MINORITY SHAREHOLDERS ARE NOT WELL PROTECTED BY COMPANY LAW. DISCUSS.

INTRODUCTION
Shareholders in company law can be divided into two (2), the Majority shareholders and the Minority shareholders. Majority shareholders are persons or conglomerate who owns more than 50% of the outstanding shares of a company. While, Minority shareholders are equity holders of a firm who does not have the voting control of a firm, by virtue of his or her below 50% ownership of the firms equity capital. The decisions on the affairs of the company are generally made by directors or shareholders, which are normally taken on the basis of majority vote. The majority rule applies whenever there is a vote regarding the running of the company. If a shareholder in a company happens to find him or herself in the minority, there is little that he or she can do about it. The purpose of this essay is to look into the minority shareholders rights and what protection there is for minority shareholders in company law. In doing this will attempt to: Identify minority shareholders right, Look into the legal protections of the minority shareholders by statutory and common law; Will identify and analyse the legal protection of minority shareholders; Will look at the legal remedies available to shareholders when their rights are abused;
I will evaluate whether these remedies effectively protect the interest of the minority

shareholder in a company.

MAJORITY RULE PRINCIPLE

All the activities of a company are in a way exercised by one or others of its own organs: the shareholders in general meeting or board of directors. Each member expresses their wishes at the general meetings by voting for or against the resolution proposed. The will of the majority of the members usually prevails and if the appropriate majority is obtained a resolution binds all members, including those who voted against it. The democratic principle of majority rule means that those who control more than half of the votes on the board or at the shareholders meeting and also those who command good less than a majority of the votes but manage to exercise de facto control.1 The controlling members do owe a duty to the company, i.e. the corporators as a body, to act bona fide for the benefit of the company as a whole and not to commit a fraud on minority. As it was held in the case of Clemens v. Clemens Bros. Ltd2 that a majority shareholder was not entitled to exercise her majority votes as an ordinary shareholder in any way she pleased. That right was subject to equitable just considerations which could make it unjust to exercise them in a particular way. In this case, the defendant owned 55 per cent of the issued shares of the family company. She was one of the five directors and proposed to give the other directors shares and set up a trust for long-service employees. The plaintiff, who was the defendants niece, held 40 per cent of the shares and not a director. The defendant proposed resolutions to increase the capital so that the plaintiffs shares would fall below 25 per cent of the total and her right to veto special resolutions would be lost. It was also clear that she would never now obtain control of the company. The decision in this case shows that the majority shareholders do not have unrestricted voting rights if it is unjust in the particular circumstances.
1 2

Hicks A. Cases and Materials on Company Law [1976] 2 All E.R. 268. 3

MINORITY PROTECTION
There are different types of action available to minority shareholders in company law. They enjoy both under the general law and under the Companies and other Acts some protection. Examples of minority protections are:3 Under the general law, the doctrine that majority of the members must not commit fraud on the minority but must act bona fide for the benefit of the company as a whole. The exceptions to the rule in Foss v. Harbottle, in which case an individual member may bring what is known as a derivative action on behalf of the company. The various sections intended to protect a minority of members. Some apply on general basis; thus under sections 122 and 124 of the Insolvency Act 1986 a member can petition the court to wind up the company on the ground that it is just and equitable that the company be wound up. Further, under section 459 of the Companies act a member can petition the court for other relief where the companys affairs are being conducted in an unfairly prejudicial manner to some of the members, including him.

Personal Actions
A minority shareholder may commence a personal action where his or her legal rights have been abused by an act deemed to be that of the company. This is between an individual shareholder and the company. Examples of a personal action will be to enforce the terms of a contractual obligation with the company.

Charlesworth & Morse :Company Law 16th ed 4

Sometimes the courts allow a minority shareholder of a company to take legal proceedings in respect of matters internal to the company and which are not regarded as vindicating the companys rights. An example given in Prudential Assurance Co Ltd v Newman Industries Ltd4 by the Court of Appeal .if directors convene a meeting on the basis of fraudulent circular, a shareholder will have a right of action to recover any loss which he has been personally caused in consequence of the fraudulent circular; this might include the expense of attending a meeting.

There are three categories; these are illegal and ultra vires acts; acts requiring a special majority and personal rights.

1. Illegality and ultra vires

An individual shareholder may obtain an injunction to restrain the company proceeding with an ultra vires or illegal act. An action by a minority shareholder to recover money or property on behalf of the company in respect of an ultra vires or illegal transactions could equally be a personal action as stated in Wedderburn.
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However, it has been stated otherwise in Smith v.

Croft6 that any action by a shareholder must be a derivative one.

2. Special majorities
A minority shareholder may seek redress where the matter is one which could validly be done or sanctioned not by a simple majority of the members but by some special majority. These are situation where the articles specify a particular procedure which must be followed in respect of a particular transaction. If the procedure is not followed, the majority cannot ratify such conduct for
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(No 2) [1982] (1957) CLJ 194 6 (No 2) [1988] Ch 114 5

that would be to deny the minority the protection afforded by the initial provision. The majority shareholders must abide by the procedure laid down in the articles or sometimes alter the articles. Where they simply purport to ratify the transaction by an ordinary resolution, the minority shareholders can bring an action to retain them. In Edwards v. Halliwell,7 the minority shareholders successfully retained.

3. Personal rights
If a minority shareholder can point to the infringement of some personal right then he need not be concern with the rule in Foss v. Harbottle8at all9.

Representative Action
Where an individual shareholders legal rights have been infringed, he or she may commence a representative action against the company. The action will commence be commenced by a shareholder on behalf of himself and all other aggrieved shareholders and will be instigated against the company. Judgment obtained as a result of a representative action will bind all the parties which are made subject to it.10

The Rule in Foss v. Harbottle

Situation where a wrong is committed against the company, minority interest is protected by the rule taken from the judgment of Wigham V-C in the case of Foss v. Harbottle.11 The remedies available to minority shareholders in this rule dominate at common law. He laid down the basic
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[1950] 2 All ER 1064 (1843) 2 Hare 9 Farrar H. : Farrars Company Law 4th ed 10 Griffin S. : Company law Fundamental Principles 4th ed 11 (1843) 6

principle that a shareholder could not sue in respect of wrongs done to a company; this today remains the basis of the modern law the wrong has been done to the company, therefore the correct claimant would be the company (the proper plaintiff rule). In this case the court refused to permit two shareholders to bring an action on behalf of the company against the director and the promoters who had sold property to the company at an inflated value. The court found that it was not open to individual members to assume to themselves the right of suing in the name of the company. This rule is based on two fundamental principles of company law, namely respect for the separate legal personality of the company and the principle of majority rule. The justification for the rule is that it prevents the company from being subject to a long and expensive litigation to no ultimate purpose. However, to protect and correct the abuse of power in the company by the board of directors and majority shareholders, the courts must in appropriate circumstances depart from the concept of majority rule. Although, courts are reluctant to overturn the wishes of the majority rule and will only do so where the actions of those in control of the company were patently inspired by the motives other than to promote the best interests of the company as a whole. The ability to override the principle of majority control is itself derived from the cases of Foss v. Harbottle. As Wigram V-C stated: ....if a case should arise of injury to a corporation by some of its members, for which no adequate remedy remained, except that a suit by individual corporators in their private characters, and of asking in such a character the protection of those rights to which in their corporate character they were entitled, I cannot but think that the claims of justice would be

found superior to any difficulties arising out of technical rules respecting the mode in which corporators are requires to sue.12 In other to convince the court that a corporate wrong should be corrected by the law, an aggrieved minority shareholder must prove that those in control of the company failed to act in the best interest of the company as a whole.

Derivative claim
The exceptions to the rule in Foss v. Harbottle,13 minority shareholders can pursue legal actions where the wrongs complained of is a fraud by the majority of the members on the minority and the wrongdoers are in control of the company in general meeting. There are some of the cases which have been decided by the courts, as it was held in Cook v Deeks14. In this case a minority shareholder brought an action to compel the directors to account for the profits made out of the construction contract which they took in their own names. The definitions of fraud have been widened in recent cases to include where majority shareholders do not commit fraud but confers some benefits.15 Under section 260 of the 2006 Act, any shareholder may now bring a derivative action on behalf of the company, provided he has the courts permission to do so. Under sections 260 and 261 the court may grant such permission if it is satisfied that there will be a benefit to the company as a whole if such an action is allowed to be brought forward. Among other things, the court will take into account whether or not the action concerned has been ratified by the shareholders as a whole, or whether it has been only an action of the board.
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Foss v Harbottle (1843) 2 Hare (1843) 2 Hare 14 [1916] 1 AC. 554 15 Daniels v. Daniels [1978] Ch. 406 8

It has long been established that there is no fiduciary duty between directors of a company directly, and the shareholders of that company. This position has not been altered by the 2006 Act. The fact that the new general duties of directors are subject to and based on common law rules and equitable principles and must be interpreted and applied in the same way as common law rules and equitable principles, as stated in section 172, demonstrates that Parliament did not intend to extend a fiduciary relationship between directors and shareholders. 16 That said however, the primary duty that shareholders now owe is no longer solely to the company but to promotion of the success of the company for the benefit of its members as a whole.17 However, it is clear that while the enlightened shareholder approach has resulted in a wide range of stakeholder interests which directors must bear in mind and take into consideration, no fiduciary duties between directors and these various stakeholders have been created. Also, shareholders have not been given direct recognition as owners of the company, as evidenced by the fact that the new act includes an entire part on derivative actions, such provisions being redundant if shareholders could bring an action as owners of the company. When the court is looking at whether or not to allow a derivative action to proceed, it is entitled to look at the proceedings of the company in general meeting. As the case of Prudential Assurance demonstrates, even when the members of a company have freely passed a resolution in general meeting, the courts are likely to look behind this decision and ask if any external pressures had been exerted on the board or on members which may make such a resolution questionable. Under section 263, a court is directed to withhold permission for a derivative action in cases where effective ratification of a move by the board has been granted by the

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Lee, Shareholders derivative claims under the Companies Act 2006: market mechanism or asymmetric paternalism, ICCLR 2007, 18(11), 378-392 17 Companies Act 2006, section 172 9

members. Under section 263(b) permission should be refused if ratification has been granted, and under section 263(c) if ratification is likely to be granted. The courts must also look at the duty of directors to promote the success of the company for the benefit of the members as a whole, and whether there is not some other legal basis under which the members concerned could personally bring an action, rather than the action being brought in the name of the company. Another important issue when looking at derivative actions is the approach courts will take when there is an allegation that the directors have acted out of a conflict of interest. In general, directors are prohibited from acting with a conflict of interest. 18 At common law, interested directors must disclose any conflicts before a decision is made. Under section 310 of the Companies Act 1985, any provision, whether contained in a companys articles or in any contract with the company or otherwise which purported to exempt directors from disclosing conflicts of interest was void. Under the 2006 Act section 175(5)(b) public companies can exempt directors from the duty to declare conflicts of interest if power to do so is granted in the constitution, and private companies can also exempt directors from declaring conflicts if nothing in the constitution would prevent such a step. However, despite the ability of companies to either exempt directors from declaring conflicts of interest, and also the ability of members to ratify actions by the board, the court will still have discretion to allow a derivative action, especially when ratification has not been sought prior to a decision being made, or is being sought after a decision in which it can be shown that a director was conflicted.19

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Davies, Gower and Davies Principles of Modern Company Law, 7th ed. (London: Sweet & Maxwell, 2003) p. 392 19 Above, note 26, p. 386 10

Another issue relating to the courts discretion in whether or not to give permission to allow a derivative action is the question of who bears the burden of proving that permission is warranted or not warranted. The Act creates a rebuttable presumption that no breach of duty has been committed and therefore, that permission for a derivative action should be refused. The burden of proving that the action should be allowed therefore falls on the minority shareholders seeking to bring the action. However, it is difficult to state what the burden of proof in such a case will be, and what information can be disclosed by the shareholders in seeking the permission of the court for the action to proceed. This creates uncertainty which will act as a disincentive to minority shareholders who might consider relying on the derivative action provisions.

Unfair Prejudice Remedy

Any member of the company may petition the court for remedy if the affairs of the company have been conducted in a way which is unfairly prejudicial to members interest.20 As provided for under the CA 2006, s.994, this replaces s. 459 of the CA 1985. The purpose of this section is to provide a remedy where a complaint exists concerning the way in which a companys affairs are being conducted through the use of, or failure to use, corporate powers in relation to the conduct companys affairs, as provided by the companys constitution. In Re Legal Costs Negotiators Ltd21, it was held that the shareholders refusal to sell his shareholding was a private matter and could not be ground for a petition under this section. Unfair prejudice is wider than and replaces the concept of the old Companies Act 1948, s. 210. For a claim to be brought both unfairness and prejudice must be established but it is not

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Hicks A. Cases & Materials on Company Law 6th ed [1999] 2 BCLC 171 11

necessary to show that the act complained of id improper or illegal and an exercise of a legal right may have an unfairly prejudicial effect. In deciding whether an act is unfairly prejudicial, the court will take into account factors such as the petitioners conduct, prior knowledge of the matters complained of as stated in Bermuda Cablevision Ltd v. Calica Trust Co. Ltd,22 any offer to buy out the petitioner, the motive of the oppressor, any delay in the petitioning, and other relevant factors. This section has proved to be beneficial and powerful weapon for the minority shareholders, especially in the case of quasi-partnerships. In such companies, minorities who are excluded from management participation or who unfairly suffer loss as a result of wrongdoing by the directors or majority shareholders get compensation under the section. In certain situation, the court may also make an order requesting the majority shareholders to sell their shares to the petitioners as decided in Re Brenfield Squash Racquets Club Ltd23

Conclusion
In conclusion however, it must be stated that overall, the provisions of the 2006 Act improve the protection of minority shareholders in a number of ways. Firstly, the broadened duties of directors require that they take into consideration the interests of the members of the company as a whole, and of each group of members against the other groups, when they are making decisions. While this duty stops short of a fiduciary duty to minority shareholders, it will still provide a useful basis under which wronged shareholders can make a claim against the directors. The main improvement however, has been the ability of minority shareholders to seek permission from the court to bring a derivative action in any circumstances. This means
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[1998] AC 198, PC [1996] 2 BCLC 184 12

shareholders are no longer subjected to the complicated and restrictive rules that had built up around the Foss v Harbotle case. While the burden of proving that a derivative action is warranted remains with the concerned shareholders, and effective ratification will debar a derivative action, the new provisions still provide a significantly greater level of protection for minority shareholders, and should be welcomed as such.

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