The derivative action involves the shareholder usurping the company’s power to sue, and makes the company a party by joining it as an additional defendant. They are four occasions when such a claim can be made: where the act is ultra vires; where it can only be sanctioned by special majority; upon invasion of personal rights; and cases of fraud.
Given the abolition of the ultra vires doctrine in CA 1985, and the possibility that such an act can be ratified by special resolution under s.35(3), this use of this exception has been limited. However, derivative claims can be made against illegal actions, such as support of an unlawful strike as seen in Taylor v. National Union of Mineworkers
. Thus it is possible to bring a derivative action to have an unlawful act set aside. Of course, such illegal acts are unratifiable.
Edwards v. Halliwell
held that if the articles of association require a special majority or procedure, and an action has been brought to challenge a decision which has disregarded such a requirement, such an action will not be subject to the Foss v. Harbottle rule. The reasoning behind this case is that otherwise a director could break the regulation by doing something without a special resolution. Then, he would rely on the rule in Foss v. Harbottle to the effect of allowing the company to do “de facto by ordinary resolution that which according to its own rules could only be done by special resolution.” This would be a clear case where the minority shareholder would be otherwise be ignored. The law allows a shareholder to pursue a claim under the name of the company, because there is no way that the company could raise the action, since the simple majority vote would prevent it. Jenkins LJ further held that, in this case the trade union had “invaded the individual rights of the complainant members”.
Furthermore, Pender v. Lushington
held that where the rights of an individual member has been infringed, he may sue in his own name. Here the chairman simply rejected the minority shareholder’s votes. It was argued that the shareholder, whether in the majority or minority “is entitled to have his vote recorded”. On the basis that the right to have his vote recorded, “is a right of property belonging to [his] interest in this company.” Clearly, outright disregard for the minority, either through disregarding their vote, or attempting to perform an action without special majority, are circumstances where the court would be willing to allow a derivative action. However, Sealy notes that matters of property, are different from those of procedure. The law prefers to allow a company to manage itself, and set its own procedures, and are therefore less willing to recognise standing in such a case.
Fraud might be seen as the only true exception
to the rule in Foss v. Harbottle. In Atwool v. Merryweather
, the minority shareholders brought an action alleging fraud. The case concerned concealed profit, and was unquestionably ‘a complete fraud’. But in such a case, the transaction might be confirmed, if they the shareholders voted in favour of it. In fact, there was a majority setting aside this transaction. However, the law intervened to stop the wrongdoers themselves ratifying the transaction. Their votes were disregarded, and it was seen that the majority of voters, ‘independent of those who implicated the fraud’, were in fact against the transaction. The judge found that to hold true to Foss v. Harbottle would make it ‘simply impossible to set aside a fraud committed’, as the director obtaining so many shares by fraud ‘would always be able to outvote everybody else.’ Edwards v. Halliwell contributed that if minority shareholders were denied derivative actions in this case, “their grievance could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue.”
The court extended the circumstances where a derivative action would be allowed through analogy to previous principles. In Menier v. Hooper’s Telegraph Works
, the majority shareholders that were dealing with the company assets so as to benefit themselves at the expense of the minority. A minority shareholder claimed the majority had in effect, divided the assets of the company between themselves, to the exclusion of the minority. The company could feasibly pass a resolution that everything must be given to them, and that the minority should have nothing to do with it. Protection was again clearly needed, to prevent the “majority [putting] something into their pockets at the expense of the minority”. A derivative action was allowed. Furthermore, Daniels v. Daniels expanded upon the notion of not allowing directors to benefit from their actions. It was held that despite the absence of fraud, minority shareholders were able to bring a derivative action to claim breach of duty. The reasoning was that if a minority shareholder can sue for fraud, there is no reason why he “can’t sue where the action of the majority and the directors confers some benefit on themselves”. The rule in Foss v. Harbottle was excepted because the law cannot allow a director to make a profit out of their negligence. It could be argued that this question should have been left for the company to decide by a majority vote, but it must be noted that there would be no other remedy.
However, it must be noted that these exceptions are not twisted to cover all occasions where the director might act to the detriment of the minority shareholder. Pavlides v. Jensen
held that the individual plaintiff may not sue when the claim is based on negligence. Whether proceedings should be taken against the directors, who were guilty of negligence, “is a matter of internal management”. However, it was noted that in certain cases, the court must go “behind the apparent ownership of shares in order to discover whether a company is in fact controlled by wrongdoers”. This clearly demonstrates the courts willingness to investigate a company to ensure that the minority shareholder is not being dictated by those in control.
Despite the court’s willingness to allow a shareholder to pursue a derivative action in the exception areas of illegality, rights infringement, special majority actions and fraud, the actual establishment of locus standi
is far from easy. The conditions on the minority shareholder’s ability to raise a derivative action are quite severe. He may only raise an action on under the exceptions stated above. Even then, locus standi is not forthcoming. He must also prove the link between the actual performance of the wrong and the people in control of the company, so that it is impossible for the company to bring a properly constituted action in its own name. The minority shareholder must also act bona fide for the benefit of the company. In addition, it is expensive to raise an action. Even if the minority shareholder succeeds he will not personally benefit, as any compensation goes to the company. He merely ensures that in future the company will be run in a more efficient manner. It is also unlikely that as a minority shareholder, he will he will have access to all the information necessary to raise an effective action, when such information would most likely be concealed by those in control.
The recent cases of Prudential Assurance
and Smith v. Croft
show that the courts are now adopting a restrictive attitude towards derivative actions. Prudential Assurance held that the shareholder cannot bring a personal claim when the loss is merely the diminution in the value of his investment in the company. This would suggest much fewer occasions where a minority shareholder would be able to raise an action. However, RP Howard Ltd v. Woodman Matthews & Co
allowed a derivative action because his shares had become ‘less easily saleable’, suggesting this is a view which the court can skate deftly around
. There was also held to be no broad exception to Foss v. Harbottle based on ‘the interests of justice’, apparently leaving no room for further exceptions. Smith v. Croft held that the shareholder will not be regarded as having a right to the procedure unless he has the backing of a majority of his fellow shareholders. This prevents a single minority shareholder from pursuing an action, when the rest of the minority shareholders feel such proceedings would do more harm than good.
Clearly the law has intervened to provide an exception to the rule in Foss v. Harbottle, but this measure has proved very difficult to obtain. We have seen that there are only certain wrongs that can be pursued under a derivative claim. We must add to this the added problem of establishing a derivative claim, let alone proving it. As the Law Commission stated in 1997, ‘the current law is archaic’, and is need of much reform. A statutory derivative action has been suggested, available where negligence, default, breach of duty or breach of trust by a director of the company arises
. Availability would also arise where a director puts himself in a position where his personal interests conflict with his duties to the company. Leading commentators have expressed discontent with such reform, as it does not clarify the issue of what constitutes ‘effective ratification’, which is currently a point of confusion under the common law derivative action. The DTI endorses the recommendation but feels the court should still pay particular regard to the views of a majority of the company’s ‘independent’ shareholders
, which follows the decision in Smith v. Croft.
There also exist certain statutory remedies, the main one being s.459 CA 1985 which affords the shareholder the right to seek relief for ‘unfairly prejudicial’ conduct. As Clark notes, the limitations of the common law remedies that paved the way for statutory protection of minority interests.
Section 459 allows a remedy when a single event which may be either an act or an omission or threatened future conduct may constitutes unfairly prejudicial conduct. Re London School
held that the petitioner need not bring the action with “clean hands”. However, bringing the action when he is somewhat to blame will affect the remedy granted. The words ‘unfair prejudice’ are wide in meaning, which is why this remedy is much favoured to that of derivative action. The Law Commission resisted giving the words defintion in its recommendation of 1997. However, it is clear that the conduct complained of must be both ‘unfair’ and ‘prejudicial’.
In stark contrast to the derivative action principle in Prudential Assurance, diminution in shareholder’s interest value may amount to evidence of prejudicial conduct. Other examples of such unfair prejudicial conduct are exclusion from management
; taking excessive renumeration
; proposing a rights issue which the minority cannot afford to take up
; not paying dividends
; failing to allow minority shareholders independent representation on the board when all control rests with the majority
. This would indicate s.459 being far more useful in protection of the minority, but there are exceptions as seen in Re Saul D Harrison plc
. Here the petitioner was held to have no legitimate expectations over and above an ‘expectation that the board would manage the company in accordance with their fiduciary obligations’ and the article of association. Importantly O'Neill v. Phillips
held that “the concept of legitimate expectation should not be allowed to lead a life of its own”. The court may grant the following orders as set out in s.461(2): regulate the future conduct of the company's affairs; require the company to refrain from committing or continuing an act; authorise civil proceedings to be brought in the name and on behalf of the company; order the purchase of shares of any members of the company by any other members or by the company itself. However, a s.459 petition is very expensive as seen in Re Elgindata
, where the court hearing lasted some 43 days, the costs amounted to some £320,000, while the shares fought over were worth less than £25,000. This remedy is not free from criticism. Reform has been suggested in the form of statutory presumptions. There would be a presumption of unfairly prejudicial conduct if a member of a private limited company could show that he has been removed as director and he holds at least a 10 per cent shareholding in that company.
The DTI expressed reservations about this proposal would lead to further litigation and.
There exists statutory and common law remedies available to the minority shareholder. However, we can see that while they may provide some form of protection they are in need of reform. However, it would it is a difficult task to balance the interests of efficient management with that of protection of minority shareholders.
(1843) 2 Hare 461
[1969] 1 All ER 969
Sealy, p.486
[1985] 1 BCLC 237
[1950] 2 All ER 1064
[1877] 6 Ch D 70
Sealy, p.489, on the basis that exceptions are for wrongs strictly against the company
[1867] LR 5 Eq 464n
[1874] 9 Ch App 350
[1956] 2 All ER 518
Civil Procedure Rules 1998, 19.9
Prudential Assurance Co Ltd v. Newman Industries Ltd (No. 2) [1981] Ch 257
Smith v. Croft (No. 2) [1988] Ch 114
[1983] BCLC 117
Sealy, p.502
Shareholder Remedies, Law Commission Report No. 246, para 6.49, cl. 1
Sealy, p.517
Bryan Clark, Unfairly Prejudicial Conduct: A Pathway Through The Maze, Comp. Law. [2001] 170
[1986] Ch 211
Re R A Noble & Sons (Clothing) [1983] BCLC 273
Re Cumana Ltd [1986] BCLC 430
Re Cumana Ltd [1986] BCLC 430
Re Sam Weller & Sons [1990] Ch 682
Re Macro (Ipswich)[1994] 2 BCLC 354
[1995] 1 BCLC 14 CA
[1999] 2 All ER 961
[1991] BCLC 959
Shareholder Remedies, Law Commission Report No. 246
