Protecting the Interest of Minority Shareholders

In the day-to-day working of a company, certain decisions need to be taken regarding the management of the company and these decisions are generally taken by the majority members. In this process of decision-making, there may arise certain occasions wherein the interests of the majority shareholders may come in conflict with that of the minority shareholders. In such a case, if the decisions taken, are not in the larger interest of the company as a whole, but only caters to the interest of one particular group, the minority group whose interest may have been violated can raise its voice against such an action.

The protection of minority shareholders within the domain of corporate activity constitutes one of the most difficult problems facing modern company law. The aim must be to strike a balance between the effective control of the company and the interest of the small individual shareholders. [1] Palmer has stated with respect to rights of shareholders:

“A proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of the company.” [2]

It is only right to expect that in matters of a company, any decisions that are taken are done so in keeping with principles of natural justice and fair play. In case of failure to do so, it is important that the interest of minority shareholders be protected. In the present research paper, the objective of the researcher is to look into the subject of the protection of the interest of minority shareholders. In course of doing so, the researcher shall first examine the rule regarding majority shareholders’ rights in detail that has been laid down by landmark judgments under Common Law. The researcher will then look into the rule regarding the minority rights and the exceptions to the majority rule. The researcher shall also examine the statutory protection that the minority shareholders have under the Indian Companies Act of 1956.

RULE OF MAJORITY: FOSS v. HARBOTTLE

The basic principle relating to the administration of the affairs of a company is that “the courts will not, in general, intervene at the instance of shareholders in matters of internal administration; and will not interfere with the powers conferred on them under the articles of the company”. [3] This is mainly the underlying principle governing the rule of majority. The rule of company governing by majority and ‘supremacy of majority’ has been settled in the very old landmark common law judgment of Foss v. Harbottle [4] .

In the instant case, an action was brought by two shareholders of a company for the illegal transactions made by the directors and solicitors, whereby the property of the company was misapplied and wasted. The plaintiffs pleaded that the losses caused thereafter to the company be made good by the defendants. In ruling over the case, the Court opined that such an action cannot be brought by minority shareholders. The claim was rejected in respect of those transactions which a majority of the shareholders of the company had the power to confirm or ratify. Thus, an action, if any, can be brought in only by the company, as company is the proper plaintiff for wrongs done to the company. [5] Since the company acts through majority, the majority should have the power to decide whether to initiate proceedings against the directors or not.

In other words, the opinion of the Court was as follows:

“The conduct with which the defendants are charged is an injury not to the plaintiffs exclusively, it is an injury to the whole corporation. In such cases the rule is that the corporation should sue in its own name and in its corporate character. It is not a matter of course for any individual members of a corporation thus to assume to themselves the right of suing in the name if the corporation. In law the corporation and the aggregate of members of the corporation are not the same the thing for purposes like this.” [6]

The justification for the rule is the need to preserve the right of the persons who can exercise a majority of the voting rights at a general meeting of the company to decide how the company’s affairs shall be conducted and the ineffectiveness of any attempt by the court to interfere when its decision could be set aside by a later converse resolution passed by the controlling votes of those persons. [7]

Reiterating this principle in MacDougall v. Gardiner [8] , Mellish LJ stated:

“In my opinion, if the thing complained is a thing which, in substance, the majority of the company are entitled to do, or something has been done irregularly which the majority of the company are entitled to do regularly, or if something has been done illegally which the majority of the company are entitled to do legally, there can be no use 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.” [9]

The rule laid down in these cases has also been applied in the Indian context in various cases. In Rajahmundry Electric Supply Corporation v. A. Nageshwara Rao [10] , the Supreme Court ruled that the courts in general will not intervene at the instance of shareholders in the matters of internal administration and management of the company by the directors so long as they act within the powers bestowed on them by the articles of the Company. Also, if the directors enjoy the support of the majority shareholders, the minority shareholders cannot do anything about it. Furthermore, in the case of, Bagree Cereals v. Hanuman Prasad Bagri [11] , Foss v. Harbottle was re-traced and reiterated.

Therefore, summarising ‘the majority rule’ governing decision-making among shareholders of a company, it is important to understand that a company is a legal person separate from its members. Although its members invest in the company, and so have a stake in it, the law does not recognise that they have even an insurable interest in its assets. If therefore, the company’s property is misappropriated or lost or if its affairs are mismanaged, the company alone is the person who should bring legal proceedings against those who have caused it damage. [12] If an individual shareholder seeks to bring such a complaint, he should do so by bringing it before a general meeting and persuade other shareholders to adopt the course of action he thus proposes. [13]

LIMITS OR EXCEPTIONS TO ‘THE MAJORITY RULE’

Even though the courts have largely ruled in favour of the majority rule, there are certain situations however, wherein this rule may not be applicable. The rule laid down in Foss v. Harbottle extends to cases where the corporations are competent to ratify managerial sins. Exceptional cases however, may exist where no majority shareholders can approve or affirm. In such cases every shareholder may sue to enforce obligations owed to the company. [14] Herein, the shareholder becomes a representative of the “corporate interest”. Following are the exceptions to the rule of majority:

Acts ultra vires – A shareholder can bring an action against the company in matters which are ‘ultra vires’ and which no majority shareholders can sanction. The rule from Foss v. Harbottle is not applicable in cases where the company exceeds its powers. This was seen in the case of Bharat Insurance Co. Ltd v. Kanhaiya Lal [15] , where the plaintiff, who was a shareholder of a respondent company, complained about several investments being made by the company without adequate security, which was contrary to the memorandum and therefore, seeked a permanent injunction against the company making any such further investments. The court ruling for the plaintiff said that even though in matters of internal management, the company was the best judge and the rule was that the court should not interfere, application of assets of a company was not merely a matter of internal management. In the instant case, the company directors were acting ultra vires and therefore, a single shareholder was eligible to bring an action against the company.

It is important to note however, that the plaintiff’s own conduct should be right when suing the company. In the event of a minority shareholder suing the company, there is the question of procedural device, and therefore for the sake of doing justice to the company which is being controlled by miscreant directors, the court may step in to verify whether the plaintiff is the proper person to sue the company. If the plaintiff’s conduct may jeopardise equitable relief from being meted out to the company or if there is an undue delay in bringing an action, the court may refuse to accept the plaintiff’s action.

Fraud on minority – A majority carrying out a fraud on the minority is also an exception to the majority rule. The meaning of “fraud” has not been clearly defined beyond a discriminatory action, but in the case of Greehalgh v. Arderone Cinemas Ltd [16] , it was laid down that:

“a special resolution would be liable to be impeached if the effect of it were to discriminate between the majority shareholders and minority shareholders, so as to give to the former an advantage of which the latter were deprived.” [17]

This concept has been best explained in Menier v. Hooper’s Telegraph Works [18] , wherein there were two companies A and B, with the majority of the members of company A also being members of company B. Now, company A commenced an action against company B and at a meeting of company A, the majority passed a resolution that was ultimately favourable to company B and not to company A. When the minority initiated an action, the impugned resolution was held invalid. The court ruled that the majority putting something in their pockets at the expense of the minority would be “a shocking thing”. [19] The rule subsequent to this case is that the court may interfere to protect the minority where the majority of a company propose to benefit themselves at the expense of the minority. This principle was reiterated in Cook v. Deeks. [20] The majority cannot appropriate either the property of the company or the interest of the minority shareholders, which includes appropriating property to another company where majority shareholders are in control and passing resolution for compulsory acquisition of shares of minority shareholders, respectively. [21]

Acts requiring special majority – Certain acts call for passing of a special resolution (i.e. at least 75% majority) at a general meeting of shareholders. In such a case, if the majority purport to do any act by merely passing an ordinary resolution or do not pass a special resolution in keeping with the law, the majority cannot enforce their decision on others and any member may bring an action restraining the majority. The reasoning behind this is that if such an act is permitted, the statutory requirement of 75% majority is defeated.

Wrongdoers in control – If wrong doers to the company are in control of the company, they will certainly not allow the company to file an action against such wrong doers. [22] To safeguard the interest of the minority or the company in such cases, any member may bring an action in the name of a company. For example, if a company was controlled equally by two defendants and plaintiffs, and an action arose against the defendants for fraudulent conversion of the company’s assets, the plaintiffs could bring an action on behalf of the company even though the defendants had the control to prevent an action against them. The underlying principle being followed is that “control” no longer necessarily means the ‘majority power’. Otherwise, the majority by virtue of its position could easily manipulate the situation and avoid any action brought against it by the company.

Individual Membership rights – Every shareholder has vested in him certain “individual membership rights” against the company [23] , some of which are vested in him by the Indian Companies Act itself. The majority rule finds applicability only in cases of rights of the company or wrong against the company and not with respect to personal rights of the shareholder.

OPPRESSION AND MISMANAGEMENT

A special mention should be made of Sections 397 and 398 of the Indian Companies Act, contained in Chapter VI, which provide for safeguards against oppression and mismanagement of the minority, respectively. [24] For an application to be made under either of the above sections, the requisition is given under Section 399.

With respect to oppression, the prejudicial matters should be such that it would be just and equitable to wind up the company, but that in turn would be unfair to certain members. In such cases, once the consent of the requisite number of members is obtained, an application may be made by one or more of the members on behalf of the rest. However, if some members eventually withdraw their consent to the application, it does not render the right of the other’s to proceed with the application. [25] Also, if some of the applicants transfer their shares and cease to be shareholders of the company, the petition does not lose its maintainability. All material facts should be set out in the petition itself. [26] Allegations of fraud, mala fide, etc. must be supported with particulars as no subsequent supporting facts can be brought in. It should be kept in mind that, a purchaser of shares who has not yet been registered may not be allowed relief against oppression. A person whose name is not borne out by the company’s register of members has no locus standi to say that a wrong has been done to his company. [27]

Earlier, if a case of oppression was established, the only remedy available was a winding up order. But after enactment of Section 397, if a case of oppression is established, then the Company Law Board, with a view to bringing to an end the matters complained of, is free to make an order as it thinks fit.

In case of mismanagement, under Section 398, the affairs of the company should be conducted in a prejudicial manner, or a change in the management of the company, should lead to lead to the affairs of the company being conducted in that manner. The Company Law Board in this case too, is free to make an order as it deems fit, to bring to an end the matter complained of. There should be present and continuing mismanagement as this section does not find retrospective applicability. Relief against mismanagement is provided to the company and not to an individual member. Moreover, it is not imperative for the court to find cause for winding up in cases of mismanagement to grant relief. [28] Proof of prejudice to either the public or the company’s interest is enough.

STATUTORY RIGHTS OF MINORITY SHAREHOLDERS

A dissatisfied minority shareholder has three general statutory remedies against mismanagement or unfairness on part of those who control the company [29] under the amended Companies Act of 1985. These are as follows:

Firstly, it gives minority shareholders a special remedy in situations where they have bee treated unfairly and harmfully. [30]

Secondly, minority shareholders are permitted to enforce certain claims of the company free from the restrictions imposed by the rule of majority when the company is wound up.

Lastly, the minority shareholders are permitted to obtain remedies indirectly through an investigation of the company’s affairs by the inspectors appointed by the Secretary of State for Trade and Industry, who may follow up the inspector’s report by taking remedial action. [31]

With respect to unfair treatment, an aggrieved member can present a relief petition to any court, (in practice, all petitions are presented to the Companies Court) [32] , which can order for the winding up of the company, on the ground of conduct that has proved to be unfair and prejudicial to the interest of the members in general or a minority of the members, including the petitioner.

In the second case, of winding up of a company, an application may be made to the court by the official receiver, the liquidator or by any creditor of the company or with leave of the court, by any present or past member of the company, for an order against any present or past officer of the company, any person who has acted as a liquidator, administrator or administrative receiver of the company or any other person who has been concerned or taken part in the promotion, formation or management of the company, and who in the case of any such person has misapplied or retained or become accountable for any money or property of the company, or has been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company. [33]

Finally, under the third remedy available to the minority shareholders, the Secretary for Trade and Industry may appoint one or more inspectors to investigate the affairs of the company. The Secretary of State has the freedom to appoint inspectors under any of the available grounds of appointment without having to specify which of the ground has been relied on. Moreover, he is under no obligation to disclose the evidence or information that initiated the investigations or the reasons for ordering the investigations.

With these statutory rights, the minority has been given more power than before to seek remedy for any violation of their rights by the majority. The minority can now seek redressal form the court for any violation of their rights and are duly protected under the laws governing the functioning of companies.

CONCLUSION

The rule concerning protection of minority shareholder’s interest has evolved through a long process since the majority rule was laid down in Foss v. Harbottle under common law. From the rule that minority or a single shareholder may not seek any relief for a right violation, we have seen the various exceptions to the majority rule that have been developed through the various case laws over the years. The rule stands changed now and therefore, minority rights are finally protected under the law. In fact, in ICICI v. Parasrampuria Synthetic Ltd. [34] , the courts ruled that the rule in Foss v. Harbottle cannot be applied mechanically in India. The courts taking in consideration, the fact that financial institutions provide huge finances to the company, though their share-holding may be small, ruled that they should be given a say in the matters of the company. In such a situation applying the majority rule would be unjust and impracticable.

The majority rule was applicable in India from 1843-1956. After the enactment of the Indian Companies Act, minority was given certain protections, which included protection against oppression and mismanagement, as we have already discussed. On a closing note, it is interesting to know, that in England, the law has changed drastically since 1980. Now, in case of oppression, the minority need not prove actual oppression but it is sufficient to show unfair prejudice. This is not the prevalent practice in India, however, it would be useful amendment to bring about to further the cause of protection of interest of minority shareholders.