Majority Rule and Minority Rights | Exception of Foss vs Harbottle Case

Introduction

The principle of majority rule fills much of company law as it is associated with the key issue of who owns and controls the company. The minority shareholders are comparatively in a weaker position than majority shareholders within the company’s matrix. The Article of Association (AoA) and Memorandum of Association (MoA) of the company create a contractual relationship between the company and its members and the members inter se. The legal effect of this contractual relationship is that a member agrees to be bound by the decisions of the majority taken at a general meeting of the company. In company management, considerable authority and power are given to those who control the board of directors or the general meeting. When the minority shareholders are ignored on a regular basis in the decision-making of the company and they are often treated harshly and wrongfully by majority shareholders then there is mismanagement and oppression in the company.

In this situation, the law seeks to strike a balance between the principle of majority rule on the one hand and protecting minority shareholders against abuse of power on the other.

The Rule in Foss v Harbottle (1843)

The Proper Plaintiff Rule

The ‘proper plaintiff rule’ was established in the landmark case of Foss v Harbottle. According to the Proper Plaintiff Rule, “If any wrong is done to the company or company suffers any loss due to the fraudulent or negligent acts of directors or any other outsider, then in such a situation in order to enforce its rights the legal action can be brought either by the company itself or by way of derivative action.”

Whereas the members of the company or any outsider cannot sue on its behalf because of the principle of a separate legal entity which considers the company as a separate legal person from all the members of the company, so it can sue and be sued in its own name. This is the only reason why only a company can bring legal action or institute legal proceedings, not any member, in order to cover losses that have been suffered by the company. A member of the company can take legal action on its behalf against the wrongdoer only if they are authorized to do so by the board of directors or by an ordinary resolution passed in a general meeting.

The origin of the formulation of this rule is found in the doctrine of indoor management. According to Indoor Management Doctrine, the court will not interfere with the internal management of companies acting within their powers and it has no jurisdiction to do so. It is settled law that in order to redress a wrong done to the company or to recover money damages alleged to be due to the company, the action should prima facie be brought by the company itself.

Majority Rule Principle

The power of internal management of a company is vested in the directors, they alone can exercise those powers. Shareholders can control the exercise of power in the following two ways –

  1. By altering the Articles of Association;
  2. By refusing to re-elect the directors of whose power they disapprove.

If the alleged wrongful act or omission can be confirmed or ratified by a simple majority of members in the general meeting then in those cases the court is reluctant to interfere. However, the application of these strict principles appeared to be harsh and unjust for the minority shareholders as though a substantive right has been provided to them still they were barred from obtaining justice under the company and minority members have no standing due to their lesser strength. Thus, once a resolution is passed by the appropriate majority of members, a dissenting member will nevertheless be bound by it.

Exceptions to the rule in Foss v Harbottle (1843)

To mitigate the harshness of the rule, four exceptions to the rule of proper plaintiff have been laid down where the litigation will be allowed:

  1. Where the complaint amounts to a fraud on the minority, in such a case if the wrongdoers are themselves in control of the company the minority shareholders may be permitted to bring a derivative action in the name of the company;  Burland v Earle (1902)
  2. Where the act complaint is wholly illegal and ultra vires the company;  Prudential Assurance Co Ltd v Newman (1982)
  3. Where the matter in issue requires the sanction of a special majority, or there has been non-compliance with a special procedure; Edwards v Halliwell (1950)
  4. Where a member’s personal rights have been infringed. Pender v Lushington (1877)

There are the following two types of shareholder action –

  1. Derivative Action – Where the claim is brought to vindicate a wrong done to the company under the four exceptions.
  2. Personal or Representative Action – Where a shareholder complains that a wrong has been done to him personally.

All these exceptions help in protecting basic minority rights that are necessary to safeguard regardless of the majority’s vote.

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