The Gazette 1978

GAZETTE

JULY-AUGUST 1978

Actions by Shareholders

—a new development

are legion. The 'locus classicus' of this exception to the doctrine in Foss v. Harbottle is the statement by Pagewood V-C in Attwool v. Merryweather [1867] LRE 5 Eq 464 to the effect that "If I were to hold that no bill could be filed by shareholders to get rid of the transaction on the ground of the doctrine of Foss v. Harbottle, it would be simply impossible to set aside a fraud committed by a director under such circumstances, as the director obtaining so many shares by fruad would always be able to outvote anybody else" (p468). It has been argued that the recent decision of Mr. Justice Templeman in Daniels v. Daniels [1978] 2 AER 89 has extended the exceptions to Foss v. Harbottle. The scope of that decision is uncertain however. In the May 1978 edition of the "Law Reporter" its was stated that Daniels v. Daniels has added negligence on the part of management to the list of exceptions to Foss v. Harbottle. A perusal of Mr. Justice Templeman's judgment, however, demonstrates that such a statement is far too wide. The facts of the case are as follows. The plaintiffs were minority shareholders in a company. The defendants were majority shareholders and directors. In October 1970 the Company sold land to one of the directors for £4,200. This was done on the instructions of the defendant directors. In 1974 the director who had bought the land sold it for £120,000. The minority shareholders brought an action alleging that the 1970 sale had been at an undervalue and that the defendants knew this.The defendants applied to have the statement of claim struck out as it did not allege fraud or any other ground which would justify an action by minority shareholders against the majority for damage done to the company. In fact the statement of claim alleged, at the most, negligence because it charged that the plaintiffs had, in October 1970, purported to adopt the probate value of the land which was usually much less than the open market value. They should have known that this was the case but apparently they did not. The application to strike out the action was dismissed. It was dismissed on the basis that, to quote the All England Reports, "The confines of [the Rule in Foss v. Harbottle] should not be drawn so narrowly that directors were able to make a profit out of their own negligence. Therefore minority shareholders were entitled to bring an action where the majority of the directors negligently, though without fraud had benefited themselves at the expense of the company." The reasoning shows confusion if not outright cowardice. Templeman J. referred with approval to authorities which stated that a shareholder has no right to bring an individual action against directors who are nothing more than "an amiable set of lunatics". What distinguished such cases from the case before him was that " . . . . to put up with foolish directors is one thing: to put up with directors who are so foolish that they make a profit of £115,000 odd at the expense of the company is

William OT>ea, Lecturer in Law, University College, Dublin.

It was decided in the case of Foss v. Harbottle [ 1843 2 Hare 461] that if a wrong has been done to a company only the company can sue. There are a number of advantages in such a rule. For example, it prevents multiplicity of actions, often for trivial reasons. Aslo, as Gower points out in his book on company law (3rd Edition 1969), if the action complained of is one which could be ratified by the company in general meeting it is pointless to have litigation about it except with the consent of the general meeting. However, the other side of the coin is that a strict application of Foss v. Harbottle would unduly strengthen the position of majority shareholders in a company. The fiduciary and other duties of the directors could be disregarded with impunity as long as they had voting control. In fact a rigid application of the rule with no exceptions would put the minority completely at the mercy of the majority. Accordingly, the courts have, since 1843, been prepared to recognise certain exceptions to it. It is generally accepted that, until recently, at least, those exceptions can be reduced to four well-defined categories (See Gower pp. 584-585; Hahlo 'Casebook on Company Law' 1977 Ed pp 533-534). Therefore it can be said that an action by an individual shareholder, instead of by the company, is allowed in four circumstances:— (i) When it is complained that the company has acted, or is proposing to act, ultra vires. Authorities for this proportion include Simpson v. Westminster Palace Hotel Co. (1860) 8 H.L.C. 712; Russell v. Wakefield Waterworks Co. [1875] Lr 20 Eq 474; and Yorkshire Miners Association v. Howden [1905] A.C. 256. (ii) Where the Act complained of could be effective only if resolved upon by more than a simple majority vote (i.e. where a special resolution or an extraordinary resolution is needed and it is said not to have been validly passed). Authorities here include Baillie v. Oriental Telephone Co [1915] 1 Ch 5038; and Cotter v. National Union of Seamen [1929] 2 Ch 589. (iii) Where the "personal" rights of the plaintiff shareholder are infringed or are about to be infringed. The meaning or extent of "personal" rights is still somewhat unclear. Such rights would include the right to vote (if granted by the Articles). Examples of "personal" rights may be found in several decided cases which include Johnson v. Lyttle's Iron Agency [18771 5 Ch D 687; Pender v. Lashington [ 1877] 6 Ch D 70; Wood v. Odessa Waterworks Co. [1899] 42 Ch D 636; and Salmon v. Quin and Axtens [ 1909] 1 Ch 311. (iv) Where those who control the company are committing, or have committed, fraud on the minority. The authorities on what constitutes "fraud"