The ability of shareholders to cast their votes in their own selfish interests does make ratification of directors wrongs a complex issue, as directors are often shareholders.

Acting on a basis of dual capacity as a director and shareholder, seems to have emerged as an exception to the conflict of interest rule.  Directors cannot act against the company but as a shareholder they can vote in their own selfish interest.  Therefore if one was to have a majority shareholding, they could ratify their own wrong.  Basically, to act bona fide is the duty which should be abided by directors, however when they put on their shareholders hat they can then actually pursue personal interests irrespective of the company and the other shareholders.  An exception to this was shown in Clemens v Clemens Bros Ltd in which the general outcome was that, shareholders have a right to vote to protect the value of the shares in any way they wish, but the best interests of the company can override that right and a decision contrary to these best interest will not be upheld.  Therefore where a director is also a shareholder which interest shall prevail?  ‘A shareholders interest in the value of their shares is a subsidiary interest which should give rise to a compensation claim if unfairly distributed but should never be allowed to override a director’s duty to act bona fide in the interest of the company’.  

Where a director is also a majority shareholder acting on his own interest there may be conflict with the minority.  It would seem fair in such a circumstance that where the company is harmed by a fundamental breach by the director the shareholders should not be able to ratify the breach unless the shareholder is to vote unselfishly and in the interest of the company.  Without such a duty shareholders will vote to protect their own property right and interest and therefore not in the interest of the company.  Generally it would seem that the law allows for shareholders to use their right to vote in their own advantage.  Even the strict fiduciary duties imposed upon directors cannot totally prevent them from acting in their own selfish interest if they are also shareholders.  In principle the decision which is reached by the majority, generally has to be accepted by the minority.  It would therefore seem to be the case that where a director has a majority shareholding, he may be able to ratify his own wrong.  An exception to this would be s.459 Companies Act 1985 which allows minority shareholders to complain.  Therefore if the director is in a position of power where he has control over the majority of shares and is profiting from acting in a fraudulent behaviour a shareholder may be able to bring a derivative action, which is the one exception to Foss v Harbottle.  

The ability of enabling the minority to prevent ratification of a directors breach of duty is best looked at through the judgements of case law over the years.  The early case of Bamford v Bamford stated that it was for the company to decide whether to sue or not, which followed the well established case of Foss v Harbottle.  Here it was said that where a director is in breach of duty, it was up to the company to sue as the duty was owed directly to the company.  Therefore, if a director is a majority shareholder he can stop the company from suing him.  However an exception was enforced in that where the known director had acted negligently, a shareholder could take a derivative action and sue on behalf of the company.  This had to be supported by two requirements: the first that the minority shareholder was to act bona fide; secondarily it was necessary to prove that the wrongdoers acting mala fide were in control of the company.  A fair criterion seemed to be laid down to give the minority an action in such a situation.  In spite of this, in 1956, the courts introduced an additional requirement.  In Pavlides v Jensen, it was required that in order for a derivative action to be successful it had to be proved that the director under scrutiny had benefited personally.  It would therefore seem that it becomes extremely hard for the minority to follow through such an action, as they in simple terms, do not have ‘a leg to stand on!’.  Further more, following Smith v Croft, it was concluded that a minority shareholder who would otherwise be able to sue on behalf of the company, under an established exception to Foss v Harbottle may be prevented from doing so if the majority of members opposed to the litigation.  If the majority of the oppressed minority is not prepared to support the action, it will not be able to go ahead.  Overall, the minority has very little protection and it is likely that most breaches of duty can be ratified, even if the director in breach of duty holds the majority of shares.  It would seem to date, that the only exception to Foss v Harbottle is fraud on the minority.

The only other protection available to the minority is through statutory protection.  This provides a requirement that a special resolution should be passed on fundamental issues.  The courts are also under an obligation to sanction certain matters which permits the minority to apply to court, in order to have the resolution set aside.   As mentioned above, s.459 Companies Act 1985, gives individuals the right to compensate for the value lost in their shares due to unfair prejudice conduct as well as s.124 Insolvency Act 1986 which gives the minority a right to petition to have the company wound up.

It is quite clear the current law lacks certainty and reform is therefore required.  It is apparent that there is much confusion and uncertainty due to the exceptions of the Foss v Harbottle rule.  Replaced by a statutory derivative action, possibly an expansion of s.459 Companies Act 1985 this should be abolished.  This would assure that limited power is giving to shareholders to act upon their own interests, shifting the control which came from outside of the company to within the company, which would correspond with that suggested in the Cadbury report.  Another recommendation, which has been put forward, is to tighten the law.  This however must leave room for directors to work efficiently, exercising power, but to an extent in which it is clear that they have a fiduciary duty and must abide by this.  A clearer definition of which ‘breaches of duty’ can be rectified is recommended.  Individual company’s can set this out in their articles, which will provide flexibility to the company and to an extent, a code of practice, in which directors will be able to abide by.  A statute should provide clear circumstances in which the breach cannot be ratified in any situation though, if it is to prove so detrimental to the company.  It has also been suggested that a clear definition of the overriding duties of a director should be portrayed.  The approach taken should be subjective as well as an objective (combined definition) and should use the Insolvency Act 1986 and Re City Equitable Fire Insurance  as a guideline.

To summarise, it is clear that more protection should be given to the minority in order to invalidate any decision which seems to be against the interest of the company and where the director as a majority shareholder is promoting his own selfish interests, which consequently means that he is going to be, in some respect, immune to any directorial wrongs committed by him as he can ratify them.  The courts reluctance to overturn the majority’s decision of a director, where although not acting in the best interest of the company, he is able to promote that what he is doing seems to be for the benefit of the company, is a clear sign that reform and a true value of ratification is required.  

Word Count: 2251

Bibliography

• Janet Dine, Company Law (4th edn) Palgrave, 2001
• Private Property and Corporate Governance Part II: Content of Directors Duties and Remedies
• Ratifying directorial wrongdoing – The legal fiction of shareholder consent, John P Lowry
• Farrar, Company Law (4th edn) Butterworths, 1998
• Gowers, Principles of Modern Company Law (6th edn) Sweet & Maxwell, 1996
• Sealy, Cases and Materials in Company Law (6th edn) Butterworths, 1996
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