Foss v. Harbottle is a landmark English case in the company law, which is known for the propounding of ‘proper plaintiff rule’ and ‘majority rule’. While the rule in Foss v. Harbottle is well laid, there exist certain exceptions to it of which personal rights enjoy a rather strong immunity to its application. In light of the above, the article aims to trace the development of the Foss v. Harbottle and highlight the relevance of personal rights of members outside the former’s purview.
I. Foss v. Harbottle[1]
In the case, a legal action was pursued by two minority shareholders (Richards Foss and Edward Starkie Turton) on their own, against the directors of a company alleging conduct of concerted and illegal transactions resulting in the loss of the company’s property. It was alleged that the directors had misappropriated the company assets and had falsely mortgaged the company property thereby adversely affecting the company and its original purpose of “laying and maintaining an ornamental park” as laid down in the Act for its incorporation by the parliament (“Act”). The main issue in the case thus was whether a company’s right to sue can be exercised by its shareholders on their own, that is, whether the shareholders could file an action for a wrong done to the company.
Herein, it was contended by the petitioners that the company was not an ordinary company as its genesis was in the Act which conferred right on the members or outsiders to file an action against the directors. It was submitted that certain illegal transactions were being conducted by the directors of the company by way of misappropriation of funds and improper mortgages on the company property, thereby causing property wastage and loss to the company. It was further prayed for the court to direct the directors to make good the losses suffered by the company.
To this, it was contended by the defendants that the petitioners did not have any locus standi to file any legal action against the directors on behalf of the company. It was submitted that the Act did not confer any rights on the petitioners to institute any legal proceedings for the loss suffered by the company.
Judgment
The Court of Chancery rejected the claim of the petitioners and held that since the impugned actions had caused loss to the company, only the company had the right to sue, that is to say that, the company was the ‘proper plaintiff’ in the given case and not the shareholders. It was further held that the minority shareholders could not bring action for a wrong which could be ratified by the majority shareholders. In the process, two rules were propounded – (1) ‘proper plaintiff rule’ which provides that in case of any wrong done to a company, only the company has the right to sue for it, that is, only the company is the proper plaintiff; and (2) ‘majority rule’ which provides that decisions of the majority shareholders are binding on the company and the court would not interfere in case of a wrong which could be ratified by the majority shareholders. The ‘proper plaintiff rule’ is also known as ‘the rule in Foss v. Harbottle’.
It was held in the case that shareholders cannot bring an action for loss suffered by the company. It was observed that a company has a separate entity distinct from its members and has the right to sue under its own name. Thus, in case of any wrong done to it, it is only the company which can institute a suit, shareholders do not have that the right. It was further observed that a company’s decisions are mainly based on the principles of democracy, and thus the majority rule prevails. All the decisions made by the majority, whether simple majority or special majority as required by the law, are binding on the company. Courts do not interfere in a matter of irregularity which can be ratified by the majority. The court in the case thus pursued the shareholders to exhaust options for redressal within the company first before coming to the courts.
Exceptions to the rule in Foss v. Harbottle
Considering the severity of the rules propounded in the case, it was observed that though the minority shareholders were conferred substantive rights, they were denied remedy on procedural grounds. Exceptions were, thus, introduced to the rule in Foss v. Harbottle to reduce the effect of harshness and unjustness on the minority shareholders.
Under the current circumstances, the rule in Foss v. Harbottle is not applicable to the acts of majority shareholders done to oppress, suppress or depress the minority shareholders, that is, it is not applicable in the case of “ultra vires and illegal acts; breach of fiduciary duties; fraud or oppression against the minority shareholders; variation of class rights; scheme of compromise or arrangement; oppression and mismanagement; rights of dissentient shareholders under takeover bids, and; class action suits”.
It is to be noted that the rule in Foss v. Harbottle is applicable only in case of infringement of corporate right of a member and is not applicable in case of denial of his individual right.
II. Personal Rights Exception
Personal rights, also known as individual rights are the rights enjoyed by the members in their own capacity with the right to apply for their infringement individually. The genesis of these rights lies in (1) the implied contract between the member and the company as entered into at the time of becoming the member of the company, and (2) the general law. These rights are contractual in nature and cannot be taken away except with the written consent of the concerned member. Provisions in the memorandum or articles of the company are said to confer personal rights on a member if the member has special interest in compliance of the concerned provisions, which is distinct from the general interest of the rest of the members.
Application of the exception
Infringement or denial of personal rights of a member is not covered under the purview of the principle of Foss v. Harbottle, that is to say, the principle of Foss v. Harbottle is not applicable to personal rights – instead it is one of the exceptions. It is said that in case of question on personal rights, a member can, on principle, go against the majority of all other shareholders.[2]
This has been further upheld in the case of MacDougall v. Gardiner[3] which is known for its application of the majority rule from Foss v. Harbottle and interpretation of the personal right exception to the rule.
This case has reinforced the rule of majority as propounded in Foss v. Harbottle and discouraged the shareholders from bringing to courts frivolous litigation relating to matters of internal management of the company. Herein, Mellish LJ distinguished between (1) mere internal irregularity in the form of infringement of the articles affecting the company but ratifiable by the majority, and (2) substantial breach of the constitution of the company giving rise to the right of shareholders to file an action. He opined that any litigation filed for a legitimate action of the majority done illegally or irregularly is redundant and infructuous as the illegality or irregularity of the legitimate action could be ratified or abrogated in the meetings of the company. However, he noted that this did not apply in the case of abuse of power by the majority causing deprivation of the rights of the minority, as therein the rights of the minority were affected and they had a right to file a valid action.
Following this, when the exception of personal rights under the rule is sought, the member is required to show that the infringement of his right is the result of breach of the company’s constitution and not a mere internal irregularity of the internal management of the company.[4] Rights like, “right to have his name and shareholding entered on the register of members[5], right to vote[6], right to have his vote recorded, right to stand as a director of a company at an election[7], right to elect directors[8], right to inspect register of members[9]right to receive notice of a general meeting[10]” are some of the personal rights arising from contract and general law.
III. Conclusion
As noted above, the rule in Foss v. Harbottle is applicable only in case of infringement of a democratic or corporate right of a member and is not applicable in case of denial of his personal or individual right.
[1] Foss v. Harbottle, (1843) 2 Hare 461.
[2] Soni, Yash, Exceptions to the Rule in Foss v. Harbottle: Indian Context, 4, International Journal of Legal Developments and Allied Issues, 116, 121 (2018).
[3] MacDougall v. Gardiner, (1875) 1 Ch. D 13.
[4] Mesimeri, Ioanna, Why is the rule in Foss v. Harbottle such an important one?, Areti Law, available at https://www.aretilaw.com/wp-content/uploads/2020/10/Ioanna-Mesimeri-Why-is-the-rule-in-foss-v-harbottle-such-an-important-one-2018.pdf (Last accessed on January 30, 2021, 5:00 PM).
[5] Re British Sugar Refining Company, (1857) 4 K&J 408.
[6] Pender v. Lushington, (1877) 6 Ch. D 70.
[7] N.V.R. Nagappa Chettiar and Another v. Madras Race Club, (1949) 1 MLJ 662.
[8] Life Insurance Company v. Escorts Limited, (1986) 59 Comp Cas 548.
[9] Companies Act, 2013, § 94, No. 18, Acts of Parliament, 2013 (India).
[10] Companies Act, 2013, § 101, No. 18, Acts of Parliament, 2013 (India).
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