Majority Rule Shareholders

In order to evaluate whether or not, the rights of minority shareholders have been improved by the enactment of the Companies Act 2006, it is essential to analyse the situation of minority shareholders prior its enactment and determine whether under the old common law, minority shareholders were given adequate protection.

The old common law position was based on the principle of the ‘Majority Rule’ laid down in Foss v Harbottle(1843). The majority rule stands for the proposition that the decisions and choices of the majority will always prevail over those of the minorities. In practice, the greater the amount of shareholding of an individual member, the greater rights and powers accrued to that individual member within the company. Thus it appears that a substantial amount of power has been placed in the hands of the majority shareholders and that by virtue of the majority rule, the minority shareholders are required to accept the decisions made by the majority shareholders. In such circumstances, the minority shareholder cannot ask for court intervention because Foss v Harbottle does not cater for minority members who complain of a wrong done to the company provided that the majority shareholders do not wish to take any action against the wrong committed. As a general principle laid down in Foss v Harbottle, where it is alleged that a wrong has been done to the company then proper claimant in such an action is the company itself and where the company is competent to settle the alleged wrong itself or, the company is competent to ratify or condone an irregularity by its own internal procedure, then no individual member may bring action.

Minority shareholders

A strict application of the general principle laid down in Foss v Harbottle appears to be harsh and unjust with regard to minority shareholders, as although a substantive right has been accrued to them, still they are barred from obtaining justice under the rule and have to submit to the wrongs done by the majority because at the end of the day it is the majority of the members that control the company and the minority members have no say due to their small strength of number. However, in order to mitigate this harshness, four exceptions to the general principle have been laid down:

The first exception is where the alleged act is ultra vires or illegal. The cases of Taylor v National Union of Mineworkers (the support of an unlawful strike) and Smith v Croft no.2 (a transaction violating the financial assistance or capital maintenance provisions of the Companies Acts) show that a member may by virtue of his right, sue against a threatened lawful act (as in Simpson v Westminster Palace Hotel Co) and may set aside an unlawful act by bringing a derivative action.

The second exception concerns a situation where the alleged matter was such that could only have been validly done or sanctioned,in violation of a requirement in the articles, by some special majority of members. An example of this is Edwards v Halliwell. It was stated in this case that the alleged act could have been done only by a two-thirds majority and not by a simple majority and thus the rule in Foss v Harbottle could not be relied upon as the members were suing in their own right only to protect their own rights in their capacity as members and were not infact suing in the right of the union because here the wrong has not been done against the union(in which case, the union would solely have been able to bring a cause of action). Instead, here the defendants had by breaching the rules of the union by which they are bound, had invaded the personal and individual rights of the minority.

The third exception relates to an alleged act which has caused the invasion of the claimant’s personal and individual rights in his capacity as a member. An example of this is Edwards v Halliwell (above).

Last but not the least, the fourth exception deals with a situation where a ‘fraud on the minority’ has been committed by the majority who themselves control the company. There are various examples of fraud on the minority. Menier v Hooper’s Telegraph Works(1874) is an example of misappropriation of corporate assets. In this case, where Menier a minority shareholder complained that there were self-interested transactions between a majority member and the company, the court held that a minority shareholder’s action was properly bought in these circumstances. An example of abuse of power or discrimination is the case of Estmanco (Kilner House) Ltd v Greater London Council(1982), where Templeman J stated that under this exception, a minority can bring a claim even in the absence of a complaint of fraud and that in the absence of any remedy, an individual member may bring a claim where the powers are used intentionally or unintentionally, fraudulently or negligently, by the directors in a way which proves beneficial to them and disadvantageous to the individuals. Thus, the court held that stultification of the purpose for which the company was formed, against the wishes of the minority shareholders, may constitue ‘fraud on minority.’ An example of a case involving negligence in a situation where the result is a personal advantage to the wrongdoer is Daniels v Daniels(1978), where three minority shareholders claimed that mr. & mrs.Daniels(two directors and majority shareholders) had acted negligently in making the company sell land to Mrs.Daniels at a very low price although it was worth a lot more money, it was held that the plaintiffs had the right to sue in such circumstances. In contrast, where a minority shareholder claimed that the directors had acted negligently in selling an asbestos mine to another company at a fraction of its true value in Pavlides v Jensen(1956), it was held that as no fraud or personal advantage was evident from the facts of the case it appeared that the minority shareholder had no right to sue in such circumstances.

It is noteworthy that even where an individual member has the right to bring a claim on behalf of the company under one of the exceptions to the general principle, he may still be prevented from bringing a claim where the wrongdoer has a sufficient level of control over the company and is opposed to the litigation. In Smith v Croft no.2(1988), where the minority shareholders claimed for the recovery of sums given away in transactions which were both in breach of the statutory prohibition on financial assistance and ultra vires, it was held that as it appeared to be a prima facie case of ultra vires and illegality, thus the plaintiffs had the right to bring a derivative action, provided that majority shareholders had no objection to the continuation of the action.

What the law needs to do is strike a balance. It can neither give more support to the majority (as the minority will then be prejudiced) and nor to the minority (who would then object on every action, resulting in the floodgates argument). However, it seems quite evident from these four exceptions and the various case law flowing as a result of them that under common law minority shareholders have been given protection to quite an extent and the law seems to have provided some remedies to meet those cases in which majority power has been abused.

Companies Act 2006

Now in order to evaluate whether or not the situation of minority shareholders has been improved by the enactment of the Companies Act 2006, it is necessary to take a look at the various remedies offered to minority shareholders under it:

Firstly, further reform with regard to minority shareholders has been made by sections 260-269 of the Companies Act 2006 which have now replaced the common law rules associated with the general principle laid down in Foss v Harbottle as far as they apply to derivative claims. S.260 defines a dreviative claim as proceedings by a member of a company in respect of a cause of action vested in the company and seeking relief on behalf of the company. The new rules contain an exclusive list of grounds under s260(3), which further states that only where a cause of action arises from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company, can a derivative claim be made and that it is not material as to whether or not the person bringing the claim became a member before or after the cause of action arose. Its noteworthy that negligence is specifically allowed as a ground for bringing proceedings for bringing statutory derivative claims and that the claim is only allowed to be brought in respect of wrongs perpetrated by the company’s directors. S.261 puts forward the requirement that in order to bring a derivative claim, an application for permission to do so must be made to the court.

Once the application is made, the court then decides whether to allow it, dismiss it or adjourn it and give appropriate directions. Similarly, under s.262 where a company has brought a claim and wished to continue it as a derivative claim, then a member of such a company must make an application to the court to seek permission to do so, on the basis that the method by which the company is continuing the claim is an abuse of the courts process, the company has not prosecuted the claim diligently and it is more suitable to continue the claim as a derivative claim. the court again has the above three options once such an application has been put forward. S263 sets out the factors that the court must consider in determining whether to grant permission to pursue claims as derivative claims under s.261 & s.262. s.264 is a similar provision in that it allows an application to court to continue a derivative claim brought by another member and the court may allow it on the same grounds as a company claim which a court allows a member as a serivative claim above.

As to the rights of minority shareholders to an indemnity in a derivative action, under the common law in Wallersteiner v Moir no.2(1975), the Court of Appeal recognised that a minority shareholder who brings a derivative claim may have the right to an indemnity in respect of his costs against the company. This right will only be available where the minority shareholder has acted in good faith in bringjng the claim. It was also stated in this case that where a shareholder brings a derivative claim, no legal aid will be available for him. It must be noted that such an indemnity order application must be made and seen along with the application for permission to continue claim as a derivative claim. However, this case was interpreted rather restrictively in Smith v Croft(1986), where it was stated that where an indemnity order application is made, there must be evidence that it is honestly needed and that a certain amount of the cost must be left for the claimant too. Thus, at seems that under common law a minority shareholder has the right to get an indemnity. However, where a minority shareholder claims for a remedy against the company under the common law rules, then the Company Act 2006 rules applicable to derivative claims will not apply, for the simple reason that sections 260-264 do not make any provision with regard to a minority shareholders right to an indemnity in a derivative claim. instead a shareholder in such circumstances may sue in a representative form (where he brings a claim together with other shareholders); or he may bring a claim in his own name and seek an injunction or an action for a declaration.

Secondly, the minority shareholders have been provided with a remedy under s.122(1)(g) of the Insolvency Act1986.