TOPIC 7
COMPANY LAW
7. SHAREHOLDER REMEDIES:
PART 1 DERIVATIVE ACTIONS:
PROBLEM QUESTION APPROACH:
1. Underline the BREACH OF DUTY that is occurring. Advise on whether a
derivative action would be likely to be successful.
2. Explain the PROCEDURE. This should include whether the courts are likely to
dismiss the action at a certain stage and the possibility of ratification.
3. Assess whether the individual shareholder could bring a PERSONAL CLAIM,
starting with the principle of reflective loss.
! Where there has been a wrongdoing by those in control (e.g. directors), a
derivative action should be brought against the wrongdoers on behalf of the
company. A corporate remedy will be available.
! Where there has been unfair prejudice to minority shareholders by the controllers
(directors or controlling shareholders), the claimant should apply to the court for an
unfair prejudice petition (which comes with a petition to wind up on just and
equitable ground). Only a personal remedy will typically be available.
â
1. INTRODUCTION:
WHAT IS A DERIVATIVE ACTION?
Ò DERIVATIVE ACTION / CLAIM: an action brought by a shareholder on behalf
of all the company’s shareholders (other than the wrongdoers who are in
control and are preventing the company from bringing a claim) when there
has been a wrongdoing by those in control (e.g. a breach of duty by a
director).
HOW DOES IT RELATE TO ENFORCEMENT OF DIRECTORS’ DUTIES?
When a director breaches their duty, a claim will typically be brought against
them in order to enforce that duty.
As directors owe their duty to the company (s 170(1), CA 2006), only the
company can enforce a breach of duty.
This means that in an action concerning a director’s breach of duty, the
company would be the proper plaintiff.
WHAT IS THE AIM OF THE LAW?
The law’s aim is to strike the optimum balance between majority rule and
safeguarding minority shareholders against abuses of power.
,TOPIC 7
COMPANY LAW
It is important to not allow the pendulum to swing too far in favour of the
minority, otherwise the shareholders could become the oppressors of the
majority and impede the carrying on of the proper business of the company.
ò
2. THE RULE IN FOSS v HARBOTTLE:
WHAT IS THE RULE?
As explained by Jenkins LJ in Edwards v Halliwell (1950), there are two limbs
to the rule:
(i) PROPER CLAIMANT PRINCIPLE: where an alleged wrong has been
done to a company (i.e. a director has breached their duty), the only
proper plaintiff/claimant is prima facie the company itself.
(ii) No individual member can proceed with the action where the alleged
wrong is a transaction which might be made binding on a company
and its members by a simple majority – in other words, if a majority
of the members are in favour of what has been done, then the action
will not be maintained because the majority rule.
FOSS v HARBOTTLE:
The above rule was set out in Foss v Harbottle (1843).
! This is a rule of procedure, rather than one of substance.
The key question behind the case was: could an individual shareholder sue
derivatively, or should litigation be left to shareholders as a whole? It was held
that litigation should be left to shareholders as a whole (the company), rather
than allowing individual shareholders to sue.
_ Foss v Harbottle: two minority shareholders in the Victoria Park company brought
a claim against five company directors for allegedly misapplying and wasting
company property (they had bought land for an extortionate price), and that
various mortgages were improperly given over company property. However, the
court (Wigram V-C) held that the two shareholders (plaintiffs) were unable to
bring proceedings against the five directors – only the company had the sole right
to bring such a claim. Further, it was stated that it was up to the majority in
general meeting to judge the defendant’s conduct.
In MacDougall v Gardiner (1875), Mellish LJ focused on the second limb of the
rule: she stressed the futility of allowing an action to proceed where the
conduct complained of is capable of ratification by the majority in general
meeting.
! It is important to note that this conclusion, i.e. leaving the decision to the majority
in GM, fails to recognise and correct deficiencies in group decision-making (e.g.
wrongdoers being in control, shareholders not being made aware of relevant facts,
etc.).
THEORY BEHIND THE RULE:
, TOPIC 7
COMPANY LAW
Why is it that only the company can be entrusted with the decision to litigate,
rather than individual shareholders?
o The principle of the MAJORITY RULE still stands.
o JUDICIAL RELUCTANCE: courts are reluctant to interfere in the internal
management of companies.
o SEPARATE LEGAL PERSONALITY: the rule accords with the
company’s right to sue and be sued in its name. This means that,
generally, it is not open to individual shareholders to initiate action on
the company’s behalf. Instead, the decision should be left to the most
appropriate organ of the company – the board of directors.
o MANAGEMENT AUTONOMY: unless stated otherwise by the articles,
the general management powers of a company are vested in the
directors.
o SECTION 33 CONTRACT: the statutory contract (this dictates that
every member is bound to the company and the other shareholders,
and recognises the relationships between these parties) recognises the
majority rule and the fact that the dissenting minority is bound by the
decisions of the majority.
A problem arises where the wrongdoers are members of the board and due to
their position, can prevent the company from taking action to obtain a remedy
for the wrongdoing.
ò
3. LIMITS TO THE FOSS v HARBOTTLE RULE:
To restate, the rule dictates that only the company itself can bring an action
to enforce breach of a director’s duty. No individual member can maintain
such an action because if a mere majority of the company is in favour of what
has been done, then so be it.
LIMITS TO THE RULE:
However, there are limits to this rule (in other words, instances where the rule
will not operate to prevent a shareholder from suing). These were set out by
Jenkins LJ in Edwards v Halliwell:
(i) Where the act complained of was illegal or wholly ultra vires
(beyond powers).
a Prudential Assurance Co Ltd v Newman Industries Ltd (No 2): CA explained that
where the alleged wrongful act is ultra vires the company, the rule does not
operate because the majority of members cannot ratify the transaction.
a Smith v Croft (No 2) (1998): this limit is exemplified in this case giving financial
assistance to facilitate the acquisition of shares in the company was contrary to
COMPANY LAW
7. SHAREHOLDER REMEDIES:
PART 1 DERIVATIVE ACTIONS:
PROBLEM QUESTION APPROACH:
1. Underline the BREACH OF DUTY that is occurring. Advise on whether a
derivative action would be likely to be successful.
2. Explain the PROCEDURE. This should include whether the courts are likely to
dismiss the action at a certain stage and the possibility of ratification.
3. Assess whether the individual shareholder could bring a PERSONAL CLAIM,
starting with the principle of reflective loss.
! Where there has been a wrongdoing by those in control (e.g. directors), a
derivative action should be brought against the wrongdoers on behalf of the
company. A corporate remedy will be available.
! Where there has been unfair prejudice to minority shareholders by the controllers
(directors or controlling shareholders), the claimant should apply to the court for an
unfair prejudice petition (which comes with a petition to wind up on just and
equitable ground). Only a personal remedy will typically be available.
â
1. INTRODUCTION:
WHAT IS A DERIVATIVE ACTION?
Ò DERIVATIVE ACTION / CLAIM: an action brought by a shareholder on behalf
of all the company’s shareholders (other than the wrongdoers who are in
control and are preventing the company from bringing a claim) when there
has been a wrongdoing by those in control (e.g. a breach of duty by a
director).
HOW DOES IT RELATE TO ENFORCEMENT OF DIRECTORS’ DUTIES?
When a director breaches their duty, a claim will typically be brought against
them in order to enforce that duty.
As directors owe their duty to the company (s 170(1), CA 2006), only the
company can enforce a breach of duty.
This means that in an action concerning a director’s breach of duty, the
company would be the proper plaintiff.
WHAT IS THE AIM OF THE LAW?
The law’s aim is to strike the optimum balance between majority rule and
safeguarding minority shareholders against abuses of power.
,TOPIC 7
COMPANY LAW
It is important to not allow the pendulum to swing too far in favour of the
minority, otherwise the shareholders could become the oppressors of the
majority and impede the carrying on of the proper business of the company.
ò
2. THE RULE IN FOSS v HARBOTTLE:
WHAT IS THE RULE?
As explained by Jenkins LJ in Edwards v Halliwell (1950), there are two limbs
to the rule:
(i) PROPER CLAIMANT PRINCIPLE: where an alleged wrong has been
done to a company (i.e. a director has breached their duty), the only
proper plaintiff/claimant is prima facie the company itself.
(ii) No individual member can proceed with the action where the alleged
wrong is a transaction which might be made binding on a company
and its members by a simple majority – in other words, if a majority
of the members are in favour of what has been done, then the action
will not be maintained because the majority rule.
FOSS v HARBOTTLE:
The above rule was set out in Foss v Harbottle (1843).
! This is a rule of procedure, rather than one of substance.
The key question behind the case was: could an individual shareholder sue
derivatively, or should litigation be left to shareholders as a whole? It was held
that litigation should be left to shareholders as a whole (the company), rather
than allowing individual shareholders to sue.
_ Foss v Harbottle: two minority shareholders in the Victoria Park company brought
a claim against five company directors for allegedly misapplying and wasting
company property (they had bought land for an extortionate price), and that
various mortgages were improperly given over company property. However, the
court (Wigram V-C) held that the two shareholders (plaintiffs) were unable to
bring proceedings against the five directors – only the company had the sole right
to bring such a claim. Further, it was stated that it was up to the majority in
general meeting to judge the defendant’s conduct.
In MacDougall v Gardiner (1875), Mellish LJ focused on the second limb of the
rule: she stressed the futility of allowing an action to proceed where the
conduct complained of is capable of ratification by the majority in general
meeting.
! It is important to note that this conclusion, i.e. leaving the decision to the majority
in GM, fails to recognise and correct deficiencies in group decision-making (e.g.
wrongdoers being in control, shareholders not being made aware of relevant facts,
etc.).
THEORY BEHIND THE RULE:
, TOPIC 7
COMPANY LAW
Why is it that only the company can be entrusted with the decision to litigate,
rather than individual shareholders?
o The principle of the MAJORITY RULE still stands.
o JUDICIAL RELUCTANCE: courts are reluctant to interfere in the internal
management of companies.
o SEPARATE LEGAL PERSONALITY: the rule accords with the
company’s right to sue and be sued in its name. This means that,
generally, it is not open to individual shareholders to initiate action on
the company’s behalf. Instead, the decision should be left to the most
appropriate organ of the company – the board of directors.
o MANAGEMENT AUTONOMY: unless stated otherwise by the articles,
the general management powers of a company are vested in the
directors.
o SECTION 33 CONTRACT: the statutory contract (this dictates that
every member is bound to the company and the other shareholders,
and recognises the relationships between these parties) recognises the
majority rule and the fact that the dissenting minority is bound by the
decisions of the majority.
A problem arises where the wrongdoers are members of the board and due to
their position, can prevent the company from taking action to obtain a remedy
for the wrongdoing.
ò
3. LIMITS TO THE FOSS v HARBOTTLE RULE:
To restate, the rule dictates that only the company itself can bring an action
to enforce breach of a director’s duty. No individual member can maintain
such an action because if a mere majority of the company is in favour of what
has been done, then so be it.
LIMITS TO THE RULE:
However, there are limits to this rule (in other words, instances where the rule
will not operate to prevent a shareholder from suing). These were set out by
Jenkins LJ in Edwards v Halliwell:
(i) Where the act complained of was illegal or wholly ultra vires
(beyond powers).
a Prudential Assurance Co Ltd v Newman Industries Ltd (No 2): CA explained that
where the alleged wrongful act is ultra vires the company, the rule does not
operate because the majority of members cannot ratify the transaction.
a Smith v Croft (No 2) (1998): this limit is exemplified in this case giving financial
assistance to facilitate the acquisition of shares in the company was contrary to
