Dissecting the 19th century fire breathing dragon known as the rule in “Foss v Harbottle” for shareholder remedies.
Source: recycledwax.deviantart.com
Within the corporate sphere, there is an ever-present tension between majority rule where the majority shareholders are allowed to dominate the decision-making process and that of protection of minority shareholders. Where majority rule is abused and wielded in the majority’s self-interest rather than in the interest of the company, then the minority shareholder may be able to seek court intervention for relief.
However, the minority must be prepared to face a foe of ancient origin. It is known as the rule in Foss v Harbottle (a 19th century decision of the English courts), which has been dubbed a “fire-breathing and possibly multiple-headed dragon.”
This dragon has two distinct heads. The first is that of the “proper plaintiff rule” being that the proper claimant to bring an action in respect of a wrong done to the company must prima facie be the company. Since the company is a separate entity from its shareholders, a shareholder may not sue to enforce a company’s rights. The second is the general principle of majority rule being the right of the majority shareholders to decide how the company’s affairs are to be conducted.
This article will touch on the three main weapons in the minority’s arsenal in attempting to slay this dragon.
With the enactment of the recent statutory derivative action provisions of the Companies Act (sections 181A – 181E), a minority shareholder is allowed to take on the name of the company in order to bring an action against a wrong done to the company. This derivative action seeks to overcome the situation where the directors (often times under the control of the majority) or the majority shareholders take no action for a wrong done to the company. This may range from directors acting in breach of their duties to the company or where company assets are being wrongly depleted. Both the heads in Foss v Harbottle would have largely prevented (although certain limited exceptions do apply) an aggrieved minority shareholder from pursuing any action in relation to these wrongs.
Any shareholder (or a former shareholder in certain circumstances) or director can apply to the Court for permission in order to control the company in initiating or continuing court proceedings.
The first element that must be satisfied is that the applicant must provide a 30-day notice to the directors of the applicant’s intention to apply to the Court. This rule allows the directors to assess whether it is a proper case for the company to take action. Secondly, the applicant must demonstrate that he is acting in good faith and finally, it must appear prima facie to be in the best interest of the company that the application be allowed.
This statutory derivative action is altruistic in nature, in that this is ultimately an action by the company, under the direction of the applicant, to seek relief for a wrong done to the company and any damages would flow back to the company itself. The applicant would not benefit directly from bringing such an action.
The oppression remedy is embodied in section 181 of the Companies Act, which allows shareholders to seek relief for personal wrongs suffered in their personal capacity as shareholders. While often relied on by the minority, even the majority shareholder can raise the issue of oppression where the majority is unable to exercise its majority will. This is often due to the written agreement among the shareholders (whether in the Articles of Association or a shareholders’ agreement).
The language of the provision covers situations where the company’s affairs are being conducted in an oppressive manner, there is disregard to a shareholder’s interests, or unfair discrimination. Ultimately, at the very heart of the oppression remedy is the question of whether there has been commercial unfairness. The starting point therefore in determining such unfairness is an examination of the agreement between the shareholders, which would be the written contract and any implied understandings and legitimate expectations among the shareholders. If a breach of such an agreement has then led to prejudice, the shareholder may be entitled to seek the appropriate remedies.
The Court will be empowered to grant any remedy to bring the oppression to an end, which oftentimes is an Order that the majority shareholder purchase the minority’s shares at a fair price. This is normally the most reasonable remedy because it allows the minority to realise the value of their interest in the company and puts an end to the unfairness – but does not destroy the company. Nonetheless, the Court has a wide jurisdiction to craft any appropriate remedy it deems fit.
A shareholder may also apply to the Court to wind up a company where it is “just and equitable” to do so. This area of the law overlaps largely with that of the oppression remedy as the Court will also be guided by the concept of fairness. Notwithstanding the corporate structure, the Court can impose equitable considerations on the relationship among the shareholders. A just and equitable winding up situation often features elements of legitimate expectation or mutual trust and confidence among the shareholders, a breach of which may then justify the winding up of the company.
The jurisdiction under a just and equitable winding up is wider than that of oppression, as it can apply in a fault-neutral situation. For instance, where there was a mutual breakdown in the relationship between the shareholders, neither party is really to blame.
Common grounds relied on in a just and equitable winding up are where there is a loss of the substratum or the sole purpose of the company, where there is an irretrievable breakdown in the trust and confidence among the shareholders, or in a situation of a shareholders’ deadlock.
The only relief that can be granted by the Court is that of a winding up of a company. The shareholder would then only be entitled to any excess proceeds from the liquidation of the company’s assets.
These are merely three of the more important weaponry available to an aggrieved minority shareholder in attempting to seek relief against any abuse by the majority. All three lead to very different results, where a statutory derivative action seeks relief and damages for the company, an oppression remedy is for a wide range of personal relief for the shareholder, and the just and equitable remedy results in the winding up of a company. While not slaying the dragon of Foss v Harbottle, these remedies, in appropriate circumstances, allow a minority to outflank the beast and thereby pierce the majority’s armour.
LB: Lee Shih is an adrenaline junkie who likes to run long distances, paddle on dragonboats and dive the depths of oceans. In his free time, he devotes some time to being a lawyer where off and on, he gets to slay a dragon or two.
Lee Shih is a corporate litigator and has a passion for international arbitration, corporate litigation and insolvency work. He juggles work with his other passion of dragon boating with the KL Barbarians team. He blogs at leeshih.com and tweets at @imleesh.
Posted on 25 October 2010. You can follow any responses to this entry through the RSS 2.0.
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