The Report has identified four problems with the rule in Foss v. Harbottle. The rule is not found in the courts, only in case law that dates back over 150 years and therefore is regarded as ancient. Also, the effect of the exceptions is that an action to recover damages suffered by a company, by a company directors breach of duty, cannot be brought unless the wrongdoing director has control over the company. This is problematic because in many large companies, directors who exercise control have less than a majority vote.
A further dilemma is that you must prove that a director´s negligence confers benefit on controlling shareholders, or that the failure of the directors to bring an action constitutes fraud on the minority. So as the rule in Foss stands now, you can only bring a derivative action if the majority shareholders benefit from the wrongdoing. This restriction would be replaced by a requirement to obtain the leave of the court under the new derivative action. Finally, the standing of the member bringing the derivative action must be established. This involves a mini trial that costs money and time. As a result of these obstacles, minority shareholders are dissuaded from bringing such proceedings.
The Commission´s aims are to make the circumstances in which a shareholder can sue on behalf of the company, laid down in an easy to find, clear and flexible set of rules.
Consequently, the Report states that attempts to provide alternative procedures for minority shareholders action by statute, such as s.461(2)(c) of the Companies Act 1985, have been unsuccessful. Thus, the first problem in the current law relates to actions brought by minority shareholders on behalf of their company.
The ‘unfair prejudice´ remedy under s.459-461 of the Act is flawed as it involves vast costs and complex factual investigations. This affects smaller companies more so as it gives members of such type easier access to the remedy and the company suffers more from the delays and expenses associated with the proceedings.
Shareholders also have alternative remedies under statute such as the ability to petition for relief on the basis that company matters have been carried out in a way which unfairly prejudices the interests of the members. The Report also focuses these remedies and indicates six guidelines in an attempt to make the law more streamline.
Normally, according to the ‘proper plaintiff principle´, a company is the only party who can enforce a cause of action belonging to it. However, a member should be able to bring such proceedings in extraordinary circumstances
Next, individual members should not be able to seek proceedings on behalf of the company regarding issues concerning internal management. By this is it meant issues that the majority shareholders have the right to control by ordinary resolution.
Thirdly, it is suggested that the court should remain to have regard to judgments of company directors if the judgement was made in good faith, and taking into consideration all the factors it seems to be the appropriate decision to have made. The courts are reluctant to interrogate the decisions of directors as the individual bringing proceedings to the court is likely to have less understanding of the company´s activities. Yet, to not question the directors in respect of decisions they make is unfair as they may be acting in an unjust manner. The principle proposed would lay down parameters for the courts to follow.
The Report also looks at the sanctity of the contract between the company and the shareholders. Members agree to the memorandum and the articles of association. This should continue to be binding unless an agreement that is not in the articles or the memo arises. This principle takes the view that the greatest guard for shareholders is in the article themselves. This reform is primarily aimed at individuals who overlook the constitution of the company.
The penultimate principle prevents shareholders from involving the company in litigation without just cause. This is so they do not cause other shareholders or the company unnecessary embarrassment. If this occurs, not only may the company may be “killed by kindness”, but it would waste time and money on a claim that was not bona fide. The significance of this guideline expands if the situations in which a shareholder can pursue derivative actions are broadened.
Finally, the Report wants to make remedies affordable and effective. The current law can prove to be expensive and lengthy.
The last three principles are applicable to all types of shareholder remedies whereas the first two only apply to derivative actions. The penultimate guideline is restricted to proceedings under s.469 as they do not generally require the company to take on an operative part. If individual member seek a wind up order as a more preferential remedy to relief under s.459, in situations where this is not justified, then the importance of this principle is increased.
It is important to discuss the issue of ‘unfair prejudice´ further. The meaning of this term originated from Re R A Noble & Sons (Clothing) Ltd. where the courts looked at whether or not the company´s transactions had been carried out in a way which unfairly prejudiced the petitioner´s interests. The test applied was an objective one; therefore there was no burden of proof on the petitioner to show that the company acted in bad faith. The conduct must have caused prejudice to the members interests and must be so unfair that it would be insufficient if the unfair conduct fulfilled only one of the tests. This would again, lead to expensive and time consuming litigation.
The Report also focuses on where a shareholder that is entitled to management participation is excluded. This constitutes ‘unfair prejudice´. However, under s.459, not all exclusion from management entitles a shareholder to a remedy. This is one of the main problems being addressed by the Law Commission Report. According to the statistics set out in the Report this is the most common claim in ‘unfair prejudice´ cases. The individual can seek to have his shares bought out without any discount that would show that the member has a minority shareholding. This method is identified as being sold on a pro rata basis. The Commission suggests a more focused alternative to the proceedings under s.459 to streamline the law.
The Report goes on to discuss the insertion of “self-help” regulations into Table A, which is the companies statutory model form article of association. The articles would include a shareholder exit for smaller private companies, an arbitration article and a valuation procedure article. The aim of this is to encourage individual to resolve any disputes outside of the courts by having pre-agreed methods of solving disputes without resorting to expensive litigation.
There has been support for the increased use of effective case management techniques to deal with the lengthy and costly procedure under s.459. The majority of people who commented on the Report concluded that the rule in Foss v. Harbottle should be partly abolished. However, there was a certain amount of apprehension regarding the introduction a new derivative action as such actions are rarely used and therefore not necessary.
In order to establish the effects of implementing the Report, we must summarise the key proposals in the report. Firstly, active case management by courts would solve the cost and length problem fundamentally. Secondly, there should be a presumption in s.459 proceedings that in certain circumstances, conduct will be presumed to be unfair and where courts allow a purchase in favor of the petitioner, the shares will be valued on a pro rata basis. Changes will be made to the s.459 proceedings, which include limitation periods in respect of claims under the section, and that winding up should be added to the remedies available. A draft regulation should be included in Table A to encourage parties to solve problems without litigation. Finally, the new derivative procedure will be modern, flexible and have accessible criteria for deciding if a shareholder can pursue an action.
In conclusion, it is apparent that the present law governing shareholder remedies are full of complexities. It does not leave minority shareholders with remedies to adequately compensate for he loss they have suffered. Therefore, the law doe not provide sufficient protection for such shareholders. The Law Commission Report on Shareholder Remedies provides invaluable insight into the current situation and adequately highlights the problem areas and has potential to overcome some of these problems. The introduction of the statutory derivative action could greatly improve the present situation. This action would be available to any shareholder if the case fell into the scope of ‘if the company were the applicant, it would be entitled to any remedy against any person as a result of threatened breach by any director of the company of any of his duties to the company´.
Additionally, it cannot be ignored that the s.459 and the derivative action are costly and lengthy. The implementation of the Report would result in the disappearance of these hurdles so long as the provisions are applied sufficiently. It would therefore, without a doubt make significant differences to the present law.
As Diana Faber, Law Commissioner stated “our aim is to provide speedy, fair and cost effective mechanisms for resolving disputes between minority shareholders and those running companies, without disturbing the current balance of power between members and managers”.
