on minority.
• And purpose of such litigation is the interest of company first and then the individual interest of a share- holder.
• But, if litigation is brought before the court just for the purpose of harassing the company then Courts will not interfere.
• Court will differentiate between the day to day management and internal affairs of company. Court will hesitate to interfere in both the cases and will ensure that the acts of company should not be voilative of company law.

Court has made this right to sue a company subject to various qualifications. Earlier these restrictions were under S.35 of Companies Act, 1985 of England but, now it is under S.35 of new Companies Act of 1989.

Concept of control by majority in AGM’s has changed over a period of time. Taking the decision to litigate is very tough one and if it is decided that no litigation is to be done then in that case it does not mean that company is laxed towards its directors. Sometimes decision to litigate against the company is beneficial for company. In such a case court will not hesitate to look into the matter.

English courts have taken very rigid views in this regard and they have laid down rules to determine, who is the appropriate person to take decision of litigation on behalf of company? And in response to this problem they have replied that it is the B.O.D who will decide or share- holders collectively who will decide it. But, this lead to a problem that minority can be suppressed by the majority. And majority will ratify the acts that are beyond the scope of company law and will be protected also as they are only the decision makers that whether the company is to be sued or not for its irregularities? And obviously they will not act in a way that is detrimental to their interest.

J. Knox in the case of Smith v. Escort’s further tightened the position by observing
“it may so happen one time that share- holders in minority decide not to litigate against the company then in that case even if one of share- holder is aggrieved and wishes to litigate against the company then in that case, no suit can be filed against the company”. Then for some period of time rules favored in preserving the collective nature of corporate decision making instead of enforcement of directors duties.

So, the Law Commission review of England thought of reviewing company law. Law Commission Review suggested that stress should be on illegality and not irregularity. And these irregularities should not be brought before the court unless the other local remedies are exhausted by the aggrieved person.

If an litigation is brought before the court without exhausting local remedies then, in such a case court would direct that meeting is to be carried out and after that wrong has been ratified then case can be brought before court. But, if the AOA or MOA of company gives power to share- holder to directly come to the court then the court will not say the aggrieved to exhaust the local remedied first.

But, if one share- holder sues to enforce his/ her own rights then in that case relief sought must be consonant with rights. Right to sue company is provided not only in AOA of company but also outside the ambit of AOA.

Before 1989, “Ultra Vires” acts could not be ratified at all. But, after companies act of 1989 wrong could be amended but by a special resolution passed by special majority.

If there are chances of “fraud on minority” then a case can be brought before court and this fraud committed by company on share- holders will make the company and its directors criminally liable and will be made liable.

Law Commission Review (LCR) suggested that a member should be able to bring and subsequently maintain a derivative action to enforce any cause of action vested in company against any person arising out of any breach or threatened breach of duty of director. Ratification of a resolution can not be used as a bar to litigate against the company. But, LCR suggested that company should not be brought to a situation of litigation without a good cause and should not be killed by kindness. It was made discretionary for the court whether any particular piece of derivative litigation is allowed to be proceeding ahead or not?

LCR further recommended that court has to consider the following things in a case while company litigation is brought before the court: -

ü Strength in a case.

ü Applicant’s good faith.

ü Interest of company.

ü Whether wrong interest was ratifiable or not?

ü Whether wrong interest has been ratified or not?

ü Views of independent organs of company.

ü Courts discretion to entertain case or not?

Foss case stressed on “Inhouse Management” in which company was to decide whether there should be litigation against the company or not? But, LCR recommended an “outdoor management remedy” in form of Courts. It was made clear in Foss case that liability of directors is not towards share- holders but, towards the company.

After suggestion of Jenkins Committee u/ S.459 of Companies Act, 1989 it is clear that wrong done to company may also bring a wrong to the interest of its members. Their can be a wrong done to the company or its members directly and which may in turn effect the company’s share- holders. Or majority uses its power to avoid the litigation against company by minority. It is a wrong done to minority and it is called as unfair prejudice remedy.

Unfair prejudice remedy means: an unlawful act, which is an indirect wrong done to company and its share- holders. There can be an informal agreement/ arrangement amongst members to run company. Consequence of such an agreement is that no power is left to court to scrutinize conduct of company controllers on basis of unfairness.

Court has made it very clear that court will not interfere in the ordinary majority decision as court is not there to take management decisions. Court further observed that until the problem of a share- holder is not solved by controller’s court will not interfere

Facts: - It was concerned with Park Land in Moss side, Manchester, which was the then leafy suburb of the city. Businessmen, in the city had grouped together to purchase land dedicate it to the then heiress to the throne, Princess Victoria. Park opened to great rejoicing. But, soon it was followed by difficulties. Two minority share- holders initiated legal proceedings against, among others, the directors of the company. They claimed that the directors had misappropriated the companies’ assets. It was alleged that the directors had sold land at an exorbitant price to company, out of the monies of company, for a price exceeding the value of land.

Judge observed: - the Victoria park company is an incorporated corporation, and the conduct with which the defendants are charged in this suits are injury not to the plaintiffs exclusively; it is an injury to the whole corporation by individuals whom the corporation entrusted with powers to be exercised only for the good of corporation. This conduct of Directors is a wrong done to company and only company can sue. This principle was applied in the case of Mc Dougall v. Gardiner (1875)

The court dismissed their claim and held that when a company is wronged by its directors it is only the company that has standing to sue.

In effect the court established rules:

Ø First, the “proper plaintiff rule” in which an action in respect of a wrong alleged done to a company is prima facie the company itself.

Ø Secondly, the “majority rule principle”. It states that if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not intervene.

Ø Thirdly, a company is a separate entity from its share- holders.

Ø Fourthly, a company can’t function effectively unless “Will” of majority prevails. The rule was later extended to cover cases where what is complained of is some internal irregularity in the operation of the company. However, the internal-irregularity must be capable of being confirmed by the majority.

Because Foss v Harbottles leaves the minority in an unprotected position, exceptions have arisen and statutory provisions have come into being which provide some protection for the minority. By far and away the most important protections are to be found in sections 459-461 of the Companies Act.

The rule in Foss v Harbottles has another important implication. A share- holder cannot generally bring a claim to recover any diminution in the value of his or her shares in circumstances where the diminution arises because the company has suffered an actionable loss. The proper course is for the company to bring the action and recoup the loss with the consequence that the value of the shares will be restored.

Impact of case was principally effecting minority share- holder’s actions. S. 459(1) is the most relevant sub-section for these purposes. It can be deduced from, that a minority share- holder is within the ambit of the section if he can show that the value of his shareholding in the company has been seriously diminished due to the conduct of persons in ‘de facto’ control of the company, which has been unfair to the member concerned. It must however affect or prejudice him.

Meaning of ‘unfairly- prejudicial conduct’ as defined by the courts includes: -

1. exclusion from management;
2. allotting shares in breach of pre-emption rights;
3. convening a meeting of the company for a date unreasonably into the distant future;
4. failure to pay proper dividends;
5. diverting business away from the company;
6. making a rights issue in certain circumstances;
7. providing misleading information to a company’s share-holders;
8. proposing to sell the company’s business at a substantial undervaluation to connected persons;
9. And using the company’s assets for the benefit of the company’s controlling share- holders and family.

Exceptions to Foss v. Harbottles have been brought by Judges through thread of justice. Through that fabric, over the years a number of exceptions to the Rule in Foss v Harbottles have developed. And exceptions are: -

a) Where the majority of Members commit a fraud on the minority;

b) Where the majority of Members have been negligent so as to benefit one of themselves;

c) To enforce AOA of Company;

d) And, in any other instance where justice so demands.

e) Special majority’s exception, If the majority by passes the required majority then individual share- holder can sue the company.

f) If the company denies the right of individuals which are set out in the Articles of company.

For Foss v. Harbottles leading British company law academic, Leonard Sealy, observed that, “the courts have made it very difficult, and in many cases impossible, for share- holders with grievances – sometimes, share- holders who are the victims of very real injustices – to obtain a legal remedy.”

Also Lord Justice Hoffman (1999) observed that, “the emancipation of minority share- holders is a recent event in company law. For most of the twentieth century minority share- holders were virtually defenceless, kept in cowed submission by a fire-breathing and possibly multiple-headed dragon called Foss vs. Harbottles. Only in exceptional cases could they claim protection of the court.”

He goes on to say: “A statutory remedy was provided for the first time in 1948 but this proved relatively ineffectual. It was not until 1980 that Parliament forged the sword which is now section 459 of the Companies Act 1985 and which enables the unfairly treated minority share- holder to slay the dragon.”

One Professor of England, named Prof. Sealey, once said for Foss v. Harbottles that even if Parliament provided a statutory remedy, the courts would reinvent just as effective way of saying “go away.”

If we do a comparative study on this point of law in different nations then law of “Singapore” has somewhat similar provision u/s. 216 A of Companies Act. And, it reads that: -

No action may be brought and no intervention in an action may be made under subsection (2) of S. 216 A of Companies Act unless the Court is satisfied that —

(a)    the complainant has given 14 days’ notice to the directors of the company of his intention to apply to the Court under subsection (2) if the directors of the company do not bring, diligently prosecute or defend or discontinue the action;

(b)    The complainant is acting in good faith; and

(c)   It appears to be prima facie in the interests of the company that the action be brought, prosecuted, defended or discontinued.

Similarly is the case with “Scotland” where four conditions are laid down under which a minority share- holder can approach court for remedy and the condition are: -

1) Firstly, any act that is Ultra Vires the company, either as prohibited by the memorandum or statute, or illegal, is incapable of being ratified by any majority.

2) Secondly, a “fraud on the minority” would relax the rule that a majority must approve litigation because, without this, the fraudulent parties could possibly prevent an action. This would apply, especially, to share- holder directors who abused their power and then ratify their acts.

3) The third category relates to someone having a personal right, as enforcement through the company is unnecessary. This will be a right that every share- holder is granted with ownership, such as the right to vote.

4) Finally, the “special minorities” exception. R.R.Drury stated that “the automatic barrier to suit has been set at the level of an ordinary majority of the general meeting.

“Under common Law” protection given to the minority share- holders are through: -

Ø Common Law.  The two main exceptions of common law include: -

A representative action i.e. where the claimant sues on behalf of himself and other members who have the same right that has been infringed.

And a derivative action i.e. where a member sues in order to enforce a company right

Ø And statutory remedies such as if any company member may now apply to the court for relief under s.459 Companies Act 1985 on the grounds that the company affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of the members generally or of some part of the members.

CHAPTER 4:- CONCLUSION

After giving a look to the remedies available in other countries let us conclude by concentrating on the remedies provided by Law of our land i.e. India. Remedy to the abovementioned is laid down u/ S. 397 of the Companies Act, 1956. As usual our law has been far ahead of the English Law. We provided these remedies as early as 1956, whereas the English had to amend their laws for three times one in 1948, other one in 1985, and finally in 1989.

Indian Companies Act, 1956 made a very strong basis of remedies, i.e. if there is an Oppression done against the minority from the side of company/ majority then, even one share- holder has a right to sue the company by applying to the board u/ S. 399. It can be done if the affairs of the company are carried out in the manner that is prejudicial to the public interest or in a manner oppressive to any member/ members.

Any member of company can apply to the Company Law Board u/s. 399on the ground that affairs of the company are conducted in a way that is prejudicial to the public interest. A member can give an application u/s. 399 for winding up of company as a “just and equitable remedy.” But, this application has to fulfill the conditions as laid down under the S.399 of companies act, 1956.

In the initial years of Act, SC did not show maturity and took the same view as was taken in the year 1843. And, observed in the case of Rajahmundry Electric Supply Co. v. Nageshwara Raothat “Courts will no, in general, intervene at the instance of share- holders in the matters of internal administration, and will not interfere with the management of the company by its directors as long as they are acting within the powers conferred on them under articles of the company. Moreover, if the directors are supported by the majority in what they do, the minority share- holders can, in genera, do nothing about it.”

Reason behind such an observation is a person can sue only if injury is caused by a breach of duty to him. Foss case applies only where the corporate right of an individual is violated.

Such a right of suing is provided to a person in the form of representative and derivative action. In derivative action individual member may bring an action to remedy a wrong done to his company or to compel his company to conduct its affairs in accordance with its constitution and rule of law governing it, even though the majority of his fellow members do not wish the action to be brought. And, the individual member sues to enforce a claim which belongs to company, and his right to sue is derived from it.

In representative action because it is brought on behalf himself and persons other than himself would go alongwith him to protect their legitimate corporate rights. Plaintiff is not an agent for the person/s on whose behalf he sues.

After discussing certain exceptions to Foss v. Harbottles (at pg. 6 and 7) let us discuss them thoroughly which have been decided by the “Courts”: -

Ultra Vires and illegal act of company – even the majority can not ratify an act which is ultra vires of company.

If the director has done a breach of fiduciary duty then every share- holder has a right to bring action against the director.

Landmark judgment of Edward v. Hill settled the position of law by observing that if the majority of company members use their power to defraud or oppress the minority then even a single share- holder has a right to get conduct of majority to be struck down.

If the minority has been given an insufficiently informative notice of a resolution to be proposed at annual general meeting, any member who does not attend the meeting, or votes against resolution, may bring a representative action to restrain the company and is directors from carrying the resolutions.

If an individual members right to vote, to receive dividends etc. entitles him to proceed against company as his personal right is violated by the company.

But, some exceptions of Foss v. Harbottles are provided in the form of “Statutory Rights” and they are: -

Ø If right of class share- holder, who has a share of class, and does not hold less than 10% shares of that class; his rights are varied by majority without his consent then, he can bring action against that company.

Ø S. 394 (1) reads that no compromise or arrangement in connection with amalgamation of a company which is being wound up shall be passed by the court unless the court is satisfied with the report of Company Law Board saying that the affairs of company are not being carried out in the manner that is prejudicial to the public interest.

Ø U/S. 397 and 399 of Companies Act, 1956 if the majority tries and uses its power with a view to suppress the majority then the minority can approach court to get its right enforced.

Ø U/ S. 395 if the take over bid took place and if certain members dissented to it then, those dissenting members have a right to apply tot the court saying that their shares should not be allowed to be acquired on the terms of scheme.

While concluding the article author would like to say that “majority rules is the principle” but, when majority goes beyond the power, as authorised by law and is acting against minority then, minority can bring action against majority.