OPPRESSION AND MISMANAGEMENT Flashcards
FOSS VS HARTBOTTLE
An action was brought by two shareholders, ‘F’ and ‘T’, of a company, on behalf of themselves and all other shareholders against the directors and solicitor of the company, alleging that by concerted and illegal transactions they had caused the company’s property to be lost. It was alleged that the directors were acting in concert and effecting various fraudulent and illegal transactions whereby the property of the company was misapplied and wasted. It was prayed that the defendant might be decreed to make good to the company the losses. The question was as to the maintainability of the suit.
The Court held that the action could not be brought by the minority shareholders. The wrong done to the company was one which could be ratified by the majority of members. The company was the proper plaintiff for wrongs done to the company, and the company can act only through its majority shareholders. The majority of the members should be left to decide whether to commence proceedings against the directors.
According to Palmer, “the rule in Foss v. Harbottle” is a phrase used to refer to two distinct, but linked, propositions of law. The first proposition, which is that the court will not ordinarily intervene in the case of an internal irregularity if the matter is one which the company can ratify or condone by its own internal procedure. The second is that where it is alleged that a wrong has been done to a company, prima facie, the only proper plaintiff is the company itself.
Exceptions to the rule in Foss v. Harbottle
1) Ultra vires and illegal acts
2) Breach of fiduciary duties
3) Fraud or oppression against minority
4) inadequate Notice of a resolution passed at a meeting of members
Ultra vires and illegal acts:
‘The rule in Foss v. Harbottle does not apply where the act complained of is ultra vires the company, since not even a unanimous vote of the shareholders can ratify such an act. In such cases it appears that the plaintiff shareholder can bring either a personal action, basing himself upon the company’s breach of its memorandum, or a derivative action, basing himself upon the wrong done to the company by those who have caused it to act ultra vires. If the action is designed to prevent a threatened ultra vires act, the plaintiff may bring either a personal or a representative action against the company, and the directors may be joined as co-defendants so that an injunction may be made against them too but if the plaintiff member seeks an order that the company shall recover compensation for an ultra vires act which has already been committed, or shall recover property disposed of by an ultra vires transaction, the action must be a derivative one.
Breach of fiduciary duties
A derivative action may be brought against directors and promoters who have been guilty of a breach of their fiduciary duties to the company, if they are able to prevent the company from suing them in its own name because they control a majority of the votes at a general meeting, or because they are otherwise able to prevent a general meeting from resolving that the company shall sue them. Thus, derivative actions have been permitted against directors who were in control of the company for misappropriating the company’s property or misapplying it in breach of the Companies Act, to compel such directors to account to the company for profits made by appropriating for themselves a business opportunity which the company would otherwise have enjoyed , or to deprive the members who controlled the company of their power to control it in the future , and to compel such directors to make a call on their own shares equal to a call which they had made on the shares of the other members. Likewise, derivative actions have been permitted against promoters who were in control of the company to rescind contracts made between them and the company when they had been guilty of misrepresentations or had failed to disclose a secret profit which they obtained from the transaction, and in those cases the court ordered the promoters to repay to the company all money received by them under the contracts.
Fraud or oppression against minority
The fraud or oppression need not amount to a tort at common law, but it must involve an unconscionable use of the majority’s power resulting, or likely to result, either in financial loss or in unfair or discriminatory treatment of the minority, and it must certainly be more serious than the failure of the majority to act in the interest of the company as a whole, which will induce the court to annul a resolution altering the company’s memorandum or articles.
In the words of Lord Davey, in Burland v. Earle [1902] A.C. 83, fraud embraces all cases where the wrongdoers “are endeavouring, directly or indirectly, to appropriate to themselves money, property or advantages which belong to the company or in which the other shareholders are entitled to participate”.
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 - Edward v. Halliwell [1950] 2 All ER 1064.
Inadequate Notice of a resolution passed at a meeting of members
It has been held in many cases that if an insufficiently informative notice is given of a resolution to be proposed at a general meeting, any member who does not attend the meeting, or who votes against the resolution, may bring a representative action to restrain the company and its directors from carrying out the resolution
Qualified majority:
Where the Act or the articles require a qualified (or special) majority for the passing of a resolution, ‘the rule in Foss v. Harbottle’ cannot be invoked to override these requirements. If this were not so, provisions requiring qualified majorities would be valueless because a bare majority could always confirm a special resolution passed irregularly. The action brought by a shareholder to complain of an irregularity in the passing of a special resolution would seem to be a personal one.
Where the personal rights of an individual member have been infringed
As already noted, the principle of majority rule is applicable only to the corporate membership rights of a member. Infringement of a member’s individual rights like right to vote, right to receive dividends, etc., entitles him to proceed in his own name.
Application of Foss v. Harbottle Rule - How far relevant in India
The principle, in the countries of its origin, owes its genesis to the established factual foundation of shareholder power centering around private individual enterprise and involving a large number of small shareholders, is vastly different than the ground realities in our country. Here the modern Indian corporate entity is not the multiple contribution of small individual investors but a predominantly and indeed overwhelmingly state-supported funding structure at all stages by receiving substantial funding up to 80% or more from financial institutions which are entirely state-controlled or represent substantial interest and, thus, their shareholding may be small but it is these financial institutions which provide entire funds for the continuous existence and corporate activities. If the Foss v. Harbottle Rule is applied mechanically, it would amount to giving weightage to that majority of the shareholding having notionally holding more percentage of shares, than to the financial institutions which may own a small percentage of shares though contributed 80% or more in terms of the finances to such companies. It is these financial institutions which have really provided the finance for the company’s existence and, therefore, to exclude them or to render them voiceless on an application of the Principles of Foss v. Harbottle Rule would be unjust and unfair.
Indirect supersession of the board not allowed
In a very comprehensive decision, the Principal Bench, CLB (New Delhi) in the Shaw
Wallace case cited earlier, has held :
(i) motive for the petition is a relevant consideration when relief sought is examined and ulterior motive, if established, would be a ground for refusal to grant the relief, notwithstanding merit of the case;
(ii) prayer for supersession of the entire Board is not sustainable when allega- tions are against only two directors;
(iii) acts of the directors/company leading to a situation of financial crisis are prejudicial to the interests of the shareholders and the company; however, if a charge against a director for misuse of fiduciary position or for fraud/ misfeasance could not be established, he would not be removed from the Board merely on suspicion.
. Losses to the company affect all the members, not simply the majority or the minority, or any particular member. Why then, should an individual member not sue, since he has been injured?
The answer is that injury is not enough. The plaintiff must show that the injury has been caused by a breach of duty to him. In the course of existence a person suffers many injuries for which no action can be brought, for no duty owed to him has been broken. The individual shareholders or even the minority shareholders who try to show that the directors owe a duty to them personally in their management of the company’s assets will definitely fail. The directors owe no duty to the individual members, but only to the company as a whole. A company is a person and if it suffers injury through breach of duty owed to it, then the only possible plaintiff is the company itself acting, as it must always act, through its majority.
Personal rights of members
A consequence of the distinction between personal and corporate rights is that a member cannot bring a personal action for the loss he has suffered by the diminution in the value of his shares resulting from breaches by the defendants of provisions of the company’s memorandum or articles which do not confer personal rights on members, or from breaches of fiduciary duties owed by the defendants to the company; even if the member can prove a conspiracy between the defendants to commit the breaches complained of, the diminution in the value of his shares is merely a reflection of the loss suffered by the company, and the proper remedy, therefore, is for the company to sue the defendants or, in appropriate circumstances for a derivative action to be brought.
Representative and Derivative Action
In certain circumstances an individual member may bring an action to remedy a wrong done to his company or to compel his company to conduct its affairs in accordance with its constitution and the rules of law governing it, even though no wrong has been done to him personally, and even though the majority of his fellow members do not wish the action to be brought. The form of his action in these exceptional cases is peculiar because the plaintiff does not sue in his own right alone, but on behalf of himself and all his fellow members other than those, if any, against whom relief is sought. If the member sues for relief against the company, it must, of course, be made a defendant; if he seeks to enforce a corporate claim against other persons, the company must still be joined as a co-defendant so that it may be bound by the judgment, and so that it may enforce any order giving relief against the substantive defendants.
Primarily section 244 allows the right to make an application to the Tribunal on two criteria
numerical strength of the members or shareholding strength of the members. Overriding these two, proviso of section 244 enables the Tribunal to authorize any member(s) to make the application notwithstanding that such member(s) does not fulfil any of the criteria. This, the Tribunal may do, on an application made to it in this behalf. Application for such waiver needs to be made in Form No. NCLT-9 of NCLT Rules (Rule 84) with the prescribed fees.
Needle Industries Ltd. v. Needle Industry Newey (India) Holding Ltd. [1981] 3 SC 333
In this case, the articles of a private company contained a clause that when the directors decide to increase the capital of the company by the issue of new shares, the same should be offered to the shareholders proportionately and, if they failed to take, they may be offered to others in such manner as may be most beneficial to the company. The company was a wholly owned subsidiary of an English company. Government of India adopted a policy of diluting foreign holdings. The company accordingly issued new shares to its employees and relatives reducing the foreign holding to sixty per cent. When section 43A [no corresponding section under the Act] came into operation, the company became a deemed public company because more than 25 per cent of its share capital was held by a body corporate. The company, however, chose to remain a private company for all other purposes. The leader of the Indian 40 per cent holding was the chief executive and the managing director of the company. The company was further required to reduce its foreign holding to 40 per cent. At this stage the English and Indian blocks developed a difference. The English block wanted that the 20 per cent reduction of their holding should be allotted to one of the Indian companies in which they had substantial interest. A meeting of the company’s Board of directors, on the contrary, adopted the policy of issuing new rights shares to the existing members, which the English company would not be able to subscribe and thereby its holding would be reduced to 40 per cent. Under the resolution 16 days’ time had to be given to the members to take their proportion. The letter offering its proportion to the holding company was sent only 4 days before the last date and it received the letter after the date for exercising the option had already expired. Similarly, the notice of the meeting of directors for completing the allotment was sent to them with so short a gap of time that they received it in England only on the day on which the meeting was being held in India. Neither was it able to exercise the option of buying its block of rights shares nor was it able to attend the crucial meeting of the Board. Its block of shares was allotted to Indian shareholders.
The holding company complained of oppression on these facts. But the court was not convinced that there was any such thing as a continuous policy of oppression. The ultimate purpose of the scheme was Indianisation to the extent of 60 per cent. This could be achieved either by buying the excess holding of the English company or by increasing the Indian shareholding. The latter course was adopted in the interests of the company as it would make available to the company extra capital. The fact that proper notice was not given, no doubt, deprived the English company of its opportunity of participating in the rights issue. But the facts were such that even if proper notice was given, the English company could neither have subscribed for its proportion nor renounced it to anyone else. There was no right in the company’s articles in favour of any member enabling him to renounce his rights shares in favour of others. In the case of a private company there simply cannot be the right of renouncing rights shares in favour of nominees because that would make it impossible for the company to restrict the number of members. The real loss suffered by the holding company was the loss in terms of the market value of the shares which fell. The market value of the shares was much higher than their nominal value. The allotment was at nominal value. The loss of the holding company was the “unjust enrichment” of those whom the block of rights shares was allotted which, but for the policy restriction, belonged to that company. The Supreme Court accordingly held that the Indian allottees of those shares must compensate the holding company to the extent to which the market value was in excess of the nominal value.
