#19677 - 5. Shareholders’ Rights And Minority Protection - Company Law

TOPIC 5: SHAREHOLDERS’ RIGHTS AND

MINORITY PROTECTION

Lecture 14-17

Essential reading:

Dignam and Lowry, ch.8

Additional reading:

• Drury ‘The relative nature of the shareholder's right to enforce the company’s articles’ (1986) 45 Camb. L.J. 219

• Baxter ‘The role of the judge in enforcing shareholder rights’(1983) 42 Cambridge Law J 96

• Wedderburn, ‘Shareholder Rights and the Rule in Foss v Harbottle’ (1957) Cambridge Law J 194 (esp.p.209 onwards)

• Hannigan, ch.5

5.1 THE PRINCIPLE, AND PROBLEM, OF MAJORITY RULE

Where shareholders do not unanimously support some action - say, sacking a director, or deciding whether to ratify a breach of duty - then the general principle is that of majority rule - the majority of shareholders should get their way. And the majority are, in general, in the absence of a specific restriction, entitled to 'vote selfishly' – i.e. to cast their votes in their own interests; see eg North-West Transportation v Beatty (1887) 12 App Cases 589. So, if the director who is threatened with dismissal owns shares, she can vote those shares to save herself, rather than thinking (and doing) what is best for all the shareholders, or for ‘the company’. No consensus by shareholders – vote. Majority decides the direction. This may not work in favour for a lot of people.

Majority rule has many advantages: it’s a relatively quick, efficient way of settling disputes, it avoids outside interference inside companies, it seems democratic, and it saves courts the task of making business judgements. But the ‘losing minority’ who is outvoted in a sense pays the price for these benefits. In a company with a large number of shareholders, the identity of the ‘loser’ may change from vote to vote, so that in the long run most shareholders may end up on the winning side more often than on the losing.

But in smaller companies, a minority shareholder is often ‘entrenched’ – in a permanent minority. They constantly are outvoted and lose out – without, arguably, reaping the benefits of majority rule. Moreover, in smaller companies, a minority who experiences that has no easy way to escape – because there is no real ‘market’ for a minority’s shares. For that reason, it’s recognised there must be some protection for minority shareholders, through ‘exceptions’ to the right of the majority to impose their wishes on the minority.

Little recap: enforcing the articles (Hannigan) chapter 5

• Generally, the courts have been reluctant to hold that an individual member has a right to have all of the articles observed (despite s.33(1) CA)

• If the directors ignore a requirement of the articles, a shareholder cannot force compliance unless the article in question confers a right on the shareholder qua member (Hickman v Kent or Romney Marsh Sheepbreeders’ Association)

• This includes

• the right of a member to have his vote recorded (Pender v Lushington (1877) 6 Ch D 70.)

• to have a dividend paid in cash if the articles so specify (Wood v Odessa Waterworks Co (1889) 42 Ch D 636)

• to enforce a declared dividend as a legal debt (Re Severn and Wye and Severn Bridge Railway Company [1896] 1 Ch 559.)

• The reason for imposing limits to the enforcement of the articles is linked to the rule in Foss v Harbottle

• first, the proper plaintiff in respect of a wrong allegedly done to a company is prima facie the company;

• secondly, where the alleged wrong is a transaction which might be made binding on the company by a simple majority of the members, no individual member of the company is allowed to bring a claim in respect of it.

* The rule then is based on two fundamental principles of company law, namely respect for the separate legal personality of the company and the principle of majority rule

Prevents multiplicity of shareholder suits and eliminates wasteful and vexatious actions by shareholders trying to harass the company

1. A company may enforce the articles against a member

   1. Hickman v Kent or Romney Marsh Sheepbreeders’ Association – when articles provide disputes between the company should be referred to arbitration. The court held the company is entitled against its own members to enforce and restrain breaches of its articles. The dispute was referred to arbitration.

2. A member may enforce the articles against a member

   1. Rayfield v Hands - a member may enforce the articles directly against the other members. A member wishing to transfer his shares was able to require the other members to take the shares and the court allowed a member to enforce that provision against the other members

   2. More generally, the expectation would be that the contract would be enforced through the company. Such actions are unusual

3. A member cannot always enforce the articles against a company

   1. a shareholder’s entitlement to enforce what they perceive to be their rights is problematic – a restrictive approach is taken

   2. conflicting authorities reviewed in Hickman v Kent or Romney Marsh Sheepbreeders’ Association - the rights purporting to be given by the articles in a capacity other than that of a member cannot be enforced against the company. Only membership rights which have been conferred on the member qua member can be enforced and so, when considering whether a provision can be enforced, it has to be asked whether it is intended to confer rights on a member in that capacity.

   3. Eg. Pender; Wood v Odessa Waterworks Co - a member was entitled to require the company to pay a dividend in cash when the articles so provided. Rights with respect to share transfer, for example to enforce compliance with a pre-emption provision on transfer, may also be enforced

   4. Members qua members may also insist on the proper conduct of meetings.

   5. Edwards v Halliwell - two members of a trade union successfully restrained an attempt by a delegate meeting to increase the members’ contribution without obtaining the two-thirds majority required under their rules.

   6. Quin & Axtens Ltd v Salmon – articles of association provided certain transactions had to be consented by both managing directors who were significant shareholders. One of the directors dissented, but the company in general meeting nevertheless tried to authorise the transaction without the director’s consent. CoA rejected (HoL affirmed) this purported authorisation, finding it was an attempt to alter the terms of the contract between the Parties by ordinary resolution (rather than special)

   2. EXCEPTION 1: PERSONAL (CONSTITUTIONAL) RIGHTS exceptions to the majority rule

      1. The basic rule – the ‘section 33 contract’

s.33 (1) The provisions of a company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions.

Can ask the court for order, for the company to follow the constitution.

• Hickman v Kent or Romney Marsh Sheep-Breeders' Association [1915] 1 Ch. 881 – confirmed by statute in CA 2006, s.33

The enforceability of an article of association which allowed for arbitration proceedings where there was a dispute between the members and the company was at issue.

Astbury J examined all the authorities on the matter and considered that ‘articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the company respectively’.

The article was, therefore, contractually binding between the members and the company.

(In case you wondered: Kent or Romney Marsh sheep) 950 621

1. Why majority rule/rule in Foss does not apply to shareholder’s action to enforce the articles:

• Pender v Lushington (1877) 6 Ch.D 70

a shareholder’s votes were refused at a general meeting, member obtained an injunction stopping the directors acting on a resolution passed at the meeting.

The shareholder ‘is entitled to have his vote recorded—an individual right in respect of which he has the right to sue. That has nothing to do with the question raised in Foss v Harbottle (1843) and that line of cases.’ (Jessel MR)

This case illustrates how difficult it is for minority shareholders to succeed – Pender was only able to succeed because he as a shareholder was entitled to a vote.

5.2.3 Are members bound to each other?

This can be an important issue for shareholders who find that they wish to enforce a particular provision of the articles against another shareholder.

• Eg. Pre-emption rights (the right to buy the shares of a member who wishes to leave the company) contained in the articles may drastically affect the shareholding of a member if they are not complied with.

• If the member can enforce the rights directly by virtue of s 33(1) it makes the rights easier to enforce.

* caused some difficulty and there has been much judicial debate.

-Welton v Saffery [1897] AC 299

There is no contract between the individual members of the company

• [i]t is quite true that the articles constitute a contract between each member and the company, and that there is no contract between the individual members of the company, but the articles do not any less, in my opinion, regulate their rights inter se. Such rights can only be enforced by or against a member through the company, or through the liquidators representing the company, but I think that no member has, as between himself and another member, any rights beyond that which the contract with the company gives.

-Rayfield v Hands [1958] 2 All ER 194.

Vaisey J considered all the conflicting authorities (in particular he focused on Lord Herschell’s statement in Welton v Saffery) on the issue and concluded that there was a contract inter se which was directly...