Foss v. Harbottle

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Introduction

‘To win in a democracy, you must have a majority.’ Similarly, a company, which is an association of individuals, acts in accordance with the majority of its members’ decisions. The minority, or dissenting members, are bound by the decisions unless and until they can demonstrate that the majority’s power has been abused or they have prejudiced the company’s interests. At general meetings, members of a company can express their opinions by voting for or against proposed resolutions. The resolution, however, binds all members, including those who vote against it.

All equity shareholders of a company have voting rights, according to section 47 of the Companies Act of 2013. They appear to have authority since they are in charge of assets. If a special resolution is required, it must be approved by a majority of 3/4 of the total shareholders. Minorities are only left with the option of following them. The basic principle governing the management of a company’s affairs is that the courts will not, in general, intervene at the request of a shareholder in matters of internal administration; and that the courts will not interfere with the management of a company by its directors so long as they are acting within the powers conferred on them by the company’s Articles.

One of the most difficult problems confronting current company law is the protection of minority shareholders within the realm of corporate activities. The goal must be to achieve a balance between the company’s effective control and the small and individual shareholders’ interests. A proper balance of the rights of majority and minority shareholders is essential for the smooth functioning of the company. 

The case of Foss v. Harbottle is a pivotal precedent in English company law. According to the ruling established in this case, if the company suffers a loss as a result of the negligent or fraudulent activities of its members or outsiders, the action cannot be initiated by the minority members on behalf of the company or as a derivative action.

Facts of the Case

  1. In the year 1985 a company named “Victoria Park Company” was set up with the goal of purchasing 180 Acres of land in Manchester which later became “Victoria Park, Manchester”. The company was incorporated for the purpose of setting out and maintaining the attractive park within the townships of Rusholme, Chorlton upon Med-lock, and Moss Side, in the county of Lancaster, by an act approved by Parliament in 1837.
  2. However, in contrast to the actual work of allegedly enclosing and planting the land in an ornamental and park-like manner, and constructing houses thereon with attached gardens and fields, and then selling, renting, or otherwise disposing of them, the company’s directors and others were engaged in the misappropriation of the company’s property. 
  3. The two minority shareholders Richard Foss and Edward Starkie Turton decided to take a legal action on behalf of themselves and all the other shareholders or proprietors of shares in the company, and therefore, filed a claim against the five directors (Thomas Harbottle, Henry Byrom, John Westhead, Richard Bealey) ,the solicitor (Joseph Denison), and architects (Thomas Bunting and Richard Lane), and also against H.Rotton , E.lloyd, T.peet, J.Biggs and S.Brooks and their assignee’s on the following grounds: 
  1. Misappropriation of assets of company
  2. The insufficiency of qualified directors in the company who can actually make up the board
  3.  The company had no clerk or office.

As a result of these conditions, the shareholders had no option but to file legal action against the directors in order to wrest control of the company from them.

Issue Involved in the case

The following issues were involved in the case:

  1. Whether the minority company members could file a suit on behalf of the company?
  2. Whether the majority shareholder can be held accountable for their deeds?

Arguments of the parties

  1. The petitioners contended that in order to support the company, the act of incorporation was passed, but the directors sought to satisfy their own desires. They further argued that according to the Act of incorporation of the company, directors should have acted as trustee of the company. Thus, they should be held liable for misappropriation of property. They further claimed that the act allowed the directors to sue anyone who harmed the corporation, but that it did not allow workers or outsiders to sue the board of directors.
  2. The defendant argued that the alleged harm is to the entire corporation and not to the plaintiffs exclusively. They further added that the individual members of the board cannot assume themselves the right to sue in the name of the corporation as the law requires the corporation to sue in its own name and in its corporate character thus, the petitioner did not have the locus to file the present suit. 

Summary of Court Decision and Judgment

Wigram VC denied the shareholders’ claim, arguing that as both the company and its shareholders are considered to be independent legal entities, no legal action against the damage done to the corporation can be filed by an individual shareholder or other outsiders. 

The court effectively created two rules. To begin with, the “appropriate plaintiff rule” states that a wrong done to the company may be redressed solely by the company. The reason shareholders cannot sue is that the company, not its members, has incurred injury, hence it is up to the corporation to sue or take legal action against those members who have misused the company’s property and that few individual members cannot assume upon themselves the right to sue on behalf of the corporation. Second, the “majority rule concept” provides that the court will not intervene if the alleged violation can be affirmed or ratified by a simple majority of members in a general meeting. Minorities must demonstrate that they have exhausted all internal avenues for redress, as he has stated that the courts will not intervene in circumstances when the majority of shareholders can confirm the irregular acts. 

Thus, the case establishes a common principle of Company Law that a shareholder cannot ordinarily make a claim to recover any reflected loss – a decrease in the value of his or her shares, unless the decrease is caused by an actionable loss sustained by the corporation. The right course of action for the company is to take legal action and retrieve the loss, restoring the value of the shares.

Critical Analysis of the judgment in the light of Indian Scenario

The ruling established in Foss v. Harbottle is justified by the fact that the majority will triumph. When a shareholder joins a corporation, he or she commits to be subject to the majority’s will. The regulation effectively protects the majority’s ability to select how the company’s affairs should be run. Furthermore, because a corporation is a legal entity, the action is vested in the corporation and cannot be filed by a single shareholder. When a corporation can file a lawsuit on its own behalf to recover property from its directors or officers, or from anybody else, that corporation is the proper plaintiff and the sole suitable plaintiff.

Another benefit of the rule is that if every individual shareholder could sue someone who had harmed the corporation due to a violation of duty, there would be as many lawsuits as there are shareholders. There would be no end to the legal proceedings, and a huge amount of time and money would be wasted. Also the judgment highlights that if the alleged irregularity can be approved by the majority later, it is pointless to pursue legal action unless the majority agrees in a general meeting. 

However, the application of these strict principles appeared to be incredibly harsh and inequitable for minority shareholders, as despite having a substantive right, they were still barred from seeking justice under the rule and were forced to accept the majority’s wrongdoings because they controlled the company and minority members had no say due to their small numbers. It is because the minority is unprotected under the rule, exceptions have emerged and statutory safeguards have been enacted to provide some protection for the minority.

Application of the rule in the Indian Context

The rule does not apply entirely to the Indian situation, because minority members’ rights are safeguarded by the law. When a minority shareholder can file an action against the corporation because the business’s actions impair its interests, the government and the courts have clearly defined the limitations. 

In Rajamundhry Electric Supply Corpn. v. A. Nageshwar Rao, the honourable Supreme Court stated that the conduct with which the defendants are charged is a damage to the entire corporation, not just to the plaintiffs. In such instances, the corporation should sue in its own name and in the capacity of a company. Individual members of a corporation do not automatically assume the right to sue in the corporation’s name. The corporation and the aggregate of the corporation’s members are not the same thing in law.

In ICICI v. Parasrampuria Synthetic Ltd, the Delhi High Court stated that applying the Foss v. Harbottle rule mechanically and automatically to Indian settings, conditions, and corporate realities would be incorrect and deceptive. The established factual base of shareholder power and majority shareholder power, centred upon private individual enterprise and engaging a large number of small shareholders, is substantially different from the ground realities in the countries of its birth. The Indian corporate sector does not include a big number of small private investors, but instead relies heavily on financial institutions, which account for at least 80% of all capital. These financial institutions are the ones who give the complete funding for the company’s continued existence and operations therefore, to exclude them or to render them voiceless on an application of the principles of Foss v. Harbottle Rule would be unjust and unfair.

Exceptions to the Rule

The majority rule, on the other hand, does not always win. The rule in Foss v. Harbottle applies to circumstances in which companies have the authority to confirm managerial misconduct. However, there are some actions that require the approval or affirmation of a majority of shareholders. In such instances, each shareholder has the right to litigate to enforce the company’s obligations. As a representative of the corporate interest, he brings the action. The following exceptions are accepted under the Law: 

  1. Ultra Vires: A shareholder has the right to sue the corporation and its officers for actions that are unlawful and cannot be sanctioned by a majority of the shareholders. The rule in Foss v. Harbottle only applies if the firm is acting within its legal authority. In the case of Bharat Insurance Company Ltd. v. Kanhaiya Lal, the court observed that the general rule is that in all matters concerning a corporation’s internal management, the corporation is the best judge of its own affairs, and the Court should not intervene. However, putting the company’s assets to work isn’t just an issue of internal management. Directors are accused of acting beyond the law in their use of the company’s funds. In these cases, a single member can file a declaratory judgement action to determine the true construction of the article in dispute.
  2. Fraud on Minority: When the majority of a company’s members use their authority to defraud the minority, even a single shareholder can bring charges against them. The fraud need not be a tort under common law, but it must involve an unconscionable use of the majority’s power that results in financial loss or unjust or discriminatory treatment of the minority. It must be far more serious than the majority’s failure to act in the company’s best interests, which will result in the Court annulling a resolution altering the company’s memorandum or articles.
  3. Acts requiring Special Majority: Certain actions can only be carried out by a special resolution passed at a general meeting of shareholders. As a result, any member or members can file an action to limit the majority if the majority intends to do so by adopting just an ordinary resolution or without issuing a special resolution in the manner required by law as held in the case of Dhakeswari Cotton Mills v. Nil Kamal Chakravarty. 
  4. Wrongdoers in control: Even if a clear wrong has been done to the company, the controlling shareholders will not allow legal action to be taken against the offender. In such instances, any member or members may initiate an action in the company’s name to protect the company’s interests. This was recognised in Foss v. Harbottle: If a case should arise of injury to a corporation by some of its members, for which no adequate remedy remained, except a suit by individual corporators in their private characters, and asking in such character for the protection of these rights to which they were entitled in their corporate character. 

This exemption to Foss v. Harbottle applies wherever the defendants are demonstrated to be able to prevent the action from being taken by the company by manipulating their position within the corporation. It has been recommended that the idea be extended to the point where, in the event of a director’s breach of fiduciary duty, every shareholder might be considered an authorised organ to bring the claim.

  1. Individual Membership Right: Every shareholder has some personal rights against the corporation and his fellow shareholders. A great number of these rights have been granted to shareholders by the laws themselves, although they may also derive from the articles of association. Individual membership rights are frequently referred to as such rights, and the rule of majority does not apply to them. 

In Nagappa Chettiar v. Madras Race Club, the Court held that a shareholder has the right to enforce his or her individual rights against the corporation, such as the right to vote, the right to have his or her vote recorded, or the right to stand for election as a director of the company. 

Individual membership rights mean that individual shareholders can insist on strict adherence to legal laws, statutory regulations, and memorandum and articles requirements that cannot be waived by a simple majority of shareholders. Every shareholder has the ability to enforce this right in his or her own name. 

  1. Oppression and Mismanagement: The Law does not define the terms “oppression” or “mismanagement.” For the purposes of Company Law, the meaning of these words should be interpreted in a wide, generic sense rather than in a strict literal sense. “The heart of the matter appears to be that the conduct complained of should at least, include a visible deviation from the rules of fair dealing, on which every shareholder who entrusts his money to the company is entitled to rely,” the court observed in Shanti Prasad v. Kalinga Tubes. 

As held in Re. Hindustan Co-operative Insurance Society Ltd, attempting to force new and more risky objects upon an unwilling minority may amount to oppression in some situations.

Conclusion 

Company law, like that of a democratic democracy, provides adequate safeguards for minority shareholders whose rights are trampled by the majority. However, in the realm of corporate concerns, the value of a single individual’s shareholding matters, and if a single individual owning a majority of the ownership votes in favour of a scheme of arrangement, it is binding on numerous individuals. In all decision-making processes, majority leadership does not always win. The ruling in Foss v. Harbottle applies to situations in which a corporation’s actions harm a minority, and the majority can get away with it because they are “in majority.” As a result, the concepts established in this case are not practically applicable in India.

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