What are the justifications for the rule in Foss v Harbottle (1843) 67 E.R. 189?
Case summary:
Facts:
Victoria Park Company was established in 1835 in relation to the acquisition of 180 acres (0.73 mk2) of land near Manchester for the establishment of the Victoria Park, Manchester. Subsequently, the company was incorporated by “An Acy for Establishing a Company for the Purpose Laying Out and Maintaining an Ornamental Park within the Townships of Rusholme, Charlton upon Medlock and Moss Side, in the County of Lancaster” and Royal assent was granted on the 5 May 1837.
Foss and Turton were two minority shareholders in the company. They were of the view that the property of the company had been misapplied and wasted and various mortgages were given improperly over the company’s property. The claimed against five company directors; the solicitors and the architect.
Claim:
Their claim was based on the following grounds:
Fraudulent transaction under which the assets of the company were misapplied;
There had ceased to be a sufficient number of qualified directors to make up a board; and
The company had no clerk or office; and that is such circumstance the shareholder had no power to take the property out of the hand of the defendant who were directors expect by commencing litigation.
The reliefs being sought by the Plaintiffs include:
That the defendants should be held accountable to the company; and
That receiver should be appointed.
Result:
The claim was dismissed.
Held:
The continuation existence of board de facto must be intended;
The possibility of convening a general meeting of shareholders capable of controlling the acts of an existing board was precluded under the not precluded under the action;
There was nothing to prevent the company from obtaining redress in its corporate character in respect of the matter complained of;
The Plaintiffs could not sue in a form of pleading which assumed the practical dissolution of the company.
The result of this case establishes that when a wrongdoing is done to a company, even if the wrong doers are its directors, it is only the company that has standing to sue.
If effect the court established two rules:
The “proper plaintiff rule”- if the alleged wrong can the company may be vindicated by the company alone; the company is the one that can enforce its rights, shareholders use ordinary resolution to start litigation in the company’s name.
The majority rule principle’- if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not interfere. What the majority decides for the company is what will happen. Equity recognises the issue – wrong doer control. This is an issue when the directors own majority of the shares.
However, there are certain exceptions to the rule in Foss v Harbottle, namely:
Ultra-vices or illegal acts;
Transactions requiring special majorities;
Personal rights; and
The “fraud on the minority” exception. – Edwards v Halliwell 1950- this is the only true exception. Where wrong doers where in control.
Shareholder will get a right of action from the company to enforce its right in its name- derivative action. a claim for standing has to be made first. – CA Part 11.
Universal Project Management Services Ltd v Fort Gilkicker Ltd [2013] All E.R. 313 – double derivative action still permitted in equity- another company can bring an action on behalf of another company for insider wrongdoing.
North West Transportation Co Ltd v Beattie (1887) L.R. 12 App. Cas. 589 – RATIFICATION OF CONDUCT. Claim would not work if the conduct has been ratified.
How effective were the common law exceptions to the rule in Foss v Harbottle (1843) 67 E.R. 189 and did they provide adequate protection for the aggrieved minority?
Is it right that the majority possess so much power in English company law? Does the law need to redress further any imbalance?
What is the formal process for bringing a derivative claim under Part 11 CA 2006?
The Part 11 Procedure:
The procedure applicable to derivate actions under the Part 11 procedure is governed by the Act and by recent amendment made to the Civil Procedures Rules (the CPR). The combined effect of these rules is as follows.
Stage one- commencement
A derivative action under the Part 11 procedure must be commenced by the issue of both a claim form (as case with ordinary proceedings) and an application by the shareholder for the court’s permission to continue the claim. The application must be supported by written evidence.
The Company must be made a defendant to claim, despite the fact that derivative actions, by definition, do not involve claims being made against the company. This is a technical requirement that ensures that the company is bound by any judgment given in the action.
The shareholder must then notify the company of the action by providing the company with a copy of the claim form and application notice. This ‘notification’ does not constitute formal services of the claim. Consequently, the company is under no obligation, at this stage, to respond in any away (although, as set out below, there might be scope for it to participate if it so chooses).
There is no requirement that the affected director be notified of the claim as well as the company. It will therefore be important for the companies who receive commencement. Companies should also consider whether to give notice under any relevant directors’ and officers’ (D&O) policies.
Stage two, part one – determination ‘on the papers’
After commencement and notification, the court will consider whether the shareholder’s application for permission and the evidence filed in support show that the shareholder has a prima facie case. The shareholder cannot take any steps in the action until the court determines this question.
The court will first consider this question ‘on the papers’ filed by the shareholder. The Act is clear in providing that, where evidence is concerned, the court must determine the question of whether a prima facie case exists by reference to evidence submitted by the shareholder alone (in order to avoid burdening the company and the directors with having to prepare evidence at this early stage).
There may be scope for the company and/ or the directors to make submissions to the court. However, the new practice direction to the CPR states that if the company volunteers a submission without invitation from the court, the company will not normally be allowed any costs relating to its submission.
Stage two, part two- possible oral hearing
If the court determines against the shareholders on the papers, the shareholder can request an oral hearing to reconsider the question.
Stage three- full hearing of shareholder’s application
The hearing of the shareholder’s application will proceed in the manner of an ordinary interim application, with both sides being afforded the opportunity to submit evidence and submissions.
What factors does a judge have to consider in deciding whether or not to grant permission for a derivative claim to continue?
The court must consider whether to grant permission to the shareholder to continue the claim by reference to a number of factors. First, the court must refuse permission if it concludes that:
A person acting in accordance with the new section 172 director’s duty (i.e., to promote the success of the company) would not continue the action;
The action concerns a future act that has been authorised by the relevant decision-making body in the company (which would either be the shareholders or directors, depending on the act in question); or
The action concerns a past act that was authorised by the relevant decision-making body prior to its being carried out, or ratified after it was carried out.
Second, in reaching its decision, the court must also take into account a number of factors including:
Whether the shareholder is acting in good faith in bring the action;
Whether the act that is the subject of the action will in the future be authorised or ratified by the company has decided not to pursue the action.
Finally, the court must have ‘particular regard’ to any evidence regarding the view of shareholders with no personal interest in the action.
If the court ultimately considers that permission should be granted, the action will continue in the same way as ordinary proceedings. In such cases, the company may be ordered by the court to indemnify the shareholder against liability for costs incurred in the permission application or in the derivative claim, or both. On the other hand, if permission is denied, then the action will be unable to proceed and the court will ordinarily order the shareholder to pay the company’s and/or the directors’ costs of defending the application. However, costs incurred in investigating the shareholder’s claim will not ordinarily be recoverable.
Has the statutory derivative claim alleviated the problems previously created by the common law?
What alternative does section 994 CA 2006 (old S 459) provide for minority shareholders and what are the justifications for this?
How effective is section 994 CA 2006 as a remedy for the aggrieved minority?
Group Discussion Question 1:
‘The procedural rule in Foss v Harbottle (1843) 2 Hare 461, 67 ER 189 caused significant damage to the interests of the minority. The recent changes brought about by the Companies Act 2006 have done very little to remedy this problem’.
Discuss
Group Discussion Question 2:
‘A natural consequence of acquiring shares in a company is that a member implicitly agrees to be bound by the principle of the majority rule. As such, it stands to reason that the legal protection afforded to the interests of the minority has, and ought to have been, approached and developed with caution by the courts.’
Critically analyse the above.
Group Discussion Question 3:
‘The view has been expressed that Part 11 of the Companies Act 2006 will lead to a spate of speculative or vexatious litigation.’
Discuss
