Essay: Majority rule

Executive Summary
“Majority rule” is an integral principle of company law: ‘those who take interests in companies limited by shares have to accept majority rule’ (per Lord Wilberforce, Re Kong Thai Sawmill [1978] 2 MLJ 277). Yet there are exceptions to this, in the various remedies open to minority shareholders for when they, or the company itself, are wronged. One of the principle remedies for minority shareholders is the derivative claim. This acts as an exception to the general rule of Foss v Harbottle, which states that the only true claimant in any action would be the company, not its shareholders. With a derivative claim a minority shareholder may pursue a claim on the company’s behalf, if it perceives that the controllers have wronged the company. The rule in Foss v Harbottle has produced a convoluted body of case law on the question of minority shareholder remedies, which, until the reforms of the Companies Act 2006, appeared largely unfavourable to a minority claimant. The Companies Act reforms have placed on a statutory footing not only the derivative claim but also another of the key remedies open to minority shareholders: unfair prejudice actions (where the minority shareholder claimant seeks a remedy in his own right). The Insolvency Act 1986 provides the third principle minority shareholder remedy: a petition to wind up the company on just and equitable grounds.
This essay shall explore the evolution of minority shareholder remedies from Foss v Harbottle to the current day in light of the latest statutory reforms, and assess the remedies’ adequacy in balancing the rights of the minority shareholder with those rights of the majority and the company. All three of the central statutory remedies are arguably structured so as to pose significant challenges to a potential minority shareholder claimant. In particular, despite the changes brought in by the Companies Act 2006, the derivative claim and unfair prejudice action still reflect the uncertainty at common law surrounding the precise extent of minority shareholders’ rights and the exact nature of their relationship to the company within the corporate structure. Whether the Companies Act 2006 has done enough to address these issues remains to be seen to some extent, but the post-2007 case law so far is not altogether encouraging.
The Companies Act 2006 arguably effected procedural, rather than substantive changes, thereby leaving unresolved key areas of uncertainty surrounding minority shareholders’ remedies, such as the scope of minority shareholders’ ability to bring personal rather than derivative claims. Furthermore, judges overseeing minority shareholder claims appear reluctant to exercise their equitable discretion to its fullest extent in the claimant’s favour. Although the 2006 Act was well intentioned in seeking to bring clarity and simplicity to the quagmire that is minority shareholders’ remedies, its changes were not far-reaching enough. A more dramatic break with the previous common law position was perhaps needed for the Act to have any significant impact on the subject of minority shareholder remedies. As it stands, ambiguities and perhaps outdated assumptions concerning company dynamics and the relationship between shareholders still suffuse the Act, limiting its ultimate effectiveness from the point of view of a minority shareholder. Substantive, rather than procedural, reforms need to be enacted if minority shareholders who have been wronged are to have any kind of meaningful redress.
Introduction
Despite the reforms of the Companies Act 2006 (CA), the key remedies available to minority shareholders arguably remain inadequate, both from their perspective and that of the company. First by examining the principles of Foss v Harbottle, and the origins of “majority rule”, and then by analyzing the central remedies open to minority shareholders, it becomes clear that the Foss v Harbottle rule retains a significant, and not altogether beneficial, influence on the subject of minority shareholder remedies. In the derivative claim, unfair prejudice action, and winding-up petition on just and equitable grounds, there remain shadows of the Foss v Harbottle dichotomy between the rights of individual shareholders and those of the company as a distinct legal entity. Without clearer resolution of this tension, there will likely remain defects in minority shareholder remedies.
Foss v Harbottle and Majority Rule
Minority shareholders derive their rights chiefly from the company’s articles of association and the Companies Act 2006. These will include general shareholder rights such as ‘to receive notice of any general meeting and to vote at the meeting’. Minority shareholders will also have further rights dependent on the size of their shareholding, such as the right to call a general meeting (requiring a 5% minimum share) or to block a special resolution (if their stake is over 25%). When voting on company resolutions, minority shareholders agree to be bound by the majority decision. Majority rule has long been a central tenet of company law. Sir Richard Baggallay, in North-West Transportation Co Ltd and Beatty v Beatty (1887) outlined the way in which minority shareholders’ rights relate to the obligation to be bound by the majority:
‘Unless some provision to the contrary is to be found in the charter… by which the company is incorporated, the resolution of a majority of the shareholders… upon any question with which the company is legally competent to deal, is binding upon the minority, and consequently upon the company, and every shareholder has a perfect right to vote upon any such question’.
This points to the arguably contradictory concept vital to understanding the complicated nature of minority shareholders’ remedies: specifically, that ‘a company is a legal person distinct from its members, whose individual identities are substantially merged in the corporate structure’.
In the seminal case of Foss v Harbottle (1843) , Wigram VC put into law this complex interrelationship, which has arguably bedeviled minority shareholders ever since. The rule of Foss v Harbottle has two key facets: the internal management rule and the proper claimant rule. The former means that individual shareholders are barred from bringing an action if the alleged wrongful act can be authorised or ratified by the company. The latter states that a ‘cause of action vested in the company should only be litigated by the company at the behest of the company’s board of directors’ [my emphasis]. Therefore, if the reasoning of Foss v Harbottle is accepted, it is only ever the company itself – via its board of directors – who should rightfully bring a claim in any instance of wrongdoing against it.
This begs the question of when, or indeed if, it is ever appropriate for a minority shareholder to bring a personal claim. That minority shareholders need to be protected in some capacity is, however, hard to dispute. ‘The concentration of power and control in voting majorities and in directors creates scope for abuse’ , and if the minority shareholder is not allowed to protest such abuse, the ‘company and controllers could exploit his position to their benefit’. After all, a minority shareholding does not necessarily equate to a small shareholding, and a minority shareholder may have invested significant sums in a company. It cannot be just to bar his access to recourse.
Exceptions to the Foss v Harbottle rule have emerged over time, reflecting the need to protect minority shareholders. These include the derivative claim where a minority shareholder may petition the court on behalf of the company if the company ‘cannot or will not bring an action against the alleged wrongdoer’. The Companies Act 2006 placed the derivative claim on a statutory footing and updated the law on another key minority shareholder remedy: the unfair prejudice claim, where a minority shareholder claimant may seek a remedy in his own right. The Insolvency Act 1986 provides the third key minority shareholder remedy: a petition to wind up the company on just and equitable grounds. There are also various personal claims available to the minority shareholder, such as for “fraud on the minority” or breach of directors’ duties not covered by the derivative process.
Minority shareholder remedies involve a delicate balancing of the minority shareholder’s rights against those of the majority and the company. Exploring each key remedy in turn will indicate that it remains doubtful whether this balance has ever been satisfactorily achieved.
Derivative Claims
ss.260-264, Part 11 of the Companies Act 2006 set out the derivative claim, where any individual shareholder, on the company’s behalf, may sue a director alleged to have committed a wrongdoing. Under the Act, a claimant must seek permission from the court to continue the claim. Derivative actions are limited in applying only against directors yet under the Act, “director” extends not only to former and shadow directors , but to anyone who acts ‘de facto [as a director]… even without having been appointed either validly or at all’. This appears to cast a broad net in terms of those against whom a minority shareholder can bring a claim. However, the courts are not always eager to utilize their wide discretion in this area. Lewison LJ, in Ultraframe (UK) Ltd v Fielding stated that:
‘The indirect influence exerted by a paradigm shadow director who does not directly deal with… the company’s assets will not usually, in my judgment, be enough to impose fiduciary duties upon him.’
In Vivendi SA v Richards Newey J criticized Lewison’s decision, remarking that Ultraframe ‘understates the extent to which shadow directors owe fiduciary duties’. Nonetheless, Newey also pointed to the contradictory body of case law on the subject and it seems as if the limits on who can be classified as a director remain somewhat uncertain.
Only individuals who are currently members of the company can bring a derivative claim under statute as, following Foss v Harbottle, the action is tied to the company, not the individual claiming on its behalf. This poses a sizeable issue in relation to double or multiple derivative claims (MDCs). MDCs arise where a person brings a derivative claim concerning a wrong done to a subsidiary of the company in which he is a shareholder. While acceptable at common law, MDCs have fallen outside the 2006 Act. They must continue to be governed by common law ; creating an impractical situation whereby ostensibly the same type of claim is governed by two different systems. This means that ‘the statutory derivative claim may be effectively toothless for all but the simplest of corporate structures’.