FOSS VS. HARBOTTLE (Hereinafter referred as Foss rule)

Facts: F and T, two shareholders of a company brought an action on behalf of themselves and all other shareholders against directors and solicitors of company, alleging that Directors and solicitor’s carried illegal transaction thereby causing losses to the company. The transactions were fraudulent and illegal whereby the property of company was misapplied and wasted. Therefore F & T claimed damages to be paid by defendants. The question was as to the maintainability of suit.

Held: The Court held that suit is not maintainable and action could not be brought by minority shareholders. The wrong done to the company is one which could be ratified by the majority of members. The company was the proper plaintiff and company can only bring the action through the majority shareholder. The majority of member should decide whether to commence proceedings against directors.

According to Palmer the rule phrased in the above case used to refer to two distinct, but linked proposition of law:

1. Court will not ordinarily intervene in the case of an internal irregularity if the matter is one which the company can ratify or condone by its own internal procedure.

2. When wrong has been done to company, the only proper plaintiff is company itself.

The reasoning of Foss vs. Harbottle rule was found in Edwards vs. Halliwell where the suit was against the executive committee. The committee increased the fees by virtue of rule 19 of the constitution of trade union. Rule 19 required a ballot and 2/3 approval. But the committee passed the resolution by calling a meeting where some of the members of the trade union participated and resolution was passed. It was held that the association of person or companies would be the proper plaintiff and therefore the members could not approach the court. Further where the alleged wrong is a transaction which might be made binding on the company or association and all of its members by a simple majority of the members, then no individual member can raise an action against it since the majority if the members of association or company has agreed in the favour of what has been done. If a simple majority of members is against the decision, then there is no reason why the company cannot approach the court of law i.e. the case arises when the majority of the members are against the decision.

The Foss vs. Harbottle rule state that the court will not interfere in matters of internal irregularity, the internal irregularity has been interpreted in Mac Dougall vs. Gardiner where the chairman who was also to director was empowered by the AOA to do the following:

1. Conduct AGM

2. Adjourn the meeting with consent

3. To conduct polls and this power is conditional if demanded by shareholders.

At AGM, adjournment was made and there was requisition for polls and the chairman said that polls was not necessary for adjournment and left the meeting. This behaviour of the chairman was questioned before court and court laid down 3 points with regards to internal irregularity:

  • If the thing complained is of substantial matter that the majority is entitled to do
  • Something irregular is done which the majority of company is entitled to do regularly
  • Something is done illegally which the majority of the company are entitled to do legally

In above cases there is no use of having litigation about the irregularity. This could e ratified by the majority of the members and if majority is against the irregularity then they could approach the court.

Advantages of rule in Foss vs. Harbottle:

1. Recognition of separate legal entity of Co.

2. Preservation of right of majority to decide

3. Courts will not interfere

The first two are recognised in India but the on the 3rd, Indian law differ.

In the Indian scenario, the Rajahmundry electric supply co. vs. Nageshwara Ra, 1956 where the SC held that “the court will not in general intervene at the instance of the shareholders in the matter of internal administration and will not interfere with the management of the company by its directors so long as they are acting witjin the powers conferred on them under the AOA of the company. Moreover if the directors are supported by the majority of the shareholders in what they do, minority shareholder can do nothing about it”.

This case itself gave exception to the Foss Rule i.e. until the act is within the parameter of the AOA court cannot interfere and if the act is ultra vires the company court can interfere.

Indian position w.r.t. Foss rule:

In ICICI vs. Parasrampuria synthetic ltd., 1998, the Delhi HC held that the mechanical and automatic application of the Foss Rule to the Indian situation would be improper and misleading. The court reasoning behind it was that the Foss rule was established because of the factual foundation of the shareholder power in the origin country is different from our country. In India the corporate entities are mostly state/Centre funded, the 80% shareholding is hold by such financial institution, (as many financial institution funds so each have small shareholding)and rest 20 % is held by Investors. So the calculation of majority and minority is complex issue and if the Foss rule applied than it will automatically give the weightage to the majority of shareholder i.e. shareholder holding majority of shares and the financial instructions which possess small shareholding will be left out so their protection is requires as because of them only the company is in existence. Therefore to protect such financial institutions application of the principle will be unfair and unjust.

Exception to Foss Rule:

Generally the rule by majority applies and thus minority shareholder cannot bring the action but in these below situation the minority shareholder can bring action to protect their interests:

1. Ultra vires and illegal acts: Acts which are violative of object clause of MOA/AOA are ultra vires & illegal acts. Such acts cannot be rectified by the majority vote on resolutions can come within purview of courts. Here, ultra vires & illegal acts cannot be rectified even by the unanimous votes by the members. Hence the Foss rule is not applicable. One can approach court in both representative/ derivative capacity depending on circumstances.

Bharat Insurance co. vs. Kanhayalal, 1935,the plaintiff was the shareholder, brought the suit against the directors, for some transaction which were committed ultra vires to the object of the MOA/AOA. The court allowed the suit and stated that normally court will not interfere but since the transactions by the directors are ultra vires the MOA/AOA, the suit is maintainable.

2. Breach of fiduciary duties: Derivative action will be taken against the directors and the promoters as they owe the fiduciary duty towards the company.

Derivative action against the directors can be taken when:

  • They are in control of company for misappropriating co.’s property
  • Misapplying the company’s property in breach of the comp.’s act
  • To compel such directors to account to the company for profits made by appropriating for themselves a business opportunity which the company would otherwise have enjoyed
  • Depriving members to carry on their actions

Derivative action against promoters:

  • To rescind those contracts between them and co. if they are guilty of misrepresentation
  • If they have not disclose certain secret profits where court will order them to repay to company all the money received by them under contracts.

3. Fraud or oppression against minority:

When the majority of the company’s members use their power to defraud or oppress the minority, their conduct is liable to be impeached even by a single shareholder. The fraud or oppression must involve an unconscionable use of majority’s power resulting or likely to result, either in financial loss or unfair or discriminatory treatment of the minority. Court will annul such resolution that tries to amend MOA/AOA that:

  • Indirectly or directly appropriating property of company to themselves
  • Appropriating money to themselves
  • Actions where shareholders are entitled to participate but are prevented by the amendment in MOA/AOA.

Reference can be made to “Menier vs. Hooper’s Telegraph work ltd.”

4. Inadequate Notice of a resolution passed at meeting of members:

When a GM is called and a proposed resolution is mention then, the insufficient information of the same arises when:

  • A member could be attending meeting & voting against the resolution
  • A member may decide not to attend

Therefore these two types of member may bring a representative suit to restrain the company and its directors from carrying out such resolution.

5. Qualified majority

If the MOA or AOA requires a qualified majority (special majority) for passing a resolution then the rule in Foss vs. Harbottle will not apply to override that requirement. The action brought for such irregularity will be a personal action.

6. Where personal rights of individual members is infringed:

The member in such case can proceed in his own name. It is not a corporate membership right e.g. right to vote, right to receive dividends.

Statutory Exceptions to Foss Rule:

The company’s acts, 2013 by virtue of certain provisions provide the protection to the rights of minority shareholders:

  • Section 48- variation of class rights: when the shares issued are divided in various classes as provided in MOA/AOA, the rights attached to the shares can be varied with the consent of 3/4th majority of the shareholders of that class. In case when the classes are made and rights are varied with consent of requisite majority, the holder of not less than 10% of issued shares of that class who has not assented to the variation may apply to the tribunal for cancellation of variation under section 48(2) of the act.

If company does not comply with order of tribunal, it is punishable with fine of not less than 25000 which can be extended up to 5 lakhs or officer of company may be awarded imprisonment for 6 month or fine or both.

  • Section 213- request for investigation :an application may be made to tribunal for investigation in the affairs of the company by:

a) Company with share capital

i) 100 or more than 100 members or

ii) Members holding not less than 1/10th of total voting power

b) In case company don’t have share capital:

i) Application may be made by not less than 1/5th of the members.

  • Section 230- Scheme of compromise or arrangement: Provides for compromise and arrangement with creditors and members and provides for protection to minority. Section 230 (7) (c) provides that if C & A results in variation of shareholder’s rights it shall be given effect to under provision of sec. 48, section 230 (7)(e) provides that tribunal order may also provide for exit offer to dissenting shareholders to effectively implement the terms of C & A.
  • Section 241-Oppression & Mismanagement: Principle of majority rule does not apply where the section 241 is applicable. If a member complains that the affairs of the company are being conducted in a manner oppressive to some of the members including him, or against public interest, he may apply to tribunal by petition under section 241.
  • Section 235-Rights of dissentient shareholders under take-over bids: offer for the purchase of the share received, 90% share holders have accepted, the party making the offer can take the rest 10% on same term. Notice to be given to dissenting shareholders, specifying the terms. They have right to make application to tribunal praying that their shares not be acquired on this terms. Tribunal may make an order, as it may think fit.
  • Section 245-Class Action: Application to the tribunal by prescribed no. of members seeking certain reliefs on the grounds that the affairs of the company are being conducted in a manner prejudicial to the interest of company and its members. Tribunal may make an order, as it may think fit.

*****

Disclaimer:- The entire contents of this document have been prepared on the basis of relevant provisions and rules and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, I assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not a professional advice and is subject to change without notice. I assume no responsibility for the consequences of use of such information.

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Qualification: CS
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Location: Shubham Phophalia, Gujarat, India
Member Since: 08 May 2021 | Total Posts: 54
I am Shubham from Batch 2016-21 of GNLU. I am in my final year of 5 years integrated BA LLB course from GNLU, Gandhinagar, and I have completed Company Secretary Course meanwhile with 3rd Rank in Ahmedabad, Gujarat in CS Professional. I am a keen reader and enthusiastic listener of Corporate laws an View Full Profile

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