Problems faced by Minority Shareholders

1) Introduction

A minority shareholder is defined as a shareholder who does not exert control over a company. The majority shareholders almost always exert an absolute control over the company, its management, its board of directors, and so on. But there are many companies that are controlled by shareholders who own only 40 percent, 30 percent, 20 percent, or less of the shares, and whom however exert full control over the company, as the remainder of the shares are scattered among a large number of shareholders, with every one of them having a minimal percentage being unable to gather a number of shares which is similar to those of the majority shareholders. In this event, all minority shareholders who are scattered, although together they could control even 80 percent of the shares, are defined as minority shareholders, as every one of them is a minority shareholder, and they cannot assemble enough votes to act as majority shareholders.

The definition of minority shareholders will be therefore shareholders who do not exert control over the board of directors of the companies, even if together they own the majority of shares, and the majority shareholders are defined as those who control the board of directors of companies, even if effectively they own much less than the majority of the shares.

2) Problems Faced By the Minority Shareholders

The origin of the abuse of minority shareholders comes mainly from the greed of some of the majority shareholders, who in some cases has no limit. Those majority shareholders believe that they can do anything, risk more and more, since they find themselves unpunished, while remaining within the very large margins of the law. This is why it is needed to examine in depth the legal protection of those minority shareholders and its efficiency, in order to verify if the law suffices for their protection, or if the minority shareholders need an ethical protection, which has a much wider scope. There are two related principles, known as the rule in Foss v Harbottle, which are the bases of the law relating to the ability of a shareholder to carry out proceedings on behalf of his company. One of the two principles is that where a wrong has been done to a company only the company, not individual members, can take action and is referred to as the “proper plaintiff” principle. A breach of duty is a wrong to the company and therefore as a general rule, the remedy for it lies with the company not with the individual shareholders. The second principle is that the will of the majority of the members of the company should in general prevail in the running of its business. This is known as the “majority rule” principle. If a majority does not want to take action, for example, because the wrong doing director(s) gets the majority of votes, a minority of shareholders must show that the facts fall within an exception to the rule. In Foss v Harbottle. The exceptions are rigid. The law in this field is complex and obscure, and this may well deter minority shareholders from bringing such proceedings. The attempt to provide an alternative procedure for minority shareholders’ actions by statute has not been successful. Other common law jurisdictions have recently introduced or considered the introduction of a statutory derivative action. Accordingly, the first problem on which this essay concentrates is the law relating to actions by minority shareholders on behalf of their company.

(Ref: The Law Commission Of Uk Shareholder Remedies, Page 9)

The main problem on which focus in this essay is required on the effectiveness of the treatment which is most commonly used by minority shareholders to get some personal treatment in wake of breaches of directors’ duties, or of other inadequate conduct of company business. This is the remedy for unfairly prejudicial conduct, to be found in sections 459-461 of the Companies Act 1985(Repealed Act). These sections provide remedies for types of conduct which sometimes cannot be remedied in any other way. Such conduct occurs most frequently in smaller companies in which most of the members are involved in management. An example of such conduct is the exclusion from management of one of the owner-managers by the others. These sections provide personal remedies, such as an order that a party’s shares should be bought by other shareholders or by the company. This remedy is particularly needed by shareholders in companies in which there is no market for the shares. However, proceedings for relief from unfair prejudice often entail complex factual investigation and result in costly and cumbersome litigation, which is particularly detrimental to smaller companies.

3) Why Minority Shareholders Seeking Remedies.

There are several laws of wrong doing to minority shareholders in unethical companies some of them are

1 – In unethical companies, the minority shareholders will always lose in the long run.

2 – Unethical managers tend to work on the verge of the law, finding loopholes, and getting the legal advice of the best lawyers, in cases of wrongdoing to the minority shareholders.

3 – Boards of Directors and executives of companies tend to safeguard primarily the interests of the majority or controlling shareholders, who have appointed and remunerate them.

4 – Independent Directors, who are appointed by the executives, decisions of their committees, and fairness opinions that they order, are in many cases unreliable to minority shareholders, as they tend to comply with the opinions of the majority shareholders.

5 – Auditors, underwriters, analysts, investment bankers, and consultants are loyal primarily to the executives who remunerate them, and the minority shareholders should be cautious with their reports and recommendations.

6 – When examining the reports of analysts and their ‘buy’ suggestions on companies, one should bear in mind what are the interests of the analysts, if they own shares of the companies, and what is their success record until now.

7 – The legal system does not safeguard in most of the cases the rights of the minority shareholders, who cannot fight on equal terms with the companies that are assisted by the best lawyers, and have much more time and resources.

8 – Companies tend sometimes to accommodate large institutions, which were wronged as minority shareholders, mainly by indirect compensation.

9 – The SEC is in many cases a panacea that is indifferent to wrongdoing to minority shareholders and to creative accounting.

10 – Society does not ostracize unethical managers and believes that ethics should be confined to the observance of the laws.

(Ref: Business Ethics, the Ethical Revolution of Minority shareholders by Jacques Cory 2005 page No. 142)

4) The rule in Foss v Harbottle

“The rule in Foss v Harbottle (1843) 2 Hare 461 provides, in essence, that, if a wrong is done to a company, then it is the company who is the proper party to bring an action. The rule is designed to avoid shareholders bringing a multiplicity of actions. However, its application may lead to injustice where the company is controlled by the wrongdoers, since it would be they who would determine whether proceedings ought to be brought. Accordingly, a number of exceptions have been established to the rule where a minority shareholder is able to bring an action on behalf of the company:

• where the act is beyond the objects of the company or is illegal;

• where the matter is one which could only be validly done by a special majority of members (in other words, the matter cannot be ratified by means of an ordinary resolution);

• where the member has a personal right, for example, a claim based on enforcement of the articles pursuant to s 14 In this case, the action would be brought by the shareholder in his personal capacity and not on behalf of the company. The shareholder must be able to demonstrate direct personal loss and not merely a general loss to the company which all shareholders suffer; where the act amounts to a fraud on the minority. In order to use this exception, the shareholder must be able to demonstrate: some form of equitable fraud, such as expropriation of the company’s property or even negligence by a director, will suffice, but only where he profits from such negligence that the wrongdoers are in control of the company – In practice, this exception is of very limited use for minority shareholders, since the amount of time and expense required in order to establish their locus standi to bring an action on behalf of the company is often disproportionate to the remedy actually achieved. In any event, any damages awarded go to the company rather than the individual shareholder, since the action is brought by the shareholder on behalf of the company”.

5) Rights of minority shareholder as per Company law

A majority shareholder is not totally important. The Companies Acts have always limited requirements giving a minority shareholder power to restrain the excesses of the majority. However, generally they were few times used against a majority shareholder who was determined to implement his plans. In these conditions, the minority shareholder will need to go to the Court for safety and relief.

Ref: (Private Company Law by Mark Stamp chapter 12 page 107)

6) Section 994. Petition by company member

(1) A member of a company can go to the court by petition for an order under the following grounds-

• that the company’s matters are being or have been handled in a manner that is prejudicial to the benefits of members generally or some fraction of its members (including himself), or
• that an actual or planned act or error of the company (including an act or omission on its behalf) is or would be so prejudicial.

(2) The provisions of this Part affect to a person who is not a affiliate of a company but to which shares in the company have been moved or transmitted by actions of law as they pertinent to a affiliate of a company.

Ref: (UK Company Law 2006)

In term of this section this section is incorporated in to the Company Law to defend the shareholders’rights for an claim that the dealings of the company are being handled by the majority in a way unfairly prejudicial to the benefits of members generally, or to some fraction of its members (as well as the applicant). This could consist of breach of a legal agreement between the shareholders violate of fiduciary duty; breach of an impartial accord or understanding; or breach of quasi-partnership values. The assistance wanted is normally an order that the other shareholders buy the minority shareholding at fair price.

However, the Court has complete prudence and if the conditions warrant can even order the minority shareholder to buy the shares of the majority. The Court can give orders to change the undue prejudice that the minority shareholder has faced

(Ref: Charles Rulles, author John Skykes, January 2009 Minority shareholder and their rights)

Once unfair prejudice is established, the court has complete discretion as to remedy granted. In particular, court can give an order to regulate the behavior of the company, injunct the company from acting in a particular manner, authorise civil proceedings to be brought by or on behalf of the company or require the shares of any member of the company to be purchased (s 461). Whilst s 459 has traditionally been considered a remedy for minority shareholders, the court in Morris and Others v Hateley and Another [1999] 2 BCLC 171 noted that the wording of s 459 does not preclude an action by a majority shareholder, for example, where the shareholder’s voting rights do not accord with its shareholding. However, as a majority shareholder will generally have the power to pass any resolution to bring to an end a prejudicial state of affairs, the circumstances in which such a petition could succeed would be limited.

Ref: (Private Company Law by Mark Stamp chapter 12 page 121)

7) Reform history

“The Cohen Committee, as long ago as 1945, designed what was to become a statutory remedy against the oppression of minority shareholders in the form of section 210 of the Companies Act 1948. The Cohen Committee took the view that just and equitable winding up, though it might be kept in reserve, was usually inappropriate and the derivative action was frequently unavailable owing to the restrictive nature of the Foss v.Harbottle rule. Even in the current law these observations remain essentially true. It has been seen that the Law Commission has undertaken a major reform of the derivative action by creating a new statutory derivative remedy. In general, however, the courts in recent years have tended to adapt the unfair prejudice remedy to make it a more suitable remedy for aggrieved minority shareholders. It will be seen that this does not exclude resort to petitions seeking a “nal and equitable winding up, or indeed a petition which seeks at the outset to combine both remedies”.

Ref: (A.J Bolye Minority shareholders’remedies page 110 Cambridge studies in corporate law, 2004)

The Law Commission published its report on Shareholder Remedies. In it recommended law reform designed to make shareholder remedies more affordable and more appropriate in modern conditions. The focus of the Law Commission’s work in this area was exclusively on remedies available to a minority shareholder,

Who was dissatis”ed with the manner in which the company of which he is a member was run. This may be owing to a breach of duty by the directors; or because of the way in which the majority shareholders had used their voting power to cause the company to act in a manner that unfairly prejudiced the interests of the minority shareholder; or it may be that the requirements of the company’s constitution had not been properly complied with. The Law Commission find out two main problems on shareholders’ remedies: the “rst one was the obscurity and complexity of the law concerning to the capability of the shareholder to take measures on behalf of the company. He may wish to do so to implement accountability for a breach by one of the directors of his responsibilities to the company. Generally, it was for the company itself with the will of a majority of its members, to carry out any such proceedings, as this is the law in Foss v Harbottle. However, where the wrongdoing directors have power over the majority of the votes, they may avert legal proceedings being brought.

Although there were some exceptions to the rulings in Foss v Harbottle, the Law Commissions were of the view that the exceptions were rigid, old fashioned and unclear. The law was inaccessible and procedures lengthy and costly. The second main problem related to the efficiency and cost of the remedy that was commonly used by minority shareholders to get some personal treatment in the wake of the not good enough conduct of a company’s business. The remedy was provided in s 459–461 of the CA 1985. The remedy was often used where there was a breakdown in relations between the owner–managers of small private companies, and one of them was prevented from taking part in management. The dissatis”ed shareholder could obtain various reliefs but the most popular one was a court order requiring the majority shareholders to purchase his shares. The Law Commissions considered that proceedings under s 459 of the CA 1985 were costly and cumbersome. Many cases that went to trial often lasted weeks and the costs of litigation were substantial.The Law Commissions identi”ed three main shareholder remedies. First, the ‘unfair prejudice’ remedy, in which a member sought redress for action by the company that injures his interest as a member. Second, the derivative action, in which a member sought to enforce a claim belonging to his company. Third, action to enforce the company’s constitution, which included the extent to which a shareholder could insist on the affairs of the company being conducted in accordance with the Articles of Association.

The unfair prejudice remedy and the derivative action were specialist remedies, and the former was far more common in practice than the latter. The unfair prejudice remedy was most commonly used by private companies of which, as at 3 August 1997, there were some 1,080,671 in Great Britain. The Law Commissions recommended statutory and other changes to simplify the remedy, and help reduce its high cost to litigant and taxpayer alike. The derivative action was not common but it was an important mechanism of shareholder control of corporate wrongs. The current law was archaic. The Law Commission’s principal recommendation was for a new rule of court that would set out, in a modern and accessible form, the circumstances in which the courts would permit the derivative action to be brought. The underlying policy, which was restrictive of the circumstances in which a derivative action may be brought, would not be not affected. The Law Commission’s view was that prevention was better than cure. Litigation was time-consuming and costly. In order to minimise reliance on shareholder remedies, it was recommended that a new article should be added to Table A, which was the statutory model form of a company’s Articles of Association. This contained a basic dispute resolution mechanism, and would encourage shareholders in future to have pre-agreed routes to resolve disputes without litigation.

(Ref: A Guide to the Companies Act 2006 by Dr. Saleen Sheikh. Routledge-Cavendish 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN 2008)

(i) Reform to section 14 by clarification of the types of situations that may fall within the section;

In section 14 of a statutory list of personal rights enforceable under this section. It would be possible to provide a non-exhaustive list of the rights which the courts have to date allowed shareholders to enforce by personal action. The statute could indicate that the fact that these rights can be enforced by personal action does not mean that there are no others that can be enforced by the same means.

(ii) Other reforms relating to proceedings under sections 459-461 ( New 994), namely:

- (a) Clarification of section 459 by authoritative guidance;

- (b) Amendment of section 459 to impose a limitation period on claims under the section;

- (c) Amendment of section 459 to make it clear that it is specific conduct, rather than the affairs of the company overall, that has to be shown to be unfairly prejudicial;

- (d) Amendment of section 459 to ensure that “unfair prejudice” is construed as broadly as appears to have been intended by the Jenkins Committee;

- (e) Amendment to add winding up to the remedies available under section 461;

- (f) Extension of the power to determine relief as between respondents to a section 459 petition;

(iii) Permitting former members to bring proceedings;

(iv) Pre-action discovery.

(Ref: THE LAW COMMISSION SHAREHOLDER REMEDIES, UK Page 119)