#3576 - Minority Rights And Remedies - Company Law

MINORITY RIGHTS AND REMEDIES

Minority shareholder; someone with not enough shares to be sure of being able to secure passing of a shareholder resolution

Danger is that dominant shareholder/bloc of shareholders will seek exercise “private benefits of control”

Potential Solutions

1. Contracting

   Shareholders may contract to ensure protection for vulnerable shareholders.

   Documents which may provide legally enforceable rights and obligation include:

1. Articles of association ( via s.33)

2. Shareholders’ agreements

   This solution more realistic in private companies

   much easier to bargain: parties deal face to face

   much more incentive to bargain: parties cannot simply sell their shares if they are unhappy, as no one wants to buy shares in company in which majority shareholder is abusing power

   Less realistic in public companies

   Not possible: high turnover of shareholders, too many shareholders for there to be contract between each of them

   Disputes less likely: disputes normally arise due to personal dislike between shareholders; this less likely in Plc where company is run by directors

2. Shareholder Remedies

   Is often case however that shareholders in private companies do not contract

1. May be unkeen to raise contentious issues at start of company’s existence

2. Shareholders in Ltds may lack knowledge to know what sort of issues will arise

3. Concerns about lawyers’ fees

   Whereas in public companies, directors’ duties are hardly ever enforced by minority shareholders

   Armour et al: found that prospect of directors being sued for breach of directors’ duties was “virtually nil”

   Is easy for minority shareholders in public companies to simply sell up and leave

Conclusion

Thus is appropriate to allow litigation by minority shareholders

However at same time, is undesirable to make minority shareholders’ rights too strong

Discourages reliance on contracting

Encourages opportunistic litigation

Put more cases into hands of judges (institutionally incompetent)

Shareholders’ options include:

1. Action for breach of shareholders’ agreement

2. Personal action (where member is “proper claimant”)

3. Derivative Claim

4. Unfair Prejudice Claim

5. “Winding Up” Claim

Foss v Harbottle

Foss v Harbottle laid down two key rules:

1. “Proper claimant” principle

• Company is “proper claimant” where directors have allegedly breached duties

• Thus not open to shareholders to sue for breach of directors’ duties

2. “Internal management” principle

• Board of directors decides on behalf of company whether company will sue a director or someone else

  • This reflected by Model Article 3

• and not the members

  Is a procedural bar on shareholders bringing actions.

  Designed to prevent wasteful litigation.

  However problem is that directors are rarely willing to sue themselves.

Modern Law

CA 2006 replaced common law principles derived from Foss v Harbottle.

1. Has NOT abolished proper claimant principle

2. But has reworked internal management principle

   Under modern law:

1. Where directors have breached a duty towards a shareholder, shareholder may sue under “proper claimant” principle

2. Where directors have breached duty to their company, Foss v Harbottle rules have been displaced by Companies Act section 260-264

1. Claims by Shareholder Personally

   Where director owes duties to shareholder individually, shareholder may sue director himself.

   Here, is no need for derivative litigation

   Section 260(1)(a): sections 260-264 only cover rights of action vested in the company.

   Hence statutory reforms have not abolished proper claimant principle from Foss

   Cinematic Finance v Ryder [2010]

Application

Director owes duties to shareholders e.g. where:

1. Shareholder has personal rights under articles

• e.g. director allots shares solely for purpose of destroying a majority

  • Here, director infringes members’ contractual rights under articles

  • Re a Company [1987]

2. Director assumes a duty towards a shareholder due to conduct in general meetings

   director refuses to acknowledge C’s votes in a general meeting

   • Pender v Lushington [1877]

     director undertakes to give shareholder advice in relation to shares

     HOWEVER director’s refusal to call a poll at a general when one is requested by member might not give rise to personal right

   • Macdougall v Gardiner [1875] (internal irregularity)

Restrictions

Shareholders cannot sue where ‘no reflective loss’ principle applies; i.e.:

1. shareholder and company have claim against directors arising out of same set of facts

2. part or all of loss for which shareholder seeks to recover merely mimics that of company

• Johnson v Gore, Wood & Co [2002] (HL) (existence of principle affirmed)

  As basic principle, any claim relating to diminution in value of shares is barred.

Extent of Principle

Reflective loss principle prevents recovery by shareholder even where:

1. Company chooses not to sue director

2. Company settles with D on terms with which shareholder does not agree

3. Director has defence to company’s claim (but not the shareholder’s); etc.

• Johnson v Gore [2002]

  Principle applies even where shareholder holds 99% of shares

  Johnson v Gore [2002]

Exceptions

Principle does not apply even if shareholder and company both have legal claims arising from same set of facts where:

1. D owes no duty to company

• Johnson v Gore [2002]

2. Shareholder’s loss is distinct to that of company

• Heron International Ltd v Lord Grade [1983]

3. Company is unable to pursue claim against D due to act of D himself

• E.g. where director’s breach of duty has resulted in company going into receivership (so that cannot afford to sue)

• Giles v Rhind [2002]

4. D has improperly pressured company into settling its claims against D

• Perry v Day [2005]

2. Derivative Claims

   Developed as common law exception to rule in Foss v Harbottle.

   Put into statutory from by Companies Act 2006.

Application

Allows shareholder to seek leave from court to bring derivative action against director.

Two hurdles for C:

1. section 261(2): shareholder must submit documentation showing a prima facie case that leave be granted

• NB no need to show prima facie that company will win case (in event it goes ahead)

2. section 261(3): where documentation justifies leave hearing, leave hearing occurs

• this allows court to form view on strength of case

• i.e. so as to know whether to grant leave to sue

Relevant Factors

1. Factors which mean judge must refuse leave

Section 263(2)

Judge must dismiss application for leave where:

1. person acting for best interests of company would not pursue claim

2. alleged breach of duty has been authorised in advance by company

3. alleged breach of duty has been authorised or ratified subsequently by shareholders

“Acting for best interests of company”

Court can only refuse leave here where satisfied that no director would seek to pursue the claim themselves

i.e. if some directors would seek to continue it, s.263(2)(a) does not apply

Iesini v Westrip Holdings [2009]

Where some would pursue claim, would fall to be considered under section 263(3)(b)

2. Others factors which judge must take into account

Section 263(3)

When deciding whether to grant leave, judge must also take into account:

1. Good faith of shareholder

2. Importance that a person acting in best interests of company would attach to continuing action

3. Where cause of action arises from act or omission that is yet to occur, whether act or omission would be likely to be authorised (beforehand) or ratified (afterwards)

4. Where cause of action arises from act of omission that has already occurred, whether act or omission would be likely to be ratified

5. Whether company has decided not to pursue the claim

6. Whether shareholder could bring a claim in his own right in respect of same breach

Section 263(4)

When giving its view court must have regard to evidence as to views of members of company with no personal interest in matter

263(3)

1. Good Faith

   Claim is in good faith where dominant purpose is to benefit the company

   and not brought for some ulterior motive

   Iesini v Westrip Holdings [2009]

2. Importance Someone Acting for Best Interests of Company Would Attach to Pursuing Claim

   Relevant test is that of a hypothetical director.

   i.e. if such a person would not attach very much importance to pursuing claim, no leave granted

   Franbar Holdings [2008]

   May be appropriate to grant leave:

   where case is very strong, even if amount of recovery would not be large

   where case is weak, but where amount of potential recovery is very large

   Stainer v Lee [2010]

   Factors which hypothetical director would take into account include:

1. Likelihood of claim being successful

2. Ability of company to recover any damages awarded

3. Costs

4. Damage to company’s reputation

• Franbar Holdings [2008]

c) + d) Ratification/authorisation

5. Company has Decided Not to Pursue the Claim

   Any board or shareholder resolution which contains decision not to pursue claim.

   Relevant factor here is reason why company has decided not to pursue claim.

   if those making decision where well informed and neutral, leave will not be granted.

   however if this is due to e.g. improper pressure, this factor disregarded

   Perry v Day [2005]

6. Shareholder Has Claim in His Own Right

   E.g. where C has alternative claim for unfair prejudice

   This has been considered important in some cases

   Franbar Holdings [2008]

   And less important in others

   Stainer v Lee [2010]

263(4)

Views of Other Members

Shareholder unlikely to be granted leave where a majority of other shareholders are against the bringing of claim

Smith v Croft [1987] (decided under old common law)

All these merely factors to be...