Foss v. Harbottle: Jurisprudence and Exceptions

The ultimate safeguard on any abuse of corporate executives remains in court action. Majority rule is the essence of democracy and the same is true with a company, which is an association of individuals and acts in accordance with the decisions taken by the majority of its members.

Where dissatisfied minorities cannot through the ordinary process of interventions at company meetings obtain satisfaction for what they consider to be an impropriety on the directors, the only option left is to appeal to the courts.[1] The Companies Act, 2013 therefore, contains provisions for the protection of the investor’s interests in the company.

Judicial control of corporate activities in English Law brought an important change about by the registration statute of 1844[2] and had a great impact on procedures of control applicable to joint-stock companies. This was to ensure that control is devised over them and the law must be respected. The King’s Court had exercised this power from time immemorial. For that reason, it was thought convenient to study the question by taking the year 1844 as a turning year.

Facts of Foss v. Harbottle

The company named “Victoria Park Company”, had been set up in September 1835. Richards Foss and Edward Starkie Turton, who were minority shareholders in the company, commenced legal action against the promoters and directors.

The claimants alleged that the property of the company had been misapplied and wasted and various mortgages were given improperly over the company’s property. They asked the guilty parties to be held accountable to the company and a receiver is appointed. Also, the defendant might be decreed to make good on the company losses.

The defendants were five company directors (Thomas Harbottle, Joseph Adshead, Henry Byrom, John Westhead, Richard Bealey) and solicitors and architects (Joseph Denison, Thomas Bunting and Richard Lane.[3]

Judgement in Foss v. Harbottle

Wigram VC dismissed the claim and held that when a company is wronged by its directors it is only the company that has standing to sue. In effect, the court established two rules.

• Firstly, the “proper plaintiff rule” is that a wrong done to the company may be vindicated by the company alone.
• Secondly, the “majority rule principle” states that if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not interfere.[4]

Legal Principle: The Rule of Majority

Lord Eldon stated, “This court is not to be required on every occasion to take the management of every playhouse and brewhouse in the kingdom.”[5] The courts have by and large followed the policy of laissez-faire principles to reign and the majority rule to operate unchecked.

The main judicial instrument by which this policy of non-intervention has been maintained is a rule not of substance but of procedure, which is popularly known as the rule in Foss v. Harbottle.[6] This rule is further based on two principles: (a) the proper claimant principle; and (b) the internal management principle. Both these principles envisage that the wrong alleged to be done to the company the claimant in that case is the company itself and the company itself is competent to settle that.

Further Developments

The rule laid down in the case underwent severe criticism across the Atlantic and in other parts of the world because of its complexity[7] and because it is considered unjust to recognise a substantive right but deny a remedy on procedural grounds.

Attempts have been made to reconcile the needs and interests of controllers and minorities like requiring a special resolution than a simple majority vote in important matters, such as constitutional alterations and court’s sanction in matters of reduction of capital. Besides this other statutory provisions give members direct access to the courts.[8]

Application of Rule of Majority in India

The rule in the impugned case is not completely applicable in India and the right of minority members are protected by the law. In India, Law provides a remedy to approach the Company Law Board when there is oppression or mismanagement in the Company where the board with certain express limitations, exercises all powers in order to set the things in the Company right and to prevent the acts of oppression and mismanagement.[9]

In Rajahmundry Electric Supply Corp. Case[10], the Hon’ble Supreme Court held that, in Law, the corporation and the aggregate members are not the same things.

Also in ICICI Case,[11] the Delhi High Court observed that the mechanical or automatic application of Foss v. Harbottle Rule to Indian situations, conditions and corporate realities would be both inapposite, improper and indeed misleading.

Exceptions to the Rule

The operative field of said rule extends to cases in which corporations are competent to ratify managerial sins. But there are certain acts which no majority of shareholders can approve or affirm and each and every shareholder may sue to enforce an obligation owed to the company. In American literature, a representative action of this kind is called the ‘derivative action’.

Ultra Vires 

A shareholder is entitled to bring an action against the company and its officers in respect of matters which are ultra vires and that no majority of shareholders can sanction.

In Bharat Insurance Company Case[12]

“There does not appear to be any case where the necessity of the corporation being a party has been expressly decided; but with respect to the first class of action, the question can admit of no doubt – the relief therein claimed against the corporation itself.”

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.

It can be best understood in the landmark Menier Case[13] It was held that Hooper’s machinations for profits derived from the improper arrangements it had made amounted to an oppressive expropriation of the minority shareholders and that a derivative action would therefore lie against it.

Wrongdoers in Control 

To safeguard the interest of the company, any member or members may bring an action in the name of the company as it would be futile because the wrongdoers would directly or indirectly exercise a decisive influence over the result. The same was held in Glass v. Atkin[14]

Acts Requiring Special Majority 

There are certain acts that required special resolutions at a general meeting of shareholders. Accordingly, 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 can bring an action to restrain the majority. Such actions were allowed in Dhakeswari Cotton Mills Case[15] and Nagappa Chettiar Case[16].

Individual Membership Rights

Every shareholder has vested in him certain personal rights against the company and his shareholders. A large number of such rights have been conferred upon shareholders by the acts itself, but they may also arise out of articles of association. Such rights are commonly known as individual membership rights and respecting them the rule of the majority simply does not operate.

Class Action 

A class action allows a number of claimants with a common grievance against a company to file a lawsuit against it. The scale of economies associated with class actions seems especially critical to those individuals who have limited resources or small claims that render individual lawsuits expensive and unfeasible. Shareholders or depositors may file an application with the National Company Law Tribunal (NCLT) alleging that the management or conduct of the affairs of any company is being conducted in a manner prejudicial to the interests of the company, its members or depositors.[17]

Oppression and Mismanagement

Calcutta High Court inKanika Mukherjee Case[18] held that the principle embodied in S. 397 and 398 of the Indian Companies Act which provides for the prevention of oppression and mismanagement, is an exception to the rule in Foss v. Harbottle which lays down the Sanctity of the majority rule.

Conclusion: Foss v. Harbottle

It can be articulated that the prominent case law of Foss v. Harbottle, is marked with a place of exceptional importance in English Jurisprudence. Its implications have been the sources of many Statutes dealing with corporate law in many countries.

However, the application of the rule of majority laid down in the said case has become subject to many exceptions, keeping in view the minority rights and oppressive approach of majority stakeholders. The majority leadership does not prevail in all decision making processes. Therefore, the principles laid down, in this case, do not have mechanical application in India.

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References

[1]. Demers & Robert, Corporate Litigation in Quebec (Montréal : Centre d’édition Juridique, 1978), P-6.

[2]. Joint Stock Companies Act, 1844 (7 & 8 Vict. c. 110).

[3]. Sealy L.S., Cases and Materials in Company’s Materials, infra, P-599.

[4]. https://en.wikipedia.org/wiki/Foss_v_Harbottle. Last appeared on 07-05-2020 at 14:30 pm.

[5]. Carlen v. Dury (1812) 1 Ves & B 154.

[6]. Sealy L.S., Cases and Materials in Company’s Materials (Oxfords University Press, New York, 2010), P-601.

[7]. RWV Dickenson, JL Howard and Getz, Proposals for a New Business Corporation Law (Information Canada, Ottawa, 1971), P-482.

[8]. Insolvency Act, 1986 (IA 1986) s 124.

[9]. Section 397 & 398, Indian Companies Act, 1956.

[10]. Rajahmundry Electric Supply Corp. v. A. Nageshwar Rao, 1956 AIR SC 213.

[11]. ICICI v. Parasrampuria Synthetic Ltd., Suit Appeal No. 2332 of 1997.

[12]. Bharat Insurance Company Ltd v. Kanhaiya Lal, AIR 1935 Lah. 792

[13]. Menier v. Hooper’s Telegraph Works Ltd., (1874) 9 C App. 350.

[14]. (1967) 65 DLR 501.

[15]. Dhakeswari Cotton Mills v. Nil Kamal Chakravarty, AIR 1937 Cal 435.

[16]. Nagappa Chettiar v. Madras Race Club, (1949) 1 MLJ 662.

[17]. Section 245, Indian Companies Act, 2013.

[18]. Kanika Mukherjee v. Rameshwar Dayal Dubey, [1966] 1 Comp LJ 65.

Author Details: Aditi Sharma (Govt. New Law College, Indore)

The views of the author are personal only. (if any)