Foss v. Harbottle: Rule of Majority

Indian Legal System > Civil Laws > Company Law > Rule of Majority

In this article, we are going to study the Foss v Harbottle case, which introduced the concept of the rule of the majority.

A company is a juristic person which is conferred a separate legal entity different from the members who form it i.e. members of the company. Decisions of the company are taken by the Member Shareholders and the Board of Directors on behalf of the Company. The company also takes decisions regarding pursuing litigation. As per the Companies Act 1956, shareholders who hold the majority of shares, rule the company. This majority principle is recognized in a landmark case Foss v Harbottle. The decision taken by the majority shareholders was binding on the minority. Now, this principle has been replaced and minority shareholders have been given greater power under Companies Act 2013. There were provisions under the Companies Act, 1956 to protect the interest of the minority shareholders. But the minority has been incapable or unwilling due to lack of time, recourse or capability- financial or otherwise. Hence there were many cases of oppression of minority shareholders. The Companies Act, 2013 has provided for protection of minority shareholders’ rights and can be regarded as a game-changer in the tussle between the majority and minority shareholders.

Rule of Majority (Rule in Foss v Harbottle):

The principle of rule by the majority has been made applicable to the management of the affairs of Companies. The members pass a resolution on various subjects either by a simple majority or by a 3/4 majority (special majority). Once passed by majority members as per requirements, it becomes binding on all the members of the Company. In such cases, Courts do not, in general, interfere in the management of the company on the insistence of shareholders in matters of internal administration as long as the directors are acting within the powers conferred to them under the Memorandum of Articles and Article of Association. The Court will not ordinarily intervene to protect the minority interest affected by the resolution, as on becoming a member, each person impliedly consents to submit to the will of the majority of the members. Thus, if wrong is done to the Company, it is the Company which is the legal entity having its own personality, and that can only institute a suit against the wrongdoer, and shareholders individually do not have the right to do so. This rule was laid down as early as 1843 in the landmark case of Foss v. Harbottle. This rule is the foundation of common law jurisprudence regarding who may bring an action on behalf of the company.

In Foss v Harbottle (1843) 67 ER 189 case, two shareholders Richard Foss and Edward Turton commenced legal action against the promoters and directors of the company alleging that they had misapplied the company assets and had improperly mortgaged the company property, thus the property of the company was misapplied and wasted. They also prayed that the defendant might be decreed to make good to the company the losses. The Court rejected the two shareholders’ claim and held that a breach of duty by the directors of the company was a wrong done to the company for which the company alone could sue.  In other words, the proper plaintiff, in that case, was the company and not the two individual shareholders.

The principle of Foss v Harbottle only applies where a corporate right of a member is infringed. The rule does not apply where an individual right of a member is denied.

In Edwards v. Halliwell, [1950] 2 All ER 1064  case, Jenkins, L.J observed: “First, the proper plaintiff is an action of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself. Secondly, where the alleged wrong is a transaction which might be made binding on the company or association and on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company or associations is in favour of what has been done, then cadet quaestio (cannot be questioned).”

Rule of Majority in Indian Scenario:

The rule of Foss v Harbottle is not completely applicable to the Indian scenario and the right of minority members are protected by the law. The legislature and the Court have clearly demarcated the boundaries as to when can a minority shareholder bring an action against the company when the act of the company prejudices its interests.

In Rajahmundry Electric Supply Corpn. v. A. Nageshwara Rao, 1956 AIR SC 213 case, the Court observed that the conduct with which the defendant is charged is an injury not to the plaintiffs exclusively, it is an injury to the whole corporation. In such cases, the rule is that the corporation should sue in its own name and its corporate character. It is not a matter of course for any individual members of a corporation thus to assume themselves the right of suing in the name of the corporation. In law, the corporation and the aggregate of members of the corporation are not the same things.

In ICICI v. Parasrampuria Synthetic Ltd, Appeal No. 2332 of 1997 case, the Delhi High Court has held that a mechanical and automatic application of Foss v. Harbottle rule to the Indian situations, Indian conditions, and Indian corporate realities would be improper and is misleading. The principle, in the countries of its origin, owes its genesis to the established factual foundation of shareholder power and majority shareholder power centred around private individual enterprise and involving a large number of small shareholders, is vastly different from the ground realities.

Exceptions to the Majority Rule:

The majority rule endorsed in Foss v Harbottle extends to cases in which the corporations are competent to ratify managerial misdeeds. There are certain acts and incidents which no majority of shareholders can approve or affirm. In such cases, each and every shareholder may sue to enforce obligation owed to the company. In American literature, the action as a representative of the corporate interest brought by the member of the company is called the ‘derivative actions’. The following are the exceptions to the rule of the majority.

Ultra Vires:

The rule in Foss v Harbottle applies only as long as the company is acting within its powers.  Ultra Vires Acts are any acts that lie beyond the authority of a corporation to perform. Such acts fall outside the powers that are specifically listed in the Companies Act and also outside those mentioned in Article of Association and Memorandum of Association.  A shareholder may bring action against a company in those instances where an act is ultra vires the Memorandum of Association and the Articles of Association. Such actions are void and cannot be made legal through ratification by majority members.

In Bharat Insurance Company Ltd v. Kanhaiya Lal, AIR 1935 Lah 742 case, the plaintiff was a shareholder of the respondent company. One of the objects of the company was: To advance money at interest on the security of lands, houses, machinery and other property situated in India. The plaintiff complained that the several investments have been made the company without adequate security and contrary to the provisions of the memorandum and therefore prayed for a perpetual injunction to restrain it from making such investment. The Court allowed the suit by the plaintiff and observed: “The broad rule in such cases is no doubt that in all matter of internal management of a company, the company itself is the best judge of its affairs and the Court should not interfere. But the application of the assets of the company is not a matter of mere internal management. It is alleged that directors are acting ultra vires in their application of the funds of the company. Under these circumstances, a single member can maintain a suit for declaration as to the true construction of the article in question.”

Good faith is an important ingredient in determining maintainability in such instances since the action of the plaintiff is for the purpose of doing justice to the company. If the plaintiff’s conduct is also tainted or if there is an inordinate delay, his claim may not be accepted.

In Nurcombe v. Nurcombe, [1985] 1 WLR 370  case, the action was by the wife, a minority shareholder, against the wrongdoings of her husband as a director. In the matrimonial proceeding between them, she came to know of the improper profits made by the husband and such profits were even taken into consideration in preparing the award, it was held that she was not a proper plaintiff for a derivative action.

In Towers v. African Tug Co., [1904] 1 Ch. 558 case, the plaintiff involved payments by directors of a company to the shareholders out of capital that, although honest, were nevertheless illegal. Three years after these payments were made, two of the shareholders brought an action on behalf of the company seeking the repayment of these sums by the directors. There was time delay at the same time it was clear that both the shareholders were well aware of the illegal nature of the dividend payments which they had themselves received and which remained “in their pockets” at the time of the trial. The Court of Appeal unanimously held that in such circumstances the plaintiffs’ action could not be allowed.

Fraud on Minority:

Where the majority of a company’s members use their power to defraud or oppress the minority, their conduct is liable to be impeached even by a single shareholder. The fraud or oppression need not amount to a tort at common law, but it must involve an unconscionable use of the majority’s power resulting, or likely to result, either in financial loss or in unfair or discriminatory treatment of the minority. The act of majority is such that it is the failure of the majority to act in the interest of the company as a whole, which will include the Court to annul a resolution altering the company’s memorandum or articles. Any breach of duty which causes loss to the company should be regarded as a fraud on the minority.

In Greenhalgh v Arderne Cinemas Limited, 1951 Ch. 286 case, the Court held that a special resolution would be liable to be impeached if the effect of it were to discriminate between majority and minority shareholders to give the former an advantage which the latter would be deprived of.

In Menier v. Hooper’s Telegraph Works Ltd., (1874) 9 C App. 350 case, a company was formed to lay down a transatlantic telegraph cable which was to be made by Hooper’s Telegraph Works Ltd. The majority shareholder ‘Hooper’ found that it could make a greater profit by selling the cable to another company which wished to lay it down on the same route, but which would not buy unless it had the necessary Government concessions for the undertaking. The first company had obtained such concessions, and so Hooper induced the trustee in whom they were vested to transfer them to the second company. To prevent the first company from suing to recover the concessions, Hooper procured the passing of a resolution that the first company should be wound up voluntarily, and that a liquidator should be appointed whom Hopper could trust not to pursue the company’s claim against Hooper and the trustee. Menier, a minority shareholder of the first company, brought a derivative action against Hooper to compel it to account to the company for the profits it derived from the improper arrangements it had made. It was held that Hooper’s machinations amounted to an oppressive expropriation of the minority shareholders and that a derivative action would, therefore, lie against it.

In Brown v British Abrasive Wheel Co [1919] 1 Ch 290 case, the company needed to raise further capital. The 98% majority were willing to provide this capital if they could buy up the 2% minority. Having failed to effect this buying agreement, the 98% purposed to change the articles of association to give them the power to purchase the shares of the minority. The proposed article provided for the compulsory purchase of the minority’s shares on certain terms. However, the majority were prepared to insert a provision regarding price which stated that the minority would get a price which the court thought was fair. Astbury J held that the alteration was not for the benefit of the company as a whole and could not be made. One reason for this was that there was no direct link between the provision of the extra capital and the alteration of the articles. Although the whole scheme had been to provide the capital after removing the dissenting shareholders, it would, in fact, have been possible to remove the shareholders and then refuse to provide the capital.

Wrongdoers in Control:

A controlling shareholder or director has a fiduciary duty toward the company. The majority cannot appropriate to themselves the property of the company or the interest of the minority shareholders.

In Daniels v Daniels, [1978] Ch. 406 409 case, where two directors who were also majority shareholders sold property belonging to the company to one of the directors knowing that the sale was undervalued, it was held that there was a breach of duty of the directors to the company even if there was no fraud alleged.

In Glass v. Atkin, (1967) 65 DLR 501 case, where the company was controlled equally by all members. The Court held that the control exists if it would be futile to call a general meeting because the wrongdoers would directly or indirectly exercise a decisive influence over the result and observed that the exception of wrongdoers in control to Foss v. Harbottle applies whenever the defendants are shown to be able by means of any manipulation of their position in the company to ensure that the action is not brought by the company and held the suit maintainable.

In Cook v Deeks [1916] A.C. 55 case, the company had 4 directors (also members) in their company, due to a disagreement between them, 3 of the directors formed a new company to carry out a contract that they had negotiated on behalf of the Company. The 3 directors then tried to ratify the wrong by voting at a general meeting by a special majority(3/4). It was held that the directors had breached their fiduciary duty and abused their power of the majority.

Acts Requiring Special Majority:

There are several decisions which shareholders of a company cannot take by a simple majority. For such decisions, they are to be ratified by special majority i.e. they require the vote of three-fourths of the members present and voting. For e.g. modification in Memorandum of association or Articles of the company. If the majority purport to do any such act by passing only an ordinary resolution or without passing a special resolution in the manner required by law, any member or members can bring an action to restrain the majority.

In Dhakeswari Cotton mills v Nil Kumal Chakravorty, AIR 1937 Cal 645 case, a special resolution was introduced in a general meeting to increase the monthly allowance and commission of the Managing Directors which was decided by a show of hands since no poll was demanded. The plaintiff sought a declaration that the resolution was not binding since it did not have the appropriate majority. The Chairman had declared that 218 had voted for and 78 had voted against the resolution which on the face of it shows that it failed. The court rule in favour of the plaintiff.

In Nagappa Chettiar v. Madras Race Club, (1949) 1 MLJ 662 case, the Court held that if the majority purport to do any such act by passing only an ordinary resolution or without passing a special resolution in the manner required by law, any member or members can bring an action to restrain the majority.

Individual Membership Rights:

Every shareholder has vested in him certain personal rights against the company and his shareholders. A large number of such rights are have been conferred upon shareholders by the acts itself, but they may also arise out of articles of association. Such rights are personal or individual’s rights commonly known as individual membership rights and respecting them the rule of the majority simply does not operate.  A shareholder is entitled to enforce his individual rights against the company like the right to vote, right to stand in elections for the director, etc. An individual membership right implies that the individual shareholders can insist on strict observance of the legal rules, statutory provisions and the provisions in the memorandum and articles which cannot be waived by a bare majority of the shareholder. Every shareholder can assert such a right in his own name.

In Nagappa Chettiar v. Madras Race Club, (1949) 1 MLJ 662 case, the Court observed that a shareholder is entitled to enforce his individual rights against the company, such as his right to vote, the right to have his vote recorded, or his right to stand as a director of a company at an election. If the shareholder, however, intends to recover damages alleged to be due to the Company, the action should ordinarily be brought by the company itself.

In Henderson v Bank of Australasia, (1890) 45 Ch. D. 330 338 case, the plaintiff moved an amendment to the proposed resolution. The Chairman refused to record the amendment in spite of the fact that it was seconded and the original resolution was passed without amendments. No reasons were given for this decision either. It was held that the shareholders have a right to move amendments to resolutions.

In Joseph v. Joss., AIR 1965 Ker 68 case, the plaintiff was a candidate and he contested the election but was defeated. He was proposed as a candidate again to fill up the second vacancy. But the chairman, on account of his previous defeat, disqualified him. In his action against the ruling, the Court held that he was entitled to a declaration that the proceeding of the meeting as regards the election of directors was null and void.

Class Action:

A class action is a legal proceeding in which one or several plaintiffs bring suit on behalf of a group. The judgment or settlement agreed to arise from the suit covers all members of the group or class. Under Section 245 of the Companies Act, investors can file a class action suit in case they feel that the management or conduct of the affairs of a company is prejudicial to their interests. There is a provision in the Act, for minimum numbers of members required to initiate class action. They must total to 100 members or the prescribed percentage for a company having share capital or for a company not having a share capital, the class must be at least one-fifth of the total number of members or if they are depositors they must be 100 depositors or the prescribes percentage of depositors. As long as the action is brought by a group satisfying the above-mentioned statutory requirements, it doesn’t need to be a majority shareholder.

Oppression and Mismanagement:

In instances where sections 241 to 246 of Companies Act, 2013 applies or section 397 and 398 of Companies Act, 1956 applies a suit that can be brought by minority shareholders. This a statutory right granted to a shareholder which overrides the limitations of the majority rule. The application must be made by one hundred members or members having one-tenth of voting power in companies having share capital or the must constitute one-fifth of the members in the company’s register. The tribunal would entertain matters where business of the company is conducted in a manner which defrauds the creditors, members or other persons, oppression of any member, company was formed for any fraudulent purpose, management is guilty of fraud or misconduct towards the company and its members or withholding of information regarding affairs of the company.

In Kanika Mukherjee v. Rameshwar Dayal Dubey, [1966] 1 Comp LJ 65 case, Sinha J of the Calcutta High Court observed that the principle embodied in Section 397 and 398 of the Indian Companies Act which provides for prevention of oppression and mismanagement, is an exception to the rule in Foss v. Harbottle which lays down the Sanctity of the majority rule.

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Indian Legal System > Civil Laws > Company Law > Rule of Majority