"The rule in Foss v Harbottle is of very little relevance following the introduction of s459 of the Companies Act 1985." Discuss.
The rule in Foss v Harbottle is of very little relevance following the introduction of section 459 of the Companies Act 1985. Discuss.
The general principle is that the power and control of a company is vested in the shareholders holding the majority of the voting power and having control of the company, that is, shareholders holding at least three-quarters of the voting power. This general principle is known as the rule in Foss v Harbottle 1, which states that only the company can sue for redress if a wrong has been done to it, not minority shareholders. However, there are exceptions to this rule, as demonstrated in case law below, and since the introduction of section 459 of the Companies Act (CA) 1985, again demonstrated by subsequent case law. Criticisms of the actions based upon exceptions to the rule in Foss v Harbottle and under section 459 led to recommendations by the Law Commission, as discussed below.
The facts in the case of Foss v Harbottle involved two shareholders in a company that was formed to buy land for a pleasure park, who sued the defendants, being directors and other shareholders, for taking certain actions to defraud the company, including selling land at an increased price. It was held that as the board of directors was still in existence, that it was the board that should call a general meeting to make a claim in this instance, and therefore the claimants’ action could not stand.
This case effectively denied minority shareholders the right to protection or to make ‘derivative’ claims.
The reasons for the application of the rule in Foss v Harbottle were, firstly that the court should not become involved in matters involving disputes over company business policy, that disputes between members should have been resolved between themselves at a general meeting, and thirdly, that otherwise there would have been the danger of multiplicity of claims, as stated by James LJ in Gray v Lewis 2.
There were certain exceptions to the rule in Foss v Harbottle, which are that a simple majority of members cannot ratify an act by the company which is illegal or ultra vires. After the introduction of the CA 1985, an individual member of a company can apply to the court for an injunction to stop directors from entering into such transactions under section 35; also if the act being complained of can only be ratified by a special or extraordinary resolution, as shown in Edwards v Halliwell 3 in which a trade union was bound by its rules that any increase in the members contributions could only be ratified by a two-thirds majority, and therefore when a simple majority to undertake such a task it was held that the claimants as minority members could validly bring such a claim.
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1 [1843] 2 Hare 461
2 [1873] 8 Ch App 1035 at 1051
3 [1950] 2 All ER 1064
Finally if there has been a fraud upon the minority shareholders by the company, there are certain examples of the how the rule in Foss v Harbottle can be avoided; firstly if the company has been defrauded, as shown in Menier v Hooper’s Telegraph Works Limited 4 in which one company having the Portuguese government’s concession to lay cables which had been transferred to that company bought cables from another company without that concession, and the director of the latter company tried to petition to voluntarily wind it up, to stop it suing for loss of profit. It was held that there was no bar to such a claim from a minority shareholder in that company, as the majority sought to obtain a benefit for themselves at the expense of the minority.
Further examples include Cook v Deeks 5 in which the directors of a construction company tried to obtain a contract with a railway in their own names rather than of the company, to obtain the benefit thereof, at the expense of the minority, and therefore it was held there was no bar to the claimant’s claim, being a shareholder.
Another example is if the minority individual shareholders have been defrauded, which include firstly if there has been an expulsion of the minority, as in Brown v British Abrasive Wheel 6, in which the majority altered the articles of association to allow the majority of the shareholders to buy out the shareholdings of the others, to enhance capital. The claim of the minority was not barred as this amounted to a fraud upon the individual minority members.
Secondly, an inequitable use of the power of the majority is not permitted, as shown in Clemens v Clemens Bros 7, in which a resolution was passed amongst the directors of a small family company, including an aunt to increase the company’s share capital, which would have reduced the shareholding of the claimant to under 25%. The aunt concluded with the resolution at an extraordinary general meeting, but it was held that the aunt could not exercise her majority voting capacity in any way she pleased, and therefore the claimant’s action was not barred.
In Pender v Lushington 8, the claimant had exceeded the voting limit of 100 votes by registering his shareholding in several nominee’s names, but lost a resolution a the general meeting when he refused to accept the nominee’s votes, and it was held that he could bring such a claim against the directors, the shareholders and the company.
In the case of negligence, it was originally held that a minority shareholder could not sue the company on the basis of negligence rather than fraud, as in Pavlides v Jensen 9 in which the directors of a cement company sold at a price which the claimant claimed was negligently and significantly under value.
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4 [1874] 9 Ch App 350
5 [1916] 1AC 554
6 [1919] 1 Ch 290
7 [1976] 2 All ER 268
8 [1877] 6 ChD 70, Court of Appeal
9 [1956] 2 All ER 518
However, in Daniels v Daniels 10, Pavlides was distinguished and it was stated per Templeman J that if a minority shareholder had no other remedy than to sue the directors or the company in the instance where there had been intentional or unintentional, fraudulent or negligent use of powers by the directors, then he should be able to sue. In this case, the directors sold to Mrs Daniels (a director) at a price which they knew or ought to have known should have been significantly higher than it was. It was held that this claim could proceed as an exception to the rule in Foss v Harbottle, as one of the directors had obtained a significant profit, which distinguished it from Pavlides.
This approach was also accepted in Prudential Assurance Co. Limited v Newman Industries Limited (No. 2) 11, which was a lengthy and expensive trial to establish whether the minority shareholder had the necessary locus standi to bring the claim, in which the claimant brought a derivative action against two directors for allegedly defrauding a third out of £440,000, and that the shareholders were misled into approving a resolution to do this at a general meeting. Vinelott J referred to East Pant Du United Lead Mining Co. Limited v Merryweather 12, in that if no good reason had been provided as to why the wishes of the majority should not be given effect to then the claim should be struck out or stood over while a general meeting is called.
However, in Prudential the Court of Appeal held that if the only loss suffered by the shareholder was a reduction in the value of his shareholding, then he had no locus standi to sue.
In Smith v Croft (No. 2) 13, it was noted that the amount of shareholders for the claim and against it was a factor to be considered when looking at whether a derivative claim could still stand, and in this case the claim was brought by the minority shareholders in respect of an alleged illegal assistance for the purchase of the company’s shares by another company controlled by one of the directors, but could not be pursued as a derivative claim because the majority of independent shareholders were against the bringing of the claim.
Section 459 of the CA 1985 lays down the primary remedy for minority shareholders, in relation to ‘unfairly prejudicial conduct by the majority’ and states A member of a company may apply to the court by petition for an order under this Part [Part XVII] on the ground that the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of some part of the members (including at least himself) or that any actual or proposed act (including an act or omission on its behalf) is or would be so prejudicial. Section 459 replaces section 210 CA 1949, in which the only remedy was to petition to wind up the company, which is now section 122(1)(g) Insolvency Act (IA) 1986.
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10 [1978] 2 All ER 89
11 [1980] 2 All ER 841
12 [1864] Hem & M 254
13 [1988] Ch 114 ChD
Originally, section 459 was applied in the manner that the claimant should have suffered prejudice as a member only, not as a director, but this has now been widened in view of the courts recognising that members may have differing interests with regard to their rights (Re A Company (No. 00477 of 1986 14).
In O’Neill v Phillips 15, it was held by Lord Hoffman in the House of Lords that unfairness to a member requires a breach of the terms upon which it had been agreed that the company affairs should be conducted. Lord Hoffman disagreed with the Court of Appeal’s finding that the defendant should buy the claimant’s shares, as there had been no agreement to give the claimant more shares, and accordingly that it was not unfairly prejudicial for the defendant to remove the claimant as a managing director or stop him from receiving equal profits.
The facts of the case were that the defendant employed the claimant, a manual worker, and initially awarded him a 25% shareholding, which led to the claimant eventually becoming a managing director, and being able to draw 50% of the profits, with a view to a promised 50% shareholding. The defendant wanted to regain control of the company when there were financial problems and stated a meeting that he would no longer receive equal profit sharing.
The idea that Parliament intended for the courts to take the principle of ‘fairness’ into consideration when applying section 459 was noted by Lord Hoffman in Re Saul D. Harrison and Sons plc, Re 16, and the term ‘legitimate expectation’ was referred to, and that there had to be a balance on equitable principles whether it was unfair for a majority to exercise their power under the articles of association to the prejudice of another member, but that it also had to be taken in a commercial context. In this case, the claimant of a family-run business brought a claim that the directors, her cousins, had run the business at a loss to finance their own remuneration when they should have sold to distribute the company’s assets to the shareholders.
The Court of Appeal held that in the context of a commercial relationship, this conduct was not ‘unfairly prejudicial’, but explained with reference to Re Elgindata Limited 17 that the courts were very reluctant to accept that managerial decisions amounted to ‘unfairly prejudicial conduct’. In this case, the claimants alleged that the directors excluded them from management, paid dividends late and awarded themselves extravagant remuneration.
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14 [1986] BCLC 376
15 [1999] 1 WLR 1092
16 [1995] 1BCLC 14, 17-20
17 [1991] BCLC 959 at 993
However, in Sam Weller & Sons Limited 18, the low payment of dividends was held to be ‘unfairly prejudicial’, and it has been established that a minority could bring a claim upon such conduct that affects the interests of all members. In this case, the claimants brought an action against their uncle who was the majority shareholder, whose conduct had caused the dividends to fail to increase in thirty-seven years. The court looked at Re Cumana Limited 19 and noted that a proposed rights issue could amount to unfairly prejudicial conduct.
In Re BSB Holdings Limited (No. 2) 20 it was held that ‘unfair prejudice’ is not restricted to breaches of fiduciary duty or breaches of articles of association, but also includes proposals from the majority not made in good faith which affect different groups of shareholders. In this case, the defendants (BSB) merged with another company causing that company to have the same 50% shareholding as the original group of shareholders in BSB, which the original group claimed was ‘unfairly prejudicial’. The court held that the directors had failed to comply with section 317 CA 1985, which imposes the duty of disclosure upon directors.
Re London School of Electronics Limited 21 has established that if a majority takes the students of the company with them to another set up by the majority, that conduct can be held to be ‘unfairly prejudicial’.
The Law Commission 22 has sought to offer solutions to the problems that have been encountered by establishing the exceptions to the rule in Foss v Harbottle. The Law Commission identified two problems; the obscurity and complexity of the law relating to the ability of a shareholder to bring proceedings on behalf of his company, and the efficiency and cost of the remedy which is most widely used by minority shareholders to obtain some personal remedy in the event of unsatisfactory conduct of a company’s business, being section 459.
The Law Commission suggested that the rule in Foss v Harbottle should be replaced by a simpler and more modern procedure, by the introduction of a new derivative action to be governed by the court, including more modern, flexible and accessible criteria to replace the fraud upon the minority exception to the rule in Foss v Harbottle, together with administrative proposals for streamlining the process of such litigation.
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18 [1990] BCLC 80
19 [1986] BCLC 430) at p435
20 [1996] 1 BCLC 155 ChD
21 [1986] Ch 211 ChD
22 Law Com. No. 246; London Stationery Office 1997
In relation to section 459, the Law Commission suggested that the length and costs of actions under section 459 should be brought under control via case management techniques by the courts, that there should be certain presumptions made by the courts that certain conduct under section 459 would be ‘unfairly prejudicial’, the introduction of a limitation period for such claims and the remedy of winding up added.
The new derivative action suggested by the Law Commission was that a statutory provision should specify the causes for which such an action may be brought, which include: negligence, default, breach of duty or trust by a director, or if a director puts himself in a position where his interests conflict with those of the company. The Law Commission also put forward a list of considerations for a court to take into account when deciding whether a claim should continue, including whether the claim has been brought in good faith; whether it is in the interests of the company, taking account of the director’s view on commercial matters; whether the director’ activity should have been approved in a general meeting; whether the action has already been considered at a general meeting and not pursued; the opinion of an independent commercial organ that such action should not be pursued and whether any other alternative remedy to the claim is available.
The subsequent cases of Re Citybranch Limited, Gross and others v Rankind and others 23 has demonstrated that the Court of Appeal, in the context of a section 459 claim, is prepared to regard one company’s affairs as that of another in the same group with regard to being able to grant relief to a minority shareholder bringing the claim. In this case, two families (Gross and Rankind) owned 50% shareholdings in a parent company with two other wholly owned subsidiaries, one of which had only Mr Rankind and Mr Gross as the directors and in the other Mr Gross was an additional director.
The Rankinds petitioned to wind up the parent company under section 122(1)(g) IA 1986 and the Gross family claimed under section 459 to stop this, and asked that the Rankinds sell their shares to them by way of relief. The basis of the claim was that the threat to wind up the company put pressure upon the Gross family to sell their shares to the Rankinds, that there was a breach of fiduciary duty in raising finances to pay corporation tax, that there was an improper use of funds and a misappropriation of funds.
The Court of Appeal held that the conduct being complained of was capable of causing prejudice to the shareholders of the parent company, as per Nourse LJ there will be a risk of diminution of value of the company’s investment in the subsidiary, which in turn will mean actual or potential prejudice to the interests of the shareholders in the company.
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23 [2004] EWCA (Civ) 815
In conclusion, it was originally thought that section 459 accorded significant protection for interests of minority shareholders in the absence of such protection being provided in the company’s articles of association. It can be seen from the above case that the Court of Appeal has now interpreted section 459 in a broad way and extended the rules to include a new rule that the directors’ conduct of a subsidiary can now be actionable by shareholders of the parent company if there are common directors to both the subsidiary and the parent companies and if there is conduct being complained of that is or could be ‘unfairly prejudicial’ to interests of shareholders in the parent company.
It is submitted that the usual procedure would have been a derivative action as an exception to the rule in Foss v Harbottle, but that an action under section 459 is much less cumbersome and expensive and therefore arguably much better for the minority shareholder to utilise, and from the latest authority it appears at the moment that section 459 is being favoured with the result that actions as exceptions to the rule in Foss v Harbottle are becoming of less importance than prior authorities have suggested.
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