Foss vs Harbottle Case

Title of the case: Foss vs Harbottle

Citation: [1843] 67 ER 189, (1843) 2 Hare 461

Court: Court of Chancery

Quorum: Wigram VC, Jenkins LJ

Petitioner: Richard Foss and Edward Starkie Turton

Defendants: Thomas Harbottle & Others

The Foss vs Harbottle case is a significant English precedent in company law. According to the rule established in this case, if the company suffers losses due to its members’ or outsiders’ negligent or fraudulent actions, legal action can be taken to address those losses. The company or a derivative action can initiate such action.

This rule gave rise to the principles of majority and minority shareholders’ rights. In matters of company management, decisions are made through resolutions passed by a simple majority or a three-fourth majority of the company’s members. The court generally does not interfere in the company’s internal management and affairs, as most members decide them. Consequently, the company becomes the appropriate plaintiff to institute a lawsuit or legal proceedings, and it does not typically allow a single shareholder to take direct legal action against the wrongdoer. The rule empowers the company to address irregularities through its internal procedures.

However, there should be a balance between the effective control of the company and the protection of individual shareholders’ interests. In certain circumstances, an individual shareholder may also be allowed to bring legal action.

Minority shareholders have often faced challenges, as derivative claims usually cover them and may not receive equal redress for discrimination. Some researchers have suggested that the Rule of Foss v Harbottle may have been altered or repealed after the introduction of current formal derivative actions. However, concerns about potential overlaps in derivative claims and unequal remedies for prejudice have been raised. The fundamental values established in the Foss vs Harbottle case remain critical in modern company law.

Facts of Foss vs Harbottle

In September 1835, the Victoria Park Company was established to acquire 180 acres of land near Manchester (later known as Victoria Park, Manchester, after incorporation by an Act of Parliament). However, instead of fulfilling the company’s objectives of developing the land for ornamental and park-like purposes, constructing houses with gardens and fields and then selling or renting them, certain individuals, including the directors and others, engaged in unlawful misappropriation of the company’s property.

Richard Foss and Edward Starkie Turton, both minority shareholders, brought attention to this matter. They reported that Thomas Harbottle, Joseph Adshead, Henry Byrom, John Westhead, Richard Bealey (the five directors of the company), as well as lawyers and architects Joseph Denison, Thomas Bunting and Richard Lane, along with H. E. Lloyd, Rotton, T. Peet, J. Biggs and S. Brooks (Byrom, Adshead and Westhead’s assignees), were involved in misapplying and falsely mortgaging the company’s assets, thus deviating from the company’s intended purpose. They argued that these wrongdoers should be held accountable for their actions and appointed a responsible receiver.

Their arguments in Foss vs Harbottle were based on three grounds. Firstly, they pointed out fraudulent practices that misused the company’s funds. Secondly, they highlighted the lack of qualified directors on the company’s board. And thirdly, they emphasised the absence of a company clerk or office. These conditions left the owners with no recourse but to pursue legal action against the directors instead of reclaiming their property directly.

Issues of the Case

The central issues at hand were twofold in Foss v Harbottle:

• Whether the company members had the authority to bring a lawsuit on behalf of the company, in other words, could the shareholders or members of the Victoria Park Company legally file a lawsuit to address the alleged misappropriation of the company’s property and funds?
• Whether the individuals responsible for the wrongdoing could be held accountable for their actions pertains to whether the directors, lawyers, architects and other involved parties could be held legally liable and face consequences for their misapplication and fraudulent mortgage of the company’s assets.

Arguments of the Petitioner

The plaintiffs in Foss vs Harbottle contended that the Victoria Park Company should be considered unique and distinct from ordinary companies due to its incorporation by an Act of Parliament. They emphasised that the purpose of this incorporation was to benefit the company as a whole, but the directors acted in their self-interests instead. 

The petitioners further asserted that the directors had a fiduciary duty to act as trustees for the company and that they should be held accountable for misappropriating its assets. According to the petitioners, the Act of Incorporation granted the directors the authority to take legal action against those who harmed the company. Still, it did not provide such rights to the members of the company or external parties to sue the board of directors.

Arguments of the Defendants

On the other hand, the defendants in Foss vs Harbottle countered the plaintiffs’ claims, arguing that the petitioners lacked the legal right to initiate a lawsuit against them on behalf of the company. They contended that only the directors, as authorised by the Act of Incorporation, possessed the standing to bring legal action against individuals who caused harm to the company. 

In their defence, the defendants in Foss vs Harbottle sought to challenge the petitioners’ authority to sue, asserting that it was outside their rights as company members.

Judgement in Foss vs Harbottle

In Foss vs Harbottle, Wigram VC, the judge, ruled in favour of the defendants and dismissed the shareholders’ claims. The court held that individual shareholders or outsiders of the company could not bring legal action against wrongs done to the corporation, as the company and its shareholders are considered separate legal entities. This principle in Foss v Harbottle is supported by Section 21(1)(a) of the Companies Act, which states that a company may sue and be sued in its name, and a member cannot take legal action on behalf of the company. If the company has a right against a party under a contract, it is the company’s responsibility to sue.

The court in Foss v Harbottle emphasised that shareholders cannot sue because the company has suffered the injury, not its individual members. Therefore, the company should be the one to initiate legal action against those who misappropriated its property. 

The judge based his decision in Foss vs Harbottle on previous judgments regarding unincorporated companies and stressed that the minority shareholders must demonstrate that they have exhausted all possibilities for redress within the internal forum. Suppose the majority of shareholders can ratify the irregular conduct. In that case, the courts will not intervene, which some consider unfavourable to the minority, as it restricts their ability to take legal action in cases where misconduct can be ratified.

Rule in Foss v Harbottle

As a result, the court in Foss v Harbottle established two principal rules. 

• The first is the “Proper Plaintiff Rule,” which states that only the company can sue directors or outsiders for any wrong or loss due to fraudulent or negligent acts. Members of outsiders cannot sue on behalf of the company because of the principle of “Separate Legal Entity,” which treats the company as a distinct legal person from its members. 
• The second rule is the “Majority Principle Rule,” where the court will not interfere if the alleged wrong can be ratified by a majority of members in a general meeting.

However, these strict principles seemed harsh and unjust for minority shareholders as they were prevented from seeking justice despite having substantive rights. To address this, the court in Foss vs Harbottle established four exceptions to the general principles where litigation would be allowed. 

Exceptions to Rule in Foss vs Harbottle

However, there are certain exceptions to the Majority Principle Rule to protect minority shareholders:

• Ultra Vires: If an action is taken by the company that is beyond the scope of its Articles of Association, any member can bring legal action against it.
• Fraud on Minority: When the majority oppresses the minority and commits fraud, even a single shareholder can initiate legal action to protect the minority’s rights.
• Oppression and Mismanagement: Shareholders have the right to seek legal action if there is oppression or mismanagement within the company. They can approach the tribunal or court under specific sections of the Companies Act.
• Individual Membership Rights: Members can enforce their rights against the company, such as the right to vote or stand in elections.
• Derivative Action: Shareholders can bring an action on behalf of the company for wrongs done, acting as representatives of other members whose relief is sought. This action is called a derivative action, and the company must be joined as a co-defendant so that the company is bound by the judgment given.

These exceptions protect minority shareholders and allow them to seek justice in certain circumstances despite the Majority Principle Rule.

Foss vs Harbottle Summary

Foss vs Harbottle is a significant case in company law where the court ruled that if a company suffers losses due to the negligent or fraudulent actions of its members or outsiders, legal action can only be brought by the company itself or through a derivative action. The court emphasised the separate legal entity principle, which prevents individual shareholders from suing on behalf of the company. 

Majority shareholders, through resolutions, manage company affairs, and the court generally does not intervene in internal matters. However, a few exceptions allow individual shareholders to bring legal action as per  Foss vs Harbottle rule. The  Foss vs Harbottle case established the “Proper Plaintiff Rule” and the “Majority Principle Rule.” Despite concerns about unequal remedies for minority shareholders, the core principles of the case remain vital in company law.