Introduction: The Foss v. Harbottle case stands as a cornerstone in corporate law, particularly regarding the rule of majority in corporate governance. This article delves into the implications of this landmark case, examining its influence on minority shareholder rights, exemptions, and relevant legal precedents.
A corporation is a juristic person endowed with a distinct legal entity status in contrast to its constituent members, who are referred to as “members of the company.” The Member Shareholders and the Board of Directors act as the company’s representatives when making decisions. Additionally, the company makes determinations concerning the pursuit of litigation. According to the Companies Act of 1956, shareholders with a majority of shares rule the company. The principle of majority is acknowledged in the seminal case of Foss v Harbottle. The minority shareholders were bound by the decision that was made by the majority. As of now, under the Companies Act 2013, this principle has been superseded and minority shareholders have been granted more authority. The Companies Act of 1956 contained provisions designed to safeguard the interests of minority shareholders. However, the minority has been unwilling or unable to do so for lack of time, resources, or capacity—be it financial or otherwise. As a consequence, numerous instances of minority shareholder oppression arose. The safeguarding of minority shareholders’ rights through the Companies Act of 2013 represents a significant development in the ongoing dispute between majority and minority shareholders.
Rule of Majority (Rule in Foss v Harbottle):
Companies’ administration of their affairs now adheres to the principle of “rule by the majority.” A resolution is approved by the members by a simple majority or a 3/4 majority (special majority) on a variety of topics. Once passed by a majority of the company’s members in accordance with the bylaws, it becomes legally binding on every member. When shareholders request judicial intervention in internal affairs matters pertaining to the company, courts generally refrain from doing so, provided that the directors are operating within the authority granted to them by the Memorandum of Articles and Articles of Association. As each individual implicitly agrees to abide by the intention of the majority of the members upon becoming a member, the Court will not typically intervene to safeguard the minority interest impacted by the resolution. Therefore, if an injustice is inflicted upon the Company, it is the Company itself, as the legal entity endowed with personality, that can initiate legal action against the perpetrator; shareholders lack the authority to do so individually. This rule was established in the landmark case Foss v. Harbottle in 1843. As to who may initiate an action on behalf of the company, this rule serves as the cornerstone of common law jurisprudence.
Richard Foss and Edward Turton, two shareholders, initiated legal proceedings against the promoters and directors of the company in Foss v. Harbottle (1843) 67 ER 189. They claimed that the individuals in question had improperly mortgaged and misapplied the company’s property and assets, resulting in the waste and inefficiency of the organization’s resources. Additionally, they prayed that the defendant be ordered to compensate the company for its losses. The Court dismissed the two shareholders’ petition and determined that a breach of duty committed by the company’s directors constituted a wrong committed against the company, for which the company could bring suit alone. In other words, the company, not the two individual shareholders, was the appropriate plaintiff in that instance.
The principle of Foss v. Harbottle is applicable solely in cases where a member’s corporate right is violated. In cases where a member’s individual right is denied, the rule is inapplicable.
Jenkins, L.J, stated in Edwards v. Halliwell, [1950] 2 All ER 1064: “To begin with, the company or association of persons itself is prima facie the proper plaintiff in a case alleging a wrongdoing action against it. Additionally, if the purportedly improper transaction is one that a simple majority of the members of the company or association could approve as binding on the organization and all its members, then no individual member is permitted to pursue legal action regarding that matter. This is because of cadet quaestio (meaning that actions are beyond reproach) if a mere majority of the members of the organization or association are in favor of the transaction.
The Rule of Majority in the Indian Context:
The rule established in Foss v. Harbottle does not fully apply to the Indian context, although minority members’ rights are safeguarded by the law. Legislators and the Court have delineated the parameters within which a minority shareholder may initiate legal proceedings against the company in cases where its actions infringe upon its interests.
In Rajahmundry Electric Supply Corpn. v. A. Nageshwara Rao, 1956 AIR SC 213 case, the Court observed that the conduct with which the defendant is charged is an injury not to the plaintiffs exclusively, it is an injury to the whole corporation. The rule in such situations is that the corporation must file suit in its name and its capacity as a corporation. Therefore, it is not customary for individual shareholders of a corporation to automatically grant themselves the authority to initiate legal proceedings in the corporation’s name. Legally speaking, the corporation and its membership as a whole are distinct entities.
The Delhi High Court ruled in ICICI v. Parasrampuria Synthetic Ltd, Appeal No. 2332 of 1997, that it would be unlawful and misleading to apply the Foss v. Harbottle rule mechanically and automatically to Indian situations, conditions, and corporate realities. The principle, which originated in countries where it was founded on the established factual basis of shareholder power and majority shareholder power revolving around private individual enterprise and a significant number of minor shareholders, differs considerably from the actual situation on the ground.
Exemptions from the Rule of Majority:
The majority rule affirmed in Foss v. Harbottle applies to situations in which corporate ratification of managerial misconduct is feasible. Certain actions and occurrences are beyond the authority of a majority vote of shareholders to affirm or sanction. Every shareholder may file suit to enforce any obligations owed to the company in such circumstances. In American literature, “derivative actions” refer to the representative actions taken by company members on behalf of the corporation. The exceptions to the rule of the majority are as follows.
Ultra Vires:
The application of the rule established in Foss v. Harbottle is contingent upon the company operating within its authorized authority. Ultra Vires Acts are any actions that a corporation is not authorized to carry out. These actions are not within the scope of the powers explicitly enumerated in the Companies Act, nor do they lie within the powers specified in the Articles of Association and Memorandum of Association. When an action violates the Memorandum of Association and the Articles of Association, a shareholder may initiate legal proceedings against the company. These actions are null and void and cannot be legitimized by the majority through ratification.
The plaintiff was a shareholder of the respondent company in the case of Bharat Insurance Company Ltd v. Kanhaiya Lal, AIR 1935 Lah 742. The company objective was to provide interest-bearing loans secured by real estate, machinery, residences, and other assets located in India. In light of the plaintiff’s complaints that the company had made several investments without sufficient collateral and in violation of the memorandum’s terms, the plaintiff sought a perpetual injunction prohibiting the company from making further investments in that manner. “The broad rule in such cases is no doubt that in all matters of internal management of a company, the company itself is the best judge of its affairs and the Court should not interfere,” the court stated after approving the plaintiff’s lawsuit. However, internal management alone cannot determine how the company’s resources should be used. The utilization of the company’s funds by directors is purported to constitute an ultra vires act. A single member may bring a suit for a declaration regarding the precise construction of the contested article under these conditions.
In such situations, the factor of good faith is crucial when assessing maintainability, as the plaintiff’s action is motivated by the desire to rectify the situation for the benefit of the company. Claim acceptance may be precluded if the plaintiff’s conduct is similarly compromised or if an excessive delay ensues.
The action in Nurcombe v. Nurcombe, [1985] 1 WLR 370 was brought by the wife, who held a minority stake in the company, in response to her husband’s misconduct in his capacity as a director. As she became aware of the husband’s improper profits during their matrimonial proceeding, which were also factored into the calculation of the award, it was determined that she did not qualify as a legitimate plaintiff for a derivative action.
As stated in 1 Ch. Towers v. African Tug Co. (1904). In the 558 case, the plaintiff was involved in payments made by company directors to shareholders using capital that, despite being honest, was unlawful. Two shareholders filed suit on behalf of the company three years after the aforementioned payments, demanding that the directors reimburse the aforementioned amounts. Simultaneously, a temporal lag occurred, and it became evident that both shareholders were cognizant of the illicit character of the dividend disbursements they had received and which were still “in their pockets” during the trial. Under these conditions, the Court of Appeal ruled unanimously that the plaintiffs’ action could not be permitted.
Fraud on Minority:
In cases where a minority shareholder or the majority of a company’s members exploit their authority to deceive or oppress the majority, even a single shareholder may impeach their conduct. While not necessarily constituting a tort under common law, the fraud or oppression must involve an unjustifiable exercise of the majority’s authority that leads to financial detriment or unjust or discriminatory treatment of the minority or is imminently likely to do so. The act of majority is defined as the majority’s failure to act in the best interest of the entire company. This includes the Court’s authority to nullify a resolution that amends the company’s memorandum or articles. Fraud on the minority should be considered any negligence that results in financial loss for the company.
1951 Ch. Greenhalgh v. Arderne Cinemas Limited. In case 286, the Court determined that a special resolution could be impeached if its sole purpose was to create a discriminatory environment between majority and minority shareholders, benefiting the former at the expense of the latter.
9 C App. (1874), Menier v. Hooper’s Telegraph Works Ltd. 350 instance, a company was established to set the foundation for a Hooper’s Telegraph Works Ltd.-manufactured transatlantic cable. According to the majority shareholder ‘Hooper’, an enhanced financial gain could be realized through the sale of the cable to another company that desired to install it along the same route but would not purchase without the requisite government concessions. As a result of the first company having acquired said concessions, Hooper persuaded the trustee responsible for their ownership to transfer them to the second company. To avert legal action by the first company seeking reimbursement for the concessions, Hooper successfully lobbied for the adoption of a resolution mandating the voluntary dissolution of the first company and the appointment of a liquidator in whose integrity Hooper could have confidence not to pursue the company’s claim against Hooper and the trustee. Hooper was sued by Menier, a minority shareholder of the first company, in a derivative action to compel the latter to reimburse the company for the profits it earned through the improper arrangements it had executed. It was determined that Hooper’s schemes constituted an oppressive expropriation of the minority shareholders; consequently, Hooper could not be held liable in a derivative action.
The company in Brown v British Abrasive Wheel Co [1919] 1 Ch 290 required additional capital. If they could acquire the 2% minority, the 98% majority would have been prepared to provide this capital. Having been unable to reach this purchasing agreement, the 98% intended to amend the articles of association to grant them the authority to acquire the minority’s shares. Conditions governing the mandatory purchase of the minority’s shares were stipulated in the proposed article. Nevertheless, the majority was amenable to inserting a price provision stipulating that the minority would receive a price deemed reasonable by the court. Because the modification did not benefit the company as a whole, Astbury J. determined that it could not be implemented. One factor contributing to this was the absence of a direct correlation between the additional capital provision and the modification of the articles. While the initial plan called for the removal of dissenting shareholders followed by the provision of the capital, it is worth noting that it would have been feasible to eliminate the shareholders and subsequently decline to furnish the capital.
Wrongdoers in Control:
Directors and controlling shareholders owe the company a fiduciary duty. The majority cannot appropriate company property or minority shareholders’ interests for themselves.
Daniels v. Daniels, Ch. (1978). In case 406 409, in which two directors who were also majority shareholders sold company property to one director with the knowledge that the sale was undervalued, it was determined that the directors breached their duty to the company, notwithstanding the absence of alleged fraud.
In the 1967 case Glass v. Atkin, 65 DLR 501, the company was held in equal control by all of its members. The Court determined that control present when convening a general meeting would be pointless due to the wrongdoers’ direct or indirect ability to influence the outcome significantly. It further noted that the exception to Foss v. Harbottle regarding wrongdoers in control applies when the defendants demonstrate, through any manipulation of their position within the company, the ability to prevent the company from initiating the action. Consequently, the Court deemed the suit maintainable.
A.C. Cook v. Deeks (1916). In case 55, the organization comprised four directors who were also members. A dispute arose among them, prompting three of the directors to establish an additional company to execute a contract that they had negotiated on the organization’s behalf. The three directors then attempted to ratify the error by voting by a special majority (3/4), as presented at a general meeting. The directors were found to have violated their fiduciary duty and exploited their majority authority.
Acts Mandating Special Majority:
There are several decisions that a simple majority cannot approve by the shareholders of a company. Such decisions must be ratified by a special majority, which is defined as three-quarters of the members in attendance and participating in the vote. For instance, a change to the Company’s Articles or Memorandum of Association. If the majority attempts to carry out such an act by adopting an ordinary resolution or failing to pass a special resolution as mandated by law, one or more members may initiate legal proceedings to impede the majority’s actions.
A special resolution to increase the monthly allowance and commission of the Managing Directors was introduced in a general meeting in Dhakeswari Cotton Mills v Nil Kumal Chakravorty, AIR 1937 Cal 645. The resolution was approved by a show of hands since no poll was requested. Plaintiff Petitioner: A declaration that the resolution lacked the required majority approval and was therefore non-binding. The Chairman had declared that 218 members had cast their vote in favor of the resolution and 78 had voted against it, which, at first glance, indicates that the resolution had failed. The court rules in the plaintiff’s favor.
The Court ruled in Nagappa Chettiar v. Madras Race Club (1949) 1 MLJ 662 that any member or members may file an action to restrain the majority if they intend to do so by passing an ordinary resolution or without passing a special resolution as required by law.
Individual Rights to Membership:
Certain personal rights are conferred to each shareholder in opposition to the company and his fellow shareholders. A considerable array of these rights have been bestowed upon shareholders by the aforementioned acts; however, they may also originate from the articles of association. These are personal or individual rights, also referred to as individual membership rights; without their observance, the principle of the rule of majority cannot function. The enforcement of an individual shareholder’s rights against the company includes the right to vote and run for director, among others. An individual membership right implies that the individual shareholders can demand strict adherence to the legal rules, statutory provisions, and provisions in the memorandum and articles, which cannot be relinquished by a simple majority of the shareholders. A shareholder may individually exercise this privilege.
The Court noted in the 1949 MLJ 662 case Nagappa Chettiar v. Madras Race Club that a shareholder may enforce his rights against the corporation, including the right to vote, the right to have his vote recorded, and the right to run for director of a company at an election. However, if a shareholder wishes to seek restitution for alleged damages owed to the company, it is customary for the company to initiate legal action.
45 Ch. (1890) Henderson v. Bank of Australasia. D. In the 330/338 case, an amendment to the proposed resolution was moved by the plaintiff. Despite being seconded, the Chairman declined to document the amendment, resulting in the original resolution being passed without amendments. Likewise, no justification was provided for this decision. The convention established that shareholders possess the authority to propose amendments to resolutions.
The plaintiff in the AIR 1965 Ker 68 case of Joseph v. Joss was a candidate who ran for office but ultimately lost. He was re-nominated as a potential candidate to occupy the second vacant position. However, due to his prior defeat, the chairman disqualified him. The court determined that he was entitled to a declaration that the meeting’s procedure about the election of directors was void and null and void in his appeal of the ruling.
Class Action:
A class action lawsuit is an action brought on behalf of a group of plaintiffs by one or more individuals. The agreed-upon judgment or settlement resulting from the lawsuit applies to every individual within the group or class. Investors may initiate a class action lawsuit under Section 245 of the Companies Act if they hold the belief that the actions or conduct of a company’s management are detrimental to their interests. The Act contains a provision specifying the minimum number of members necessary to commence a class action lawsuit. Class must consist of a minimum of one-fifth of the total number of members or 100 depositors or the prescribed percentage of depositors if the company has share capital; otherwise, it must have no share capital. The class must have a total of 100 members of the prescribed percentage of depositors if it is a depositor organization. The action need not be initiated by a majority shareholder, provided that the group involved satisfies the aforementioned statutory requirements.
Oppression and Mismanagement:
Minority shareholders may initiate legal proceedings in situations where sections 397 and 398 of the Companies Act, 1956 or sections 241 to 246 of the Companies Act, 2013 are applicable. One statutory privilege that is bestowed upon shareholders is the ability to circumvent the restrictions imposed by the majority rule. One hundred members or members holding one-tenth of the voting power in companies with share capital, or one-fifth of the members listed in the company’s registration, are required to apply. Instances in which the company’s operations are carried out fraudulently towards its members, creditors, or other individuals, member oppression, the formation of the company for a fraudulent purpose, management misconduct or fraud towards the company and its members, or the withholding of information about the company’s affairs would be heard by the tribunal.
Sinha J. of the Calcutta High Court stated in Kanika Mukherjee v. Rameshwar Dayal Dubey, [1966] 1 Comp LJ 65, that the principle embodied in Sections 397 and 398 of the Indian Companies Act, which provides for the prevention of oppression and mismanagement, is an exception to the rule in the Harbottle Act, which establishes the Sanctity of the Companies.
Conclusion: The Foss v. Harbottle case laid the foundation for the rule of majority in corporate governance, emphasizing the authority of majority shareholders in decision-making processes. However, with the evolution of corporate laws and changing societal norms, the rights of minority shareholders have been increasingly recognized and protected. Understanding the implications of this landmark case is crucial for navigating the complexities of corporate governance and ensuring equitable treatment of all stakeholders within a company.
Author Bio
great research. Prabhat Kaushik (AOR), Supreme Court of India