The Rights of a Shareholder

One is regarded to be a shareholder if his or her name is entered into a company’s share register as being a holder at that time of one or more shares in the company or if you are entitled to be on the register and waiting to be included on it. The rights of a shareholder can be found in the Company’s Act as well as the Company’s Constitution. The responsibility of the company’s board of directors is to deal with day to day management of the company whilst the shareholders rights and powers include;

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• Voting out directors
• Exercising minority buy out rights
• Passing resolutions at shareholder meetings
• Electing to sell their shares
• Requesting the company in writing to provide information held by the company and
• Requiring the company to provide the shareholder with the statement of shares that he or she holds, various rights, privileges, conditions and limitations that are attached to those shares.

The shareholders then own the company and the directors manage it. Unless the articles say so, a director does not need to be a shareholder and a shareholder has no right to be a director. If two or three people set up a company together, they mostly regard themselves as partners. Comparatively to partnerships where the assets of the business are jointly owned by the partners, shareholders do not have partial ownership in the property of the company. Rather the relationship of a shareholder lies with the company as a separate and distinct entity as referred in the case of Macaura v Northern Assurance Co Ltd where the House of Lords decided that shareholders have no legal or equitable interest in their company’s property. The property belongs to the company which had a legal personality. Therefore the insurers were not liable in this case but rather Macaura’s Company and not Macaura even could insure its property against loss or damage.

The majority rule principle touches on the key issue of who controls the company. It should be noted that once a company is incorporated it becomes a separate legal entity and treated separate from its shareholders. The concept of separate legal entity as well provides that a company as a legal entity can sue to enforce its legal rights and can be sued for breach of its legal duties. However this is not open to the individual shareholders to initiate action on the company’s behalf. The decision has to be left to the hands of the proper organ of the company (which is normally the board of directors).

S 33 contract provides that every member of a company is contractually bound by the articles and memorandum to the company as well as the company’s other shareholders. This statutory contract lays down the legal relationship between the company, members and its members inter se. The main issue on law is to strike a balance between the concepts of majority rule on one hand and ensure safety on the minority shareholders against abuse of power. The old common law position was based on the concept of the ‘Majority Rule’ which was laid down in the case of Foss v Harbottle, for the fact that the decisions and choices of the majority will always prevail over the decisions and choices of the minorities. A substantial amount of power has been placed in the hands of the majority shareholders and on the basis of a majority rule, the minority shareholders have to accept the decisions made by the majority shareholders. In Foss v Harbottle (1843) there were two members of the Victoria Park Co who brought an action against the company’s five directors and other shareholders saying that they took certain actions to defraud the company including selling land at an increased price. It was held that the board of directors should be the ones to call a general meeting to make a claim in this instance and not the claimant. The issue of who is a proper claimant, an explanation was made by Jenkins LJ in the case of Edwards v Halliwell where there were two limbs to the rule in Foss v Harbottle (1843):

1. If a wrong is done to the company, the company is to be the proper plaintiff that only the company may sue and an individual shareholder or a group of shareholders may not sue
2. If a company wrongs a member, the member may not sue if the act complained of could be done by an ordinary resolution in a general meeting.

The principle then in Foss v Harbottle seems to be harsh and unjust to the minority shareholders although a substantive right has been given to them, still they are prevented from obtaining justice from the rule and submit the wrongs done by the majority because at the end it is the majority members that controls the company and the minority members have no say as they are regarded to be the weak position in the company. However in order to reduce this harshness, there are various exceptions laid down:

1. The first exception is the where the said act is ultra vires or illegal. In the case of Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) the Court of Appeal said that where the wrongful act is ultra vires the company, then the rule will not operate because the majority of members cannot confirm the transaction. As well in the case of Smith v Croft (No 2) (which was about a transaction violating the financial assistance or capital provisions of the Company’s Act) and Taylor v National Union of Mineworkers (Derbyshire Area) (which was about the support of an unlawful strike) show that a member by virtue of his right may sue against a threatened lawful act and may set aside the unlawful act by bringing a derivative action which are proceedings brought by a member of a company in respect of a cause of action settled in the company and seeking relief on behalf of the company.
2. The second exception is where the matter in issue was such that it could only be validly done in violation of what is required in the articles by a special majority of members. An individual shareholder will have standing to sue where the act complained of is one which requires the approval of a special majority of members and then such solution has not been obtained. In the case of Edwards v Halliwell (1950) as mentioned above, there were two members of trade union who obtained a declaration that a resolution increasing members’ subscriptions was invalid because the required two-thirds majority for such a resolution was not obtained. It was then stated that the stated act could have been done only by two-thirds majority and not by a simple majority, therefore the rule in Foss v Harbottle cannot be relied upon as the members were suing only to protect their own rights in their capacity as members and not suing in the right of the union because the wrong had not been done against the union. Instead the defendants by breaching the rules of the union they were bound had intruded upon the personal and individual rights of the majority.
3. The third exception is where the member’s personal rights have been invaded. In these situations a member has no right to sue. In seeking to bring an action to the rule in Foss v Harbottle (1843) there are two things that need to be overcome: first, the issue of enforcing outsider rights which are conferred on a member by the articles of association; and second, the difficulty in predicting when the court will say that the breach of a provision in a company’s constitution is a mere internal irregularity procedure, and therefore a wrong to a company, as opposed to a constitutional infringement for which a member can sue.
4. The forth exception and the last deals with the situation where fraud has been committed against the company and the wrongdoers are in control. There are various examples of fraud on the minority. In the case of Menier v Hooper’s Telegraph Works where Menier was a minority shareholder who complained that there were self interested transactions between a majority member and the company. The main issue here on fraud is about misappropriation of corporate assets. The court then held that a minority shareholder’s action was properly given in such circumstances. Another example is about the issue of fraud is abuse of power or discrimination as seen in the case of Estmanco (Kilner House) Ltd v Greater London Council where it was stated that under this, a minority can bring a claim even in the absence of complaint of fraud. An individual member may bring a claim where the power is used intentionally or not intentionally, fraudulently or negligently by the directors in such a way that is beneficial to them and not to the individuals. In Daniels v Daniels another example of fraud can be seen on the issue of negligence which becomes beneficial to the wrongdoers. In this case there were three minority shareholders who claimed that the two directors and minority shareholders had been negligent in making the company sell land to Mrs. Daniels at a lower price although it was worth more. It was held that it was right to sue in such a situation.

Even where an individual member has a right to bring a claim on behalf of the company, he may still be prevented from bringing a claim where the wrongdoer has control over the company. In Smith v Croft (No 2) where the minority shareholders claimed for the recovery of the sum given away in transactions which both were in breach of statutory provision on financial assistance and illegal. It was held to be an issue of ultra vires and illegality therefore the plaintiff has a right to bring a derivative action given that the majority shareholders had no objection.

The law needs to give a balance. It can decide give much support to the majority which will then undermine the minority. However from the above mentioned exceptions together with the case laws under common law, minority shareholders seem to be given protection to some extent and the law has given remedies to the situations in which minority power has been abused.

So as to determine whether the position of the minority shareholders has been improved or not, The Company’s Act 2006 (hereinafter referred to the 2006 Act) was introduced and came up with various remedies in order to serve the minority shareholders.

S 260 to S 269 of the 2006 Act have now replaced the common law rules together with the principle given in Foss v Harbottle as they apply to derivative claims. S 260 of the Act defines derivative claims as proceedings brought by a number of companies in respect of a cause of action vested in the company and seeking relief on behalf of the company. The grounds for bringing a derivative claims are given in S 260(3) of the said Act which provides that such a claim may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence , default, breach of duty or trust by a director of the company. This provision is important because it is clear that claims against directors for breach of their duties owed to the company fall within the scope. This section then permits a derivative claim involving such situations (breach of duties) to exercise reasonable care. S 263 also provides that a derivative claim can be brought against a third party who dishonestly assists a director on the breach of his fiduciary duty.

S 261 of the 2006 Act puts forward the requirement that when one wants to bring a derivative claim, an application for permission to do so has to be made do the court. When the application is made, the court will then decide whether to allow it or not. As well under S 262 of the said Act, when a company has brought a claim and wishes it to be a derivative claim, then the company must make an application to the court also to seek permission to do so. However when a company goes to liquidation then the court will not allow derivative claims to be made or continued because the liquidator then has the statutory power to litigate in the company’s name. This is given under S 165(3), S 167(1) and Schedule 4 Para 4 of the Insolvency Act 1986 as well as in the case of Fargo Ltd v Godfroy

The rights of minority shareholders to compensation in a derivative action under common law in the case of Wallersteiner v Moir (No 2) the court recognized that a minority shareholder who brings a derivative claim may have a right of compensation of his costs against the company. This right is only available when a minority shareholder has acted bona fide in bringing the claim. No legal aid will be available to the shareholder when bringing the claim. However in Smith v Croft (1986) this issue was interpreted where it was regarded that where a compensation order application is made, there has to be evidence that it is honestly needed and that a certain amount of the cost is to be left for the claimant.

The Company’s Act 2006 incorporates amendments in the Company’s Act 2004 to the Company’s Act 1985. S 232 of the 2006 Act renders void any provisions in the articles or any other contract with the company that leads to an exemption of a director from, or indemnifying him against any liability that would be connected to him with any negligence, default or breach of duty in relation to the company. Similarly by S 234 of the said Act, the prohibition against the provision of indemnifying directors as laid down in S 232 above will not apply to qualifying third party indemnity provisions. A provision will qualify if it indemnifies directors against liabilities in a civil action rather than a company. (That is the third party).

The issue of unfair prejudice which is the most important protection towards the minority shareholders contrary to S 996 of the Company’s Act 2006 whereby a minority shareholder who has been prejudice may petition the court in which under this section he is empowered to make such an order as he thinks fit to do so. S 996(2) (c) of the said Act grants the court the power to authorize civil proceedings to be brought in the name and on behalf of the company by the prejudiced minority. As well on the issue of voting power where before the majority shareholders were the one to participate in doing so, seemed to be unfair to the minority shareholders and therefore a right has been granted to them to do so since both were joined together to form a company and the fact that they gave rise to an understanding that each shareholder would participate in the company. Moreover under the issue of just and equitable winding-up, given there were obstacles under the rule in Foss v Harbottle which then aggrieve the minority shareholders in small private companies who historically either suffered their lot through a winding-up order on just and equitable ground. S 122(1) (g) of the Insolvency Act 1986 provides that a company maybe wound up by the court if at all the court is of the opinion that it is just and equitable should be wound up. The court is asked to end the life of the company and distribute the remaining assets to the shareholders. In this respect S 127 of the 1986 Act also renders the company incapable of carrying on business freely. Any disposition of the company’s property, and any transfer of shares in the status of the company’s members made after the admission of the winding up is void unless the courts orders otherwise.

Conclusively, the effectiveness of the true exceptions to the rule in Foss v Harbottle against the wrongdoers was clearly depended upon by the shareholders so as to detect fraudulent conduct on the part of the controllers. It is evident that shareholders performed a task of policing the wrongdoers mainly in large public companies given that as a body they are given limited access to material information. It was difficult to understand why minority shareholders would want to bring derivative actions, but due to the number of things (mentioned above) that were done mostly by the minorities towards them, then by all means they deserve to bring derivative claims so as to stop them. The introduction of a number of statutory procedures which was laid down in the Company’s Act 2006 has represented a lost opportunity to the concerned. However, the Company Reform Bill whose objectives were to encourage shareholder engagement, minimizing complexity and maximizing accessibility seems to have been lost somewhere along the way. As a result, the effectiveness of the derivative claim as a tool of ensuring corporate governance still remains an issue to be questioned. Much now depends on how the judges exercise their powers under the provisions given in the Company’s Act 2006.