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.
FOSS VS. HARBOTTLE – THE CASE:
Since this principle is based on the case of Foss v. Harbottle [(1843) 2 Hare 461] a brief mention of the fact would not be out of place. In this case action was brought by two shareholders against the alleged fraudulent and illegal transactions by the directors and to make up for the resultant loss to the company. It was held that since the loss is to the company, only the company can bring an action and not the minority shareholders.
RATIONAL BEHIND THE RULE:
…that the rule refers to two distinct but linked propositions of lawTypes of Stridhana (Stridhan) – Part 3 of 3 (Yajnavalkya’s view - and Conclusion). Read more ... ». First, the court will not intervene in case of internal irregularity. Second, in case of an alleged wrong, the company is the plaintiff.
In MacDougall Vs. Gardiner…
…the real reason behind the rule is given. It was said that where an illegal thing is done which can be rectified by the majority, there is no use of litigating, as the ultimate end will be that a meeting will be held, and the majority wishes will be granted.
Jenkins in Edward Vs. Halliwell Said…
…that where the majority is in favour of what is done then, cadet quaestio (i.e. it cannot be questioned)
MAJORITY SUPREMACY AND MINORITY PROTECTION
Along with the rule of majority supremacy provisions are also made by way of exceptions, for protecting of minority interest. This is essential because, in its absence the company cannot function smoothly.Palmer points out, and rightly so, that a proper balance of right of majority and minority shareholder is essential for the smooth functioning of the company. Therefore it is necessary for the courts to do justice; there must be some exceptions to the rule.
Started in another manner, the rule extends only in situations where the “managerial sins” may be ratified. In other cases every shareholder may sue in representative character of the corporate interest i.e. may bring a derivative action (as it is called in America.)
The protection of minority rights as mentioned in the previous part is realized by making out some exceptions to the Foss v. Harbottle rule.
These exceptions are:
Ultra Vires or Illegal Act : Exception One :
-Where the act complained of is against the memorandum the Foss v. Harbottle rule is inapplicable.
Wrongdoer in Control : Exception Two :-
If the person against whom the relief is sought is himself in control, the rule of majority supremacy cannot be applied.
Fraud on Minority : Exception Three :-
Where the act is not for the benefit of the company and discriminates between majority and minority shareholders, action can be brought by the minority.
Inadequate Notice : Exception Four :-
Where a shareholder because of inadequate notice, could not present himself in the meeting where a resolution against him is passed, the rule does not apply.
Qualified Majority : Exception Five :-
Where a resolution requiring special majority is actually passed by simple majority, an exception to the rule is found.
Personal Rights : Exception Six :-
Personal rights are not covered by Foss v. Harbottle rule.
ULTRA VIRES ACT: EXCEPTION ONE
Where the actsTypes of Stridhana (Stridhan) – Part 3 of 3 (Yajnavalkya’s view - and Conclusion). Read more ... » complained of is out side the scope of the company that is where it is ultra vires the memorandum of association of the company the rule laid down in Foss v. Harbottle is not applicable.
Meaning of Ultra Vires:
Ultra vires means those things which are outside the scope. In case of a company any act which is not allowed under the memorandum of association is ultra vires. However where the acts are only contrary to the articles of association but allowed by the memorandum those acts are not ultra vires and in such cases the rule in Foss v. Harbottle is applicable. These are any act which is beyond the object clause.
Every shareholder has a right, by injunction, to restrain the company from doing any act which are ultra vires the company or are illegal. A shareholder is entitled to bring an action against the company and its officers in respect of matters which are ultra vires the company.
The Rational Behind the Exception:
This exception is based on the rational that acts which are beyond the memorandum are completely illegal and cannot be ratified by a majority resolution. Thus the shareholders cannot validate it by even a unanimous vote.
Some Illustrative Cases:
Bharat Insurance Co. ltd v. Kanhaiya Lal. [AIR 1935 Lah 729]
In this case the plaintiff was the shareholder of the respondent company. One of the object clause was, ‘to advance money at interest on the security of land, houses, machinery and other properties situated in India…’ the plaintiff complained that ‘several investments have been made by the company without adequate security and contrary to the provisions of the memorandum and therefore prayed for a perpetual injunction to restrain it from making such investments.’
The court observed, that “the broad rule in such cases is no doubt that in all matters of internal management of a company, the company itself is the best judge of its affairs and the court should not interfere. But the application of the assets of the company is not a matter of mere internal management. It is alleged that the directors are acting ultra vires in their application of the funds of the company. Under these circumstances a single member can maintain a suit for declaration as to the true construction of the article in question.”
Lowe v. Fahey [(1996) 1 BCLC 262 Ch D]
In this case the funds of the company were diverted to extraneous purposes. The court held that it had jurisdiction to pass an order for repayment to the company not only against the guilty members and directors but also against third persons who had knowingly received such money or improperly assisted the wrongful diversion.
What Actions Can Be Brought:
In such a case 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 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.
When A shareholder Is Incapable To Bring An Action Under This exception.
A shareholder will be barred from bringing an action under this exception if:
Plaintiff’s improper conduct:
The plaintiffs own conduct in the circumstances must be proper. Since the minority shareholders action in which the plaintiff shareholder sues on behalf of the company is a procedural device for the purpose of doing justice for the benefit of the company where it is controlled by miscreant directors or shareholders, the court is entitled to look at the plaintiff’s conduct to satisfy itself that the plaintiff is a proper person to bring the action. Thus, if the plaintiffs conduct was so tainted as to bar an equitable relief, he will not be allowed to bring the action.
Where there is unacceptable and unexplained delay in filing the action, the plaintiff may be barred from bringing the action.
Plaintiff not a proper person:
Also where the plaintiff is not the proper person to bring the action he would be barred from taking the benefit of the exception. Thus in Narcombe v. Narcombe [(1985) 1 All ER 65 CA], an action was brought by the wife, a minority shareholder, against the wrong doing of her husband as a director. In a matrimonial proceeding between them she came to know about the improper profits made by the husband and such profits were taken into consideration in preparing the award, it was held that she was not a proper plaintiff for a derivative action.