Protection of Minority Shareholders

In a world of capitalism and widespread corporate affairs and entities, there will always

exist the utilitarian principle of the majority good for a majority amount of people. This

is where the principle of the “majority rule” stands –  where  where shareholders who majorly

collectively vote for an agenda during a general meeting will have the upper hand in

most of the affairs run by the company. The minority shareholders however, will be

expected to conform to the flow and be bound by the decisions agreed upon by the

majority. Thus, they shall only thrust themselves into the limelight of decisions when

they petition to the court against the unjust acts or omissions made by the directors

and/or majority shareholders.

In status quo, there exist three routes where minority shareholders can rely on in

order to contest the decisions of directors and majority shareholders: the derivative

claim, the unfair unfair prejudice petition, and finally, by enforcing personal entitlements

“under the articles of association.” This paper will analyse the first two remedies that

are available for aggrieved minority shareholders.

This paper will not only analyse both the common law and statutory remedies

mentioned above separately, but also the procedures and requirements that particular

petitioners have to comply with when petitioning to the court as well as the limitations

to these remedies. One will also evaluate the rule in Foss v Harbottle (which shall

herein be addressed as Foss) and the general attitude of the courts in safeguarding

the rule against unjustified, malicious minority shareholders. Finally, the strengths and

weaknesses of each respective remedy will be accessed and compared in order to

determine the ultimate saviour of minority shareholders’ rights in a “solvent company” .

Companies Act 2006 and the Duties of Shareholders

Generally, the duties and capacities of shareholders are illustrated in section 33(1) of

the Companies Act 2006 (CA 2006). This section upholds the power of the majority

vote where any decision decided upon by the majority shall bind all shareholders within

the company.

Thankfully though, there are checks and balances when it comes to equal footings

of power –  dissented shareholders may vote "against the resolution in question" or

they can "alter the articles or...[refuse] to re-elect the directors of whose powers they

disapprove." However, as much as a number of shareholders may disapprove of the

decisions made in the general meeting, once the final tally of votes is recorded and

conceded to, all shareholders are at its mercy regardless of inconsistent attitudes.

 As a result, this may highly likely deter smaller shareholders from voting to begin

with as they feel like their dissent will hold no water to the decisions of the majority.

This will be mutually exclusive to the position of majority shareholders as they

consequentially will have "virtually unlimited decision making power" without any

hindrance from opposing minority shareholders during general meetings. This is where

the exceptions to the Foss rule come into play.

The Rule in Foss v Harbottle

The rule in Foss was developed in order to protect the standing of the company as a

whole against fragmented shareholders and it acts as an order in determining locus

standi (capacity to sue in court). Status quo has declared the company as the only

entity with legal standing to sue when a wrong has been committed against it; and

once an ultimate decision has been reached by the majority no individual shareholder

should be allowed to express his or her dissatisfaction "for the simple reason that, if a

mere majority of the members of the company...is in favour of what has been done,

then cadit quaestio" - meaning that "the question is at an end." That means that all

collective decisions are final.

The attitude of the courts has long been "non-interventionist" , in which the courts

have steered clear of interfering with the “internal management” of companies. This is

known as the internal management rule. Their justifications are primarily to uphold the

rights of the majority shareholders’ and the choices they make in general meetings, as

well as the opinion that the directors themselves are in a far better position to

determine how the company should run. The courts also believe that for any decision,

the majority will supersede regardless in any way in a collective meeting so there is no

constant need for the courts to intervene. Moreover, there is a presumption by the

courts that the companies are “acting within their powers” until proven otherwise. The

proof for otherwise will be elaborated in the requirements of derivative claims below.

Derivative Claims

Derivative claims are legal actions brought by a minority shareholder on behalf of a

company for a cause and consequence of the company’s interests. It is expounded in

Section 260 CA 2006 to mean that all actions pursued by the minority shareholder

must be tied and largely rooted by the company’s best interests and nothing else.

Derivative claims are most greatly known as the top exception to the Foss rule, largely

because it manages to overreach the barriers placed by the majority rule in allowing

minority shareholders to claim. One must note, however, that this ability provided to

minority shareholders does not substantially substitute the rule in Foss, but it namely

acts as a last resort or final alternative route to shareholders who have felt that “the

majority are abusing their powers, and are depriving the minority of their rights” in a

company.

 Although other shareholders’ actions exist under the CA 2006, namely personal

actions and representative actions (group litigation), but it is derivative actions that

have a higher call towards minority shareholders. This is because of the discretionary

attitude of the courts as mentioned above.

Personal actions are generally not affected by the Foss rule since it would be an action

by a particular shareholder regarding the question of his or her rights, and not on

behalf of the company. Such claims will usually be allowed by the courts where the

minority will be “entitled to come before the court to maintain their rights.”

Reflective loss on the other hand, will not be entitled to claim under personal actions.

This is where the only loss encountered by the shareholder is exhibited by the

diminution of finances by the company itself. It is said that a shareholder

“cannot…recover damages merely because the company in which he is interested has

suffered damage.” A shareholder cannot claim where he has not been compelled to

endure a personal loss near and dear to him, but simply a loss faced by the company.

Such loss is not reciprocal onto the shareholder. On the other hand, if a shareholder

can prove that the defendant had indeed breached a duty that correlated to his rights

personally –  for example, under a contract or a tort  – and it results in a “personal loss,

separate and distinct from that suffered by the company”, and said shareholder

manages to establish all other requirements demanded by the courts, then said

shareholder may be authorised to bring a personal action.

Representative actions (or group litigations) on the other hand, are much more

precarious. Although it brings the benefit of reducing the amount of identical suits

against the company, but the requirements are specific in which under rule 19.6 of the

Civil Procedure Rules (CPR), a class right has been violated and there must be more

than one individual who has an interest in a claim. Rule 19.6(4)(a) CPR also states

that whatever resulting judgement will be “binding on all persons represented in the

claim.”

Requirements of Derivative Claims

In order for a minority shareholder to bring forward a derivative claim, one must first

establish the requirements set out by the courts. The most important aspect is the fact

that the wrongdoing as specified by the minority shareholder is being controlled by the

defendant directors and it is those who are in control that are thwarting the company

from launching an action. It is here that the company will no longer be the ultimate

claimant, but will also be included as the defendant with the actual perpetrators; so that

the company can both receive compensation for the wrong done onto it as well as be

bound by any resulting decision made by the courts.

 Another important element to note is that there must be a “majority of the minority [that]

wish the action to proceed” otherwise the derivative action will fail. This is important in

that it is the corporation that would highly likely bear the costs of the derivative action

in question and thus, there must be some collective consensus amongst the

aggrieved.

Generally, there are a number of exceptions to the rule in Foss before a minority

shareholder can pursue a derivative action. The first requirement is that the act(s)

forwarded by the company was “illegal or [was] wholly ultra vires the company.” This

was where the directors propelled decisions that surpassed and exceeded beyond the

boundary of their duties. In the event this occurs, it becomes nearly impossible for the

remaining shareholders to “ratify the transaction” or rectify any “informality or

irregularity” found in the decisions of the company.

The second requirement is where the subject in question “requires the sanction of a

special majority” or there exists non-adherence of a “special procedure.” If a particular

decision of the company requires a “special resolution” but there is no approval by the

“special majority,” then the individual minority shareholder will have enough basis to

sue via a derivative claim.

The third requirement is on the notion that an individual member’s direct rights have

been violated. Two obstacles must be overcome before this requirement can be

satisfied. Firstly, there must be a distinction between outsider and insider rights in

which only the latter is enforceable. The second obstacle is the distinguishment by the

courts on whether the wrong was only inside irregularities  – “which can be waived by a

majority vote” – or that it is a “constitutional right” or constitutional infringement in

which the claimant would be allowed the cause for claiming.

The fourth requirement is the execution of fraud against minority shareholders.

Fraud can be defined as “an abuse or misuse of power;” or as “when the majority are

endeavouring directly or indirectly to appropriate to themselves […]” which means the

seizing of benefits which would otherwise belong to the company or other shareholders.

Surprisingly, the definition for ‘fraud’ has been rather wide in whic h the courts have

even allowed a claim albeit the presence of an actual fraud where the directors have

misused their powers “intentionally or unintentionally, fraudulently or negligently, in a

manner which benefits themselves at the expense of the company. ” The requirement

for fraud would also be met if particular shareholders attempt to “use their voting power

to stultify any proceedings being taken against them.”

 Apart from that, there is the minor exception where a shareholder can sue when the

interests of justice demands it. This is the ultimate last resort for minority shareholders

when no other viable and visible remedy exists “except that of a suit by individual

corporators.” It is only then that “the claims of justice would be found superior” to all

the barriers initially placed by the technicalities of the derivative actions.

Limitations of Derivative Claims

 As much as the courts and the rules of justice intend to uphold the rights of minority

shareholders in a company, there must exist some limitations to derivative claims as to

safeguard not only the company as a whole but also innocent shareholders who have

not been tainted by the actions and decisions of the wrongdoers, as well as “shadow

directors” (third parties who assist the directors or former directors) who may or may

not be equally guilty.

In Smith v Croft (No 2), the courts took into account shareholders who “were

independent of the wrongdoers” and the fact that they refused for actions to be

commenced “for disinterested reasons.” For this reason, the individual member seeing

for derivative action would not be able to be successful without the support of “the

majority inside the minority.”

It is also said that all derivative actions must be sought “bona fide on behalf of t he

company” and there cannot exist any reasonable doubt of the member being enticed

by external interests or possessing any ulterior motives. This is primarily to protect the

company from any frustrated shareholders who may be “acting through malice or

misjudgement” and end up consuming a hefty amount of time, “trouble and expense

for the company.”

Unfair Prejudice Rule

The unfair prejudice rule –  which was previously laid down under Section 459 of the

Companies Act 1985 but is now replaced with Section 994 CA 2006 –  aimed to protect

minority shareholders’ rights where the issue arose “from unfairly prejudicial conduct of

the company’s affairs.” Where derivative claims are actions sought by a member on

behalf of the company for “wrongs done to the company,” the unfair prejudice rule on

the other hand is partially contradictory in that it is to remedy “wrongs done to the

shareholder” –  although in rare instances, it can include wrongs done onto both

parties.

In order to determine unfairness, the courts resort to an objective approach in which

it observes the conduct and demeanour between the company and its members. The

 Articles of Association can also be utilised as an important benchmark in determining

whether the actions of the company conform to how it should treat its members

especially if it relates to any specific “shareholder agreements that may be present.”

The significant case of Clark v Cutland exemplifies the usage of the unfair prejudice

rule where the capacity of the rule has been extended by Arden LJ to include an

individual shareholder to acquire a considerable remedy for the company over the

injustice committed onto it as well as “possibly…obtaining a remedy for themselves

personally.” As a result of such judgement, there will now be an unavoidable

combination of “personal and corporate issues” of both individual and corporate claims.

The claimant shareholder may even obtain a “costs order” so that it will be the

corporation and not the petitioner who will finance the action.

The result from Clark v Cutland has sparked numerous criticisms in allowing the

remedy of unfair prejudice to expand so wide as to award minority shareholders an

incredible leeway to petition for both personal and company-related claims. Critics

exclaim that the methods utilised by the courts in filtering out unnecessary claims is

“inadequate” and that the “collective position” of the remaining shareholders in a

company should be taken into account.

Thankfully, the case of Hecquet v McCarthy managed to draw the line on minority

shareholders gaining unreasonable remedies apart from the sake of the companies

they serve. All in all, it is agreed upon that minority shareholders should not be given

“an indefeasible right to obtain substantive corporate relief” under the unfair prejudice

rule.

Comparison and Criticisms

The statement for this paper claims that despite the fact that the unfair prejudice rule is

more feasible in protecting minority shareholders’ rights, individual members still opt

for derivative claims –  albeit the presence of a newly fortified Section 994 CA 2006.

This statement does appear to be true based on the extended grounds for derivative

actions as well as the insufficient accessibility of the unfair prejudice rule.

 An advantage of derivative claims is the expansion to incorporate “mere negligence

and breach of regulatory duties” when seeking an action under Section 260 CA 2006.

 Although it will still be up to the ultimate discretion of the courts to allow such claims to

pass, but it is still a considerable relief from the existing “procedural hurdles” that

surrounds the action.

 Another difference between the common law and statutory law rule is that public

companies can rely on derivative actions but not the unfair prejudice rule. For

derivative actions, the court may declare the corporation to compensate the charges

reasonably sustained by the petitioner when bringing an action. However, no such

compensation costs exist under the unfair prejudice rule.

Furthermore, there exist numerous criticisms for both remedies respectively. The

main criticism of derivative claims is its complicity and the unpredictable scrutiny of the

courts in respect to each individual claim. The initiation of any petition on behalf of a

company will inevitably cause a “substantial diversion of management time and

resources” and despite all the hurdles intended to reduce unnecessary claims, it will

only be evident after the company has endured the long and complex procedures.

As for the unfair prejudice rule, the largest criticism is the lack of accessibility for

petitioners to obtain the proof of prejudice. Minority shareholders have to bear the

“limited access…to the ‘inside’ corporate information necessary to underpin a

shareholders’ action” and thus, will not be able to substantially gather the proof

needed for the courts. Exclusion of minority shareholders in “small companies” is also

an issue faced by unfair prejudice petitioners. Moreover, the “long length of

proceedings” as well as their high resulting fees is also a flaw. Lastly, as a result of the

decision in Clark v Cutland, there is a risk of a minority shareholder attaining “a

corporate remedy in response to a corporate wrong without going through the leave

and notice requirements which are in place in a derivative action scenario.”

Conclusion

Based on the extensive deduction of derivative claims and the unfair prejudice rule, as

well as the comparative studies of their strengths and weaknesses, one can finally

make a conclusion on the credibility of the statement. With the extension of grounds for

petitioning derivative claims to include negligence, minority shareholders still rely on

the common law remedy regardless of the flexible nature of the statutory alternative. It

is reasonable to speculate that both remedies will encumber a company of its valuable

time and money however, it is practical to conclude that an individual minority

shareholder would rather opt for derivative claims as compared to the statutory remedy

because of its nature as being the last resort for aggrieved shareholders. Where proof

is incredibly difficult to attain due to the stronghold of those in charge of the company,

a derivative claim is what remains as the prevailing action for minority shareholders

who feel that they have been misled or deceived. It is for this reason that the statement

should stand.