A Critique on the Rule of Foss v. Harbottle

CONTENTS

i) Table of Cases

ii) Table of Statutes

1) Introduction

2) Foss v. Harbottle

3) Exceptions

4) Conclusion

iii) Bibliography

TABLE OF CASES

1) Bhajekar v. Shinkar

2) Rajahmundry Electric Supply Corpn Ltd. v. Nageshwara Rao

3) Dr. Satya Charan Law and others v. Rameshwar Prasad Bajoria and others

4) Edward v. Haliwell

5) Heyting v. Dupont

TABLE OF STATUTES

Companies Act, 1956 (India)

Companies Act, 2006 (UK)

INTRODUCTION

Foss v Harbottle1 is a leading English precedent in corporate law. In any action in which a

wrong is alleged to have been done to a company, the proper claimant is the company itself.

This is known as "the rule in Foss v Harbottle", and the several important exceptions that

have been developed are often described as "exceptions to the rule in Foss v Harbottle".

Amongst these is the 'derivative action', which allows a minority shareholder to bring a claim

on behalf of the company.

This applies in situations of 'wrongdoer control' and is, in reality, the only true exception to

the rule. The rule in Foss v Harbottle is best seen as the starting point for minority

shareholder remedies.

The management of a company is based on the majority rule. The majority right to manage

the affairs of the company is vested in the directors who are elected representatives of the

share holders.

Those rights, which are not vested in the directors, are exercised by the members in their

general meetings, as are all the other decisions are taken on the basis of majority. Thus, the

majority has its way in the general meeting. This principle is that the will of the majority

should prevail and bind the minority is known as the principle of majority rule. This is also

known as the Foss v. Harbottle Rule.

This rule was established in given legal recognition and established in 1843 in the case of

Foss v. Harbottle. Two minority shareholders in a company alleged that its directors were

guilty of buying their own land for the company’s use and paying themselves a price greater

than its value. T

his act of the directors resulted in a loss to the company. The minority shareholders,

therefore, decided to take an action for the damage against the directors. The shareholders

hence in a general meeting by the majority resolved not to take any action against the

directors alleging that they were not responsible for the loss which had been incurred.

The Court dismissed the suit on the ground that the proper plaintiff for the wrongs done to the

company is the company itself and not he minority shareholders. It further held that the

company can act only through its majority shareholders.

1 (1843) 67 ER 189

The basis of specific rule in this case is that the protection of the majority is supreme.

Whenever a person becomes member of a company he gives his implied consent to accept the

decision of the majority in the general meeting of their company provided the meeting is held

in accordance with the provisions of the Companies Act, 1956, the memorandum and the

articles of association.

Foss v. Harbottle

This case was brought by two shareholders in the Victoria Park Co against the company’s

five directors and others, alleging that the property if the company had been misapplied and

wasted and certain mortgages improperly given over the company’s property. It asked that

the defendants should be held accountable to the company, and also sought the appointment

of a receiver, The Vice-Chancellor ruled, however, that it was incompetent for the plaintiffs

to bring such proceedings, the sole right to do so being that of the company in its corporate

character.

“It is only necessary to refer to the clauses of the Act to show that, whilst the supreme

governing body, the proprietors at a special general meeting assembled, retain the power of

exercising the functions conferred upon them by the Act of Incorporation, it cannot be

competent to individual corporators to sue in the manner proposed by the Plaintiffs........

The very fact that the governing body of proprietors assembled at the special general meeting

may so bind even a reluctant minority is decisive to show that the frame of this suit cannot be

sustained whilst that body retains its functions.”2

“A major advance in the law in regard to minority shareholders was marked by the decision

in Foss v. Harbottle which transformed the old partnership rule into one of the leading

principles of modern company law.

Though the case concerned a statutory company created by private Act, the decision came

just before Gladstone’s Act of 1844 extended the right to incorporate to ordinary trading

companies by simply registering their deed of settlement. The courts had now to apply a

quasi-partnership rule in a corporate setting.

In his judgment in Foss v. Harbottle, Wigram VC followed the older cases on unincorporated

companies by insisting that the minority must show that they had exhausted any possibility of

redress within the internal forum. Some notion of majority rule had been implicit in the

earlier cases, but Wigram VC was the first to state plainly that the court will not intervene

where a majority of the shareholders may lawfully ratify irregular conduct. This is a

somewhat circular argument. On the other hand, his judgment implies that where it is futile to

hope for action by the general meeting a suit may nevertheless be brought by the minority

2 Stephen D. Girvin and Sandra Frisby et. al, Charlesworth’s Company Law, pg no. 509, Thomson

Reuters, UK, Eighteenth edn, 2010

even for matters which might in law be ratified by the majority. On this last point, the rule

was to become even more unfavourable to the minority.

It was later established that the Foss v. Harbottle rule barred a minority action whenever the

alleged misconduct was in law capable of ratification, whether or not an independent majority

would ever be given a real opportunity to consider the matter.”3

“Professor Sealy draws a contrast with other types of litigant, for example those seeking

judicial review. The latter receive, on the question of locus standi, a more favourable judicial

acceptance than does the minority shareholder: ‘Time and again he is sent away with no

answer, as often as not with a rebuke for troubling the court.” 4

Further confusion can arise where the court decides to resolve the Foss v. Harbottle point by

referring the matter to the shareholders in general meeting. It may not be clear whether the

majority are to resolve whether or not the company should litigate, or whether they are being

asked to ratify the wrongdoing that has occurred.

In either case the shareholders in a large public company are unlikely to have the information

to make a proper judgment of their own interests or those of the company. On any careful

analysis, the Foss v. Harbottle rule is (like any other rule determining locus standi) a mixture

of substance and procedure.5

The common law derivative action- At common law the rule in Foss v. Harbottle was

subject to an exception that a derivative claim could be brought by a minority shareholder on

behalf of the company in order to remedy a wrong that otherwise go without redress. This

action was brought instead of an action in the name of the company. The shareholders as such

had no such right and if their own personal right were being infringed they might bring a

representative action.6

3 A. J. Boyle, Minority Shareholder’s Remedies, Cambridge University Press, University of London,

20024 Sealy, ‘The Problems of Standing, Pleading and Proof in Corporate Litigation’ in B. G. Pettet (ed.),

Company Law in Change (Stevens & Sons, 1987), p. 2.5 European Business Law Journal, May–June 2000, pgs.1–9, in respect of the application of conflicts

of laws concepts to the Foss v. Harbottle rule.6 Stephen D. Girvin and Sandra Frisby et.al, Charlesworth’s Company Law, pg no. 511, Sweet and

Maxwell, UK, Eighteenth edn, 2010

In Bhajekar v. Shinkar7, the board of directors of a company passed a resolution appointing

certain persons as managing agents. The resolution was confirmed by the company in general

meeting with the full knowledge of all the material facts. Some of the directors brought a suit

for declaration that the resolution was invalid on the ground of certain irregularities. Held, it

was open to the company to ratify the resolution even if it was irregular and the plaintiffs

were not under these circumstances entitled to maintain the suit and ask the Court to interfere.

Only the company may sue: The decision in Foss v. Harbottle, is the logical result of the

principle that a company is a legal entity from the members who compose it. As such if any

wrong is done in the company, it is the company and not he individual members which can

bring an action. This follows from the rule that only the injured party may sue.8

In Rajahmundry Electric Supply Corpn Ltd. v. Nageshwara Rao9, the Court observed that the

Courts, will not, in general, intervene at the instance of the shareholders in the matters of

internal administration and will not interfere with the management of a company by its

directors so long as they are acting within the powers conferred on them under the Articles of

Association of the company.

Moreover, if the directors are supported by the majority of the shareholders in what they do,

the minority shareholders can, in general, do nothing about it.

The appeal judges’ preference for an “old fashioned” rule in Foss v. Harbottle points to a

possible key to the modern riddle of the meaning of "control," which, in my view, was

originally set in the 1870s by James L.J.'s forceful judgments that the minority must prove

fraud and control, strongly implying that control involved the delinquents (alone or with

abettors) holding most of the votes in general meeting.

This narrowing of exception produced two main difficulties: first, it swept into oblivion a line

of cases headed by Davidson v. Tulloch, which held a small category frauds and deceits

incapable of “confirmation at the option of the corporation”, and thus capable of minority

7 (1934) 36 BOMLR 4838 Dr. Ashok Sharma, Company Law and Secretarial Practice, V. K. Enterprises (India), New Delhi,

20109 1956 AIR 213

redress without proof of control; secondly, the very narrowness of it is hardly reconcilable

with the wider exception favoured by other judges.10

Sources of the Rule- The corporation principle, that “the proper plaintiff in an action in

respect of a wrong alleged to be done to a company or association of persons is prima facie

the company or association itself”11, springs naturally from the treatment in law of the

corporation as a “person” separate from the members of which it is composed; and it was

well established by the nineteenth century that “the individual members id a corporation are

quite as distinct from the metaphysical body called ‘the corporation’ as any others of his

Majesty’s subjects are. Thus, injuries allegedly caused to the corporation alone and not to its

members, must be remedied not by the members but by corporate action. That was the

decision in Foss v. Harbottle.12

So where people took over the office of the director was said to an invasion and the result

was held the same.

Once established, however, the principle was applied rigorously to the many irregularities

committed by people who managed joint stock companies. So if the complaint is about

something which in substance the majority of the company are entitled to do, or if something

that has been done irregularly which the majority of the company is entitled to do regularly

then, there can be no purpose of litigation over the matter, the ultimate end of it would be in

the general meeting when it is called and the majority gets its wishes.

EXCEPTIONS

10 R. Gregory, “What Is the Rule in Foss v. Harbottle?”, Vol. 45, The Modern Law Review, pg. 584-

588, No. 5 (Sep., 1982), also available at http://www.jstor.org/stable/109520011 Jenkins L. J in Edwards v. Haliwell, [1950]2 All E. R 1064, 1066.12 K. W. Wedderburn, “Shareholders' Rights and the Rule in Foss v. Harbottle”, Vol. 15, The

Cambridge Law Journal, pg. 194-215, No. 2 (Nov., 1957), also available at

http://www.jstor.org/stable/4504462

There are certain exceptions to the rule of in Foss v. Harbottle, where litigation is allowed.

The following exceptions protect the rights of the minorities, regardless of the majority's vote

because they are also a method to safeguard the minority’s interests.

Palmer’s Company Law recognises the exceptions to the rule in Foss v. Harbottle as

follows:"The following exceptions to the rule in Foss v. Harbottle are admitted as pointed out

by Jenkins L. J. in Edwards v. Halliwell13; the majority cannot confirm:

1) an act which is ultra vires the company or illegal ;

The directors of a company or a shareholding majority may not use their control of the

company to paper over actions which would be ultra vires the company, or illegal.

2) an act which constitutes a fraud against the minority and the wrong-doers are themselves

in control of the company; or

3) a resolution which requires a qualified majority but has been passed by a simple

majority."14

If some special voting procedure would be necessary under the company's constitution or

under the Companies Act, it would defeat both if that could be sidestepped by ordinary

resolutions of a simple majority, and no redress for aggrieved minorities to be allowed.

In Dr. Satya Charan Law and others v. Rameshwar Prasad Bajoria and others, 1949-50,

Federal Court Reports, 673 at 687, (7) the court stated the position thus :

"The correct position seems to us to be that ordinarily the directors of a company are the only

persons who can conduct litigation in the name of the company, but when they are

themselves the wrong doers against the company and have acted mala fide or beyond their

powers, and their personal interest is in conflict with their duty in such a way that they cannot

or will not take steps to seek redress for the wrong done to the company the majority of the

shareholders must in such a case be entitled to take steps to redress the wrong."15

13 [1950] 1 All ER 1064 (CA)14 Geoffrey Morse, Palmer’s Company Law, Sweet and Maxwell, UK, 200715 L. S. Sealy and Sarah Worthington, Sealy's Cases And Materials In Company Law, Oxford

University Press, Oxford, 9th edn., 2010

Gower in his Principles of Modern Company Law16 comments that the rule in Foss v.

Harbottle greatly strengthens the position of the majority; if there were not exceptions to it

the minority would be completely in their hands. He notices the exceptions which the courts

have recognised and writes that there are certain judicial dicta which would add a further

exception, to the well recognised exceptions a further exception, namely, "any other case

where the interests of justice require that the general rule requiring suit by the company

should be disregarded”.

In some cases, it has been held that further exceptions to the rule in Foss v. Harbottle, are

permissible in cases in which "justice requires that the courts should intervene" to assist an

otherwise minority shareholder.

In Heyting v. Dupont17, Harman L. J. said (at page 854): "....there are cases which suggest

that the rule is not a rigid one and that exception will be made where the justice of the case

demands it.”

K.K. Mathew J. was dealing in Joseph v. Jos18, with a suit for a declaration that the

proceedings of the meeting regarding the election of certain directors was null and void and

for a permanent injunction restraining defendants from functioning as director and for

directing the defendant-company to hold a meeting for re-electing three directors.

After referring to the rule in Foss v. Harbottle and the exceptions thereto, the learned judge

made a distinction between "individual membership right' and the "corporate membership

right" of a shareholder. It was held that the rule against interference by court with the internal

management of companies was not applicable to cases of infringement of the individual

membership right. The learned judge quoted from Palmer's Company Law:

"By contract with the company, the shareholder undertakes with respect to some, in fact,

most rights which his membership carries, to accept as binding upon him, the decision of the

16Sarah Worthington, Gower and Davies, Principles of Modern Company Law, Sweet and Maxwell,

UK, 8th edn., 2008 17 1964] 1 WLR 843 (CA)18 [1964] 34 Comp Cas 931 (Ker)

majority of shareholders, if attained in accordance with the law and the articles; these

membership rights are known as corporate membership rights.”

Other rights of the shareholder, according to his contract with the company, cannot be taken

away from him unless he consents to the same. If such rights are in question, a single

shareholder can, on principle, defy a majority consisting of all the other shareholders. Rights

of this type are known as individual membership rights.

"...the wrong done to the plaintiff is not wrong which the majority can ratify as it would be

against the provisions of the articles of association, and it is settled by authorities the a

shareholder can insist on the strict observance of the legal rules, statutory provisions and

provisions in the memorandum and articles cannot be waived by a bare majority of

shareholder."19

And the plaintiff’s right to move the civil court was upheld.

CONCLUSION

19 Geoffrey Morse, Palmer’s Company Law, Sweet and Maxwell, UK, 2007

Rule in Foss v. Harbottle is actually rule of majority supremacy. It means that once a

resolution is passed by majority, it is binding on all the members. Also the courts will in such

cases not interfere to protect the minority interest. This is based on the rational that on

becoming a member, each person impliedly consents to submit to the will of majority. Said in

another way it is a corollary to the rule that only the company can sue, which again translates

to the wish of the majority.

For protecting the rights of minority, certain exceptions to the above rule are recognized and

applied. These exceptions are as follows:-

(i) Ultra vires acts

(ii) Fraud on the minority

(iii) Act requiring special majority

(iv) Wrongdoers remain in control

(v) Individual membership rights

The exceptions and the rule together provide an opportunity for certain advantages to be

tagged along with the

The following are the advantages of the rule in Foss v. Harbottle:-

(i) Recognition of the separate legal personality of the Company

(ii) Preservation of the Right of Majority to decide

(iii) Multiplicity of futile suits avoided

BIBLIOGRAPHY

Books:

1) Geoffrey Morse, Palmer’s Company Law, Sweet and Maxwell, UK, 2007

2) L. S. Sealy and Sarah Worthington, Sealy's Cases And Materials In Company Law, Oxford

University Press, Oxford, 9th edn., 2010

3) Sarah Worthington, Gower and Davies, Principles of Modern Company Law, Sweet and

Maxwell, UK, 8th edn., 2008

4) Stephen D. Girvin and Sandra Frisby et.al, Charlesworth’s Company Law, pg no. 511,

Sweet and Maxwell, UK, Eighteenth edn, 2010

5) Dr. Ashok Sharma, Company Law and Secretarial Practice, V. K. Enterprises (India),

New Delhi, 2010

6) A. J. Boyle, Minority Shareholder’s Remedies, Cambridge University Press, University of

London, 2002

Articles/Journals/Essays:

1) R. Gregory, “What Is the Rule in Foss v. Harbottle?”, Vol. 45, The Modern Law Review,

pg. 584-588, No. 5 (Sep., 1982)

2) K. W. Wedderburn, “Shareholders' Rights and the Rule in Foss v. Harbottle”, Vol. 15, The

Cambridge Law Journal, pg. 194-215, No. 2 (Nov., 1957

3) Sealy, ‘The Problems of Standing, Pleading and Proof in Corporate Litigation’ in B. G.

Pettet (ed.), Company Law in Change (Stevens & Sons, 1987), p. 2.

4) European Business Law Journal, May–June 2000, pgs.1–9, in respect of the application of

conflicts of laws concepts to the Foss v. Harbottle rule.

Websites:

1) http://www.jstor.org/stable/1095200

2) http://www.jstor.org/stable/4504462