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A Critique on the Rule of Foss v.

Harbottle

CONTENTS

i) Table of Cases ii) Table of Statutes

1) Introduction 2) Foss v. Harbottle 3) Exceptions 4) Conclusion

iii) Bibliography

TABLE OF CASES

1) Bhajekar v. Shinkar 2) Rajahmundry Electric Supply Corpn Ltd. v. Nageshwara Rao 3) Dr. Satya Charan Law and others v. Rameshwar Prasad Bajoria and others 4) Edward v. Haliwell 5) Heyting v. Dupont

TABLE OF STATUTES

Companies Act, 1956 (India) Companies Act, 2006 (UK)

INTRODUCTION

Foss v Harbottle1 is a leading English precedent in corporate law. In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself. This is known as "the rule in Foss v Harbottle", and the several important exceptions that have been developed are often described as "exceptions to the rule in Foss v Harbottle". Amongst these is the 'derivative action', which allows a minority shareholder to bring a claim on behalf of the company. This applies in situations of 'wrongdoer control' and is, in reality, the only true exception to the rule. The rule in Foss v Harbottle is best seen as the starting point for minority shareholder remedies. The management of a company is based on the majority rule. The majority right to manage the affairs of the company is vested in the directors who are elected representatives of the share holders. Those rights, which are not vested in the directors, are exercised by the members in their general meetings, as are all the other decisions are taken on the basis of majority. Thus, the majority has its way in the general meeting. This principle is that the will of the majority should prevail and bind the minority is known as the principle of majority rule. This is also known as the Foss v. Harbottle Rule. This rule was established in given legal recognition and established in 1843 in the case of Foss v. Harbottle. Two minority shareholders in a company alleged that its directors were guilty of buying their own land for the companys use and paying themselves a price greater than its value. T his act of the directors resulted in a loss to the company. The minority shareholders, therefore, decided to take an action for the damage against the directors. The shareholders hence in a general meeting by the majority resolved not to take any action against the directors alleging that they were not responsible for the loss which had been incurred.

(1843) 67 ER 189

The Court dismissed the suit on the ground that the proper plaintiff for the wrongs done to the company is the company itself and not he minority shareholders. It further held that the company can act only through its majority shareholders. The basis of specific rule in this case is that the protection of the majority is supreme. Whenever a person becomes member of a company he gives his implied consent to accept the decision of the majority in the general meeting of their company provided the meeting is held in accordance with the provisions of the Companies Act, 1956, the memorandum and the articles of association.

Foss v. Harbottle

This case was brought by two shareholders in the Victoria Park Co against the companys five directors and others, alleging that the property if the company had been misapplied and wasted and certain mortgages improperly given over the companys property. It asked that the defendants should be held accountable to the company, and also sought the appointment of a receiver, The Vice-Chancellor ruled, however, that it was incompetent for the plaintiffs to bring such proceedings, the sole right to do so being that of the company in its corporate character. It is only necessary to refer to the clauses of the Act to show that, whilst the supreme governing body, the proprietors at a special general meeting assembled, retain the power of exercising the functions conferred upon them by the Act of Incorporation, it cannot be competent to individual corporators to sue in the manner proposed by the Plaintiffs........ The very fact that the governing body of proprietors assembled at the special general meeting may so bind even a reluctant minority is decisive to show that the frame of this suit cannot be sustained whilst that body retains its functions.2 A major advance in the law in regard to minority shareholders was marked by the decision in Foss v. Harbottle which transformed the old partnership rule into one of the leading principles of modern company law. Though the case concerned a statutory company created by private Act, the decision came just before Gladstones Act of 1844 extended the right to incorporate to ordinary trading companies by simply registering their deed of settlement. The courts had now to apply a quasi-partnership rule in a corporate setting.

In his judgment in Foss v. Harbottle, Wigram VC followed the older cases on unincorporated companies by insisting that the minority must show that they had exhausted any possibility of redress within the internal forum. Some notion of majority rule had been implicit in the earlier cases, but Wigram VC was the first to state plainly that the court will not intervene

Stephen D. Girvin and Sandra Frisby et. al, Charlesworths Company Law, pg no. 509, Thomson

Reuters, UK, Eighteenth edn, 2010

where a majority of the shareholders may lawfully ratify irregular conduct. This is a somewhat circular argument. On the other hand, his judgment implies that where it is futile to hope for action by the general meeting a suit may nevertheless be brought by the minority even for matters which might in law be ratified by the majority. On this last point, the rule was to become even more unfavourable to the minority.

It was later established that the Foss v. Harbottle rule barred a minority action whenever the alleged misconduct was in law capable of ratification, whether or not an independent majority would ever be given a real opportunity to consider the matter.3 Professor Sealy draws a contrast with other types of litigant, for example those seeking judicial review. The latter receive, on the question of locus standi, a more favourable judicial acceptance than does the minority shareholder: Time and again he is sent away with no answer, as often as not with a rebuke for troubling the court. 4

Further confusion can arise where the court decides to resolve the Foss v. Harbottle point by referring the matter to the shareholders in general meeting. It may not be clear whether the majority are to resolve whether or not the company should litigate, or whether they are being asked to ratify the wrongdoing that has occurred. In either case the shareholders in a large public company are unlikely to have the information to make a proper judgment of their own interests or those of the company. On any careful analysis, the Foss v. Harbottle rule is (like any other rule determining locus standi) a mixture of substance and procedure.5

The common law derivative action- At common law the rule in Foss v. Harbottle was subject to an exception that a derivative claim could be brought by a minority shareholder on behalf of the company in order to remedy a wrong that otherwise go without redress. This action was brought instead of an action in the name of the company. The shareholders as such
3

A. J. Boyle, Minority Shareholders Remedies, Cambridge University Press, University of London, Sealy, The Problems of Standing, Pleading and Proof in Corporate Litigation in B. G. Pettet (ed.),

2002
4

Company Law in Change (Stevens & Sons, 1987), p. 2.


5

European Business Law Journal, MayJune 2000, pgs.19, in respect of the application of conflicts

of laws concepts to the Foss v. Harbottle rule.

had no such right and if their own personal right were being infringed they might bring a representative action.6

In Bhajekar v. Shinkar7, the board of directors of a company passed a resolution appointing certain persons as managing agents. The resolution was confirmed by the company in general meeting with the full knowledge of all the material facts. Some of the directors brought a suit for declaration that the resolution was invalid on the ground of certain irregularities. Held, it was open to the company to ratify the resolution even if it was irregular and the plaintiffs were not under these circumstances entitled to maintain the suit and ask the Court to interfere. Only the company may sue: The decision in Foss v. Harbottle, is the logical result of the principle that a company is a legal entity from the members who compose it. As such if any wrong is done in the company, it is the company and not he individual members which can bring an action. This follows from the rule that only the injured party may sue.8 In Rajahmundry Electric Supply Corpn Ltd. v. Nageshwara Rao9, the Court observed that the Courts, will not, in general, intervene at the instance of the shareholders in the matters of internal administration and will not interfere with the management of a company by its directors so long as they are acting within the powers conferred on them under the Articles of Association of the company. Moreover, if the directors are supported by the majority of the shareholders in what they do, the minority shareholders can, in general, do nothing about it. The appeal judges preference for an old fashioned rule in Foss v. Harbottle points to a possible key to the modern riddle of the meaning of "control," which, in my view, was originally set in the 1870s by James L.J.'s forceful judgments that the minority must prove fraud and control, strongly implying that control involved the delinquents (alone or with abettors) holding most of the votes in general meeting.

Stephen D. Girvin and Sandra Frisby et.al, Charlesworths Company Law, pg no. 511, Sweet and

Maxwell, UK, Eighteenth edn, 2010


7 8

(1934) 36 BOMLR 483 Dr. Ashok Sharma, Company Law and Secretarial Practice, V. K. Enterprises (India), New Delhi,

2010
9

1956 AIR 213

This narrowing of exception produced two main difficulties: first, it swept into oblivion a line of cases headed by Davidson v. Tulloch, which held a small category frauds and deceits incapable of confirmation at the option of the corporation, and thus capable of minority redress without proof of control; secondly, the very narrowness of it is hardly reconcilable with the wider exception favoured by other judges.10 Sources of the Rule- The corporation principle, that the proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or association itself11, springs naturally from the treatment in law of the corporation as a person separate from the members of which it is composed; and it was well established by the nineteenth century that the individual members id a corporation are quite as distinct from the metaphysical body called the corporation as any others of his Majestys subjects are. Thus, injuries allegedly caused to the corporation alone and not to its members, must be remedied not by the members but by corporate action. That was the decision in Foss v. Harbottle.12 So where people took over the office of the director was said to an invasion and the result was held the same. Once established, however, the principle was applied rigorously to the many irregularities committed by people who managed joint stock companies. So if the complaint is about something which in substance the majority of the company are entitled to do, or if something that has been done irregularly which the majority of the company is entitled to do regularly then, there can be no purpose of litigation over the matter, the ultimate end of it would be in the general meeting when it is called and the majority gets its wishes.

10

R. Gregory, What Is the Rule in Foss v. Harbottle?, Vol. 45, The Modern Law Review, pg. 584-

588, No. 5 (Sep., 1982), also available at http://www.jstor.org/stable/1095200


11 12

Jenkins L. J in Edwards v. Haliwell, [1950]2 All E. R 1064, 1066. K. W. Wedderburn, Shareholders' Rights and the Rule in Foss v. Harbottle, Vol. 15, The Law Journal, pg. 194-215, No. 2 (Nov., 1957), also available at

Cambridge

http://www.jstor.org/stable/4504462

EXCEPTIONS

There are certain exceptions to the rule of in Foss v. Harbottle, where litigation is allowed. The following exceptions protect the rights of the minorities, regardless of the majority's vote because they are also a method to safeguard the minoritys interests. Palmers Company Law recognises the exceptions to the rule in Foss v. Harbottle as follows:"The following exceptions to the rule in Foss v. Harbottle are admitted as pointed out by Jenkins L. J. in Edwards v. Halliwell13; the majority cannot confirm: 1) an act which is ultra vires the company or illegal ; The directors of a company or a shareholding majority may not use their control of the company to paper over actions which would be ultra vires the company, or illegal.

2) an act which constitutes a fraud against the minority and the wrong-doers are themselves in control of the company; or 3) a resolution which requires a qualified majority but has been passed by a simple majority."14 If some special voting procedure would be necessary under the company's constitution or under the Companies Act, it would defeat both if that could be sidestepped by ordinary resolutions of a simple majority, and no redress for aggrieved minorities to be allowed.

In Dr. Satya Charan Law and others v. Rameshwar Prasad Bajoria and others, 1949-50, Federal Court Reports, 673 at 687, (7) the court stated the position thus :

"The correct position seems to us to be that ordinarily the directors of a company are the only persons who can conduct litigation in the name of the company, but when they are themselves the wrong doers against the company and have acted mala fide or beyond their powers, and their personal interest is in conflict with their duty in such a way that they cannot
13 14

[1950] 1 All ER 1064 (CA) Geoffrey Morse, Palmers Company Law, Sweet and Maxwell, UK, 2007

or will not take steps to seek redress for the wrong done to the company the majority of the shareholders must in such a case be entitled to take steps to redress the wrong."15 Gower in his Principles of Modern Company Law16 comments that the rule in Foss v. Harbottle greatly strengthens the position of the majority; if there were not exceptions to it the minority would be completely in their hands. He notices the exceptions which the courts have recognised and writes that there are certain judicial dicta which would add a further exception, to the well recognised exceptions a further exception, namely, "any other case where the interests of justice require that the general rule requiring suit by the company should be disregarded. In some cases, it has been held that further exceptions to the rule in Foss v. Harbottle, are permissible in cases in which "justice requires that the courts should intervene" to assist an otherwise minority shareholder. In Heyting v. Dupont17, Harman L. J. said (at page 854): "....there are cases which suggest that the rule is not a rigid one and that exception will be made where the justice of the case demands it.

K.K. Mathew J. was dealing in Joseph v. Jos18, with a suit for a declaration that the proceedings of the meeting regarding the election of certain directors was null and void and for a permanent injunction restraining defendants from functioning as director and for directing the defendant-company to hold a meeting for re-electing three directors. After referring to the rule in Foss v. Harbottle and the exceptions thereto, the learned judge made a distinction between "individual membership right' and the "corporate membership right" of a shareholder. It was held that the rule against interference by court with the internal management of companies was not applicable to cases of infringement of the individual membership
15

right.

The

learned

judge

quoted

from

Palmer's

Company

Law:

L. S. Sealy and Sarah Worthington, Sealy's Cases And Materials In Company Law, Oxford
th

University Press, Oxford, 9 edn., 2010


16

Sarah Worthington, Gower and Davies, Principles of Modern Company Law, Sweet and Maxwell,
th

UK, 8 edn., 2008


17 18

1964] 1 WLR 843 (CA) [1964] 34 Comp Cas 931 (Ker)

"By contract with the company, the shareholder undertakes with respect to some, in fact, most rights which his membership carries, to accept as binding upon him, the decision of the majority of shareholders, if attained in accordance with the law and the articles; these membership rights are known as corporate membership rights. Other rights of the shareholder, according to his contract with the company, cannot be taken away from him unless he consents to the same. If such rights are in question, a single shareholder can, on principle, defy a majority consisting of all the other shareholders. Rights of this type are known as individual membership rights. "...the wrong done to the plaintiff is not wrong which the majority can ratify as it would be against the provisions of the articles of association, and it is settled by authorities the a shareholder can insist on the strict observance of the legal rules, statutory provisions and provisions in the memorandum and articles cannot be waived by a bare majority of shareholder."19 And the plaintiffs right to move the civil court was upheld.

19

Geoffrey Morse, Palmers Company Law, Sweet and Maxwell, UK, 2007

CONCLUSION

Rule in Foss v. Harbottle is actually rule of majority supremacy. It means that once a resolution is passed by majority, it is binding on all the members. Also the courts will in such cases not interfere to protect the minority interest. This is based on the rational that on becoming a member, each person impliedly consents to submit to the will of majority. Said in another way it is a corollary to the rule that only the company can sue, which again translates to the wish of the majority. For protecting the rights of minority, certain exceptions to the above rule are recognized and applied. These exceptions are as follows:(i) Ultra vires acts (ii) Fraud on the minority (iii) Act requiring special majority (iv) Wrongdoers remain in control (v) Individual membership rights The exceptions and the rule together provide an opportunity for certain advantages to be tagged along with the The following are the advantages of the rule in Foss v. Harbottle:(i) Recognition of the separate legal personality of the Company (ii) Preservation of the Right of Majority to decide (iii) Multiplicity of futile suits avoided

BIBLIOGRAPHY

Books: 1) Geoffrey Morse, Palmers Company Law, Sweet and Maxwell, UK, 2007 2) L. S. Sealy and Sarah Worthington, Sealy's Cases And Materials In Company Law, Oxford University Press, Oxford, 9th edn., 2010 3) Sarah Worthington, Gower and Davies, Principles of Modern Company Law, Sweet and Maxwell, UK, 8th edn., 2008 4) Stephen D. Girvin and Sandra Frisby et.al, Charlesworths Company Law, pg no. 511, Sweet and Maxwell, UK, Eighteenth edn, 2010 5) Dr. Ashok Sharma, Company Law and Secretarial Practice, V. K. Enterprises (India), New Delhi, 2010 6) A. J. Boyle, Minority Shareholders Remedies, Cambridge University Press, University of London, 2002

Articles/Journals/Essays: 1) R. Gregory, What Is the Rule in Foss v. Harbottle?, Vol. 45, The Modern Law Review, pg. 584-588, No. 5 (Sep., 1982) 2) K. W. Wedderburn, Shareholders' Rights and the Rule in Foss v. Harbottle, Vol. 15, The Cambridge Law Journal, pg. 194-215, No. 2 (Nov., 1957 3) Sealy, The Problems of Standing, Pleading and Proof in Corporate Litigation in B. G. Pettet (ed.), Company Law in Change (Stevens & Sons, 1987), p. 2. 4) European Business Law Journal, MayJune 2000, pgs.19, in respect of the application of conflicts of laws concepts to the Foss v. Harbottle rule.

Websites:
1) http://www.jstor.org/stable/1095200 2) http://www.jstor.org/stable/4504462