The Rule In Foss V Harbottle: Facts of the Case, Rules, Exceptions

Generally, the rule in Foss v. Harbottle is based on the doctrine of corporate legal personality inherent in the company upon incorporation.

Rule in Foss V Harbottle 

Generally, the rule in Foss v. Harbottle is based on the doctrine of corporate legal personality inherent in the company upon incorporation and the principle of majority rule. This gives exclusivity to the company as the proper claimant in legal action in cases where an injury is allegedly done to the corporate body. It also gives relevance to the democratic powers of the majority members of the corporate body to decide whether to treat such a wrong which ought to be redressed or to overlook same without redress. As a result, whatever their decision, it is deemed the decision of the company and therefore binding on all the members including any dissenting shareholder. Relatively, the rule also applies to unincorporated associations.

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The rationales behind the rules are to avoid potential multiple suits arising from the same facts and from different individual members of the company; to maintain the power of majority members to ratify acts; and to preserve the principle of majority rule and the doctrine of corporate legal personality. Essentially, the rule in Foss v Harbottle offers insights into the procedural rules governing locus standi in the case of a corporate body and it has been codified in Section 341 of the Companies and Allied Matters Act (CAMA) 2020. 

Also, it has been given further expression in notable number of judicial cases which will be further enumerated below. Noteworthy however, the rule is not absolute as minority shareholders can litigate in exceptional cases.

In this light, this paper intends to appraise the rule in Foss v Harbottle, as it reflects the concepts of corporate legal personality and majority rules, the exceptions to the rules as provided in the relevant provisions of CAMA 2020, and the categories of persons that can bring an action under the exceptions.

THE FACT OF FOSS V HARBOTTLE 

In September 1835, the Victoria Park Company was established to acquire 180 acres of land near Manchester (later known as Victoria Park, Manchester, after incorporation by an Act of Parliament). However, instead of fulfilling the company’s objectives of developing the land for ornamental and park-like purposes, constructing houses with gardens and fields, and then selling or renting them, certain individuals, including the directors and others, engaged in unlawful misappropriation of the company’s property.

Richard Foss and Edward Starkie Turton, both minority shareholders, brought attention to this matter. They reported that Thomas Harbottle, Joseph Adshead, Henry Byrom, John Westhead, Richard Bealey (the five directors of the company), as well as lawyers and architects Joseph Denison, Thomas Bunting and Richard Lane, along with H. E. Lloyd, Rotton, T. Peet, J. Biggs and S. Brooks (Byrom, Adshead and Westhead’s assignees), were involved in misapplying and falsely mortgaging the company’s assets, thus deviating from the company’s intended purpose. They argued that these wrongdoers should be held accountable for their actions and appointed a responsible receiver.

Their arguments in Foss vs Harbottle were based on three grounds. Firstly, they pointed out fraudulent practices that misused the company’s funds. Secondly, they highlighted the lack of qualified directors on the company’s board. And thirdly, they emphasized the absence of a company clerk or office. These conditions left the owners with no recourse but to pursue legal action against the directors instead of reclaiming their property directly.

The court held that individual shareholders or outsiders of the company could not bring legal action against wrongs done to the corporation, as the company and its shareholders are considered separate legal entities.

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THE RULE IN FOSS V HARBOTTLE

The landmark case of Foss v. Harbottle established two pivotal rules that have shaped the legal landscape of company law and corporate governance. These rules strike a delicate balance between upholding the distinct legal personality of a company and respecting the democratic principles of majority rule.

The first rule, known as the "Proper Plaintiff Rule," underscores the principle of separate legal entity. It states that only the company itself can initiate legal proceedings against directors or outsiders for any wrongdoing or loss resulting from fraudulent or negligent acts. This rule stems from the recognition that a company is a distinct legal person, separate from its members or shareholders. Consequently, members or outsiders are precluded from suing on behalf of the company, as it would undermine the company's own legal standing and autonomy.

The second rule, termed the "Majority Principle Rule," upholds the democratic principle of majority rule in companies. According to this rule, the court will not intervene if the alleged wrong committed against the company can be ratified by a majority of members in a general meeting. This principle acknowledges that the majority of shareholders have the power to decide the course of action for the company, including whether to condone or ratify any alleged wrongdoing.

The principles established in Foss v. Harbottle have been enshrined in Nigerian company law through Section 341 of the Companies and Allied Matters Act (CAMA) 2020, which states: 

"Subject to the provisions of this Act, where an irregularity is made in the course of a company's affairs or any wrong is done to the company, only the company can sue to remedy that wrong, and only the company can ratify the irregular conduct."

These rules, while intended to promote order and efficiency in corporate governance, were perceived as unduly harsh and unjust towards minority shareholders. Minority shareholders, despite holding legitimate rights, were effectively barred from seeking redress for wrongs committed against the company, which indirectly impacted their interests.

Overall, the rules established in Foss v. Harbottle have had a profound impact on the development of company law and corporate governance practices. They have fostered order and efficiency in the management of companies while also recognizing the need to protect the rights of minority shareholders through carefully crafted exceptions. This landmark decision continues to shape the legal framework governing the intricate relationships between companies, their directors, and their shareholders.

EXCEPTIONS TO THE RULE IN FOSS V HARBOTTLE 

The exceptions to the rule in Foss v HARBOTTLE are expressly provided under Section 343 (a-f) CAMA 2020. The sections provides that:

Without prejudice to the rights of members under sections 346-351 and sections 353- 355 of this Act or any other provisions of this Act, the Court, on the application of any member, may by injunction or declaration restrain the company or its officers from-

(a) purporting to do by ordinary resolution any act which by its articles or this Act required to be done by special resolution;

(c) any act or omission affecting the applicant's individual rights as a member,

(d) committing fraud on either the comparty or the minority shareholders where the directors fail to take appropriate action to redress the wrong done;

(e) where a company meeting cannot be called in time to be of practical use in redressing a wrong done to the company or to minority shareholders;

(f)where the directors are likely to derive a profit or benefit, or have profited or benefited from their negligence or from their breach of duty;

1. ULTRA VIRES

The company needs to work by the objectives mentioned in the memorandum of association of the company and nothing beyond that. If the company acts beyond its powers then it is said to be ultra vires and upheld as void. Even a single member can bring a suit against a corporation if the acts so performed fall outside the Memorandum or Article of Association and hence, such acts would be declared as ultra vires. Therefore, such acts or actions are held void and cannot be held legal even if the majority shareholders ratify. 

In Prudential Assurance Co. Ltd. v. Newman Industries Ltd., the Court of Appeal explained that where the wrongful act in issue is ultra vires the company, the rule does not operate because the majority of members cannot ratify the transaction. This point is further exemplified by Smith v. Croft It was held that an individual shareholder could bring a personal action to restrain the company from so acting because it infringed his personal right as an investor to have the business conducted in accordance with the memorandum and the Articles of Association. However, where the shareholder is seeking damages for the loss suffered by the company as a result of a transaction actually entered into, the action will fail if he does not satisfy the requirement of wrongdoer control. This is because the wrong is done to the company directly and so, the company is the proper claimant.

2. FRAUD ON MINORITY

Where fraud is committed against the minority as a result of the decision of the majority shareholders or the Board of Directors, such acts which amount to fraud can be challenged by the minority. However, the judges have not set precise parameters on the meaning of fraud in this context; it has been acknowledged that it is plainly wider than fraud at common law. It is encouraging that the courts have stepped up to expand minority protection in light of the legislature's lack of action in that area and give minorities more opportunities than ever before to express their grievances in court.

In Estmanco (Kilner House) Ltd. v. Greater London Council,' Megarry V-C said that:

The essence of the matter seems to be an abuse or misuse of power and that the term carried its wider equitable meaning. It therefore covers conduct that is plainly improper but not necessarily deceitful.

3. IRREGULAR PROCEDURE 

Purporting to do by Ordinary Resolution any act the Company's Articles or Companies and Allied Matters Act requires to be done by Special Resolution. Where a special resolution is required to be passed, it is expected that the proper procedure be followed and not otherwise. Non-compliance would amount to irregular procedure that would give rise to minority protection. 

In Edward v. Halliwell," the defendant's trade union rules stipulate that the employee's contribution must be in accordance with the stated table and no alteration is allowed until a ballot resolved to increase the amount of contribution. The action succeeded.

4. INDIVIDUAL MEMBERSHIP RIGHTS

Any act or omission affecting the applicant's individual rights as a member. It should be noted that the rights of a member are fundamental and as such, the breach of such rights are enforceable against the company or its management as the case may be. Membership rights that may be affected includes the right to give notice of meetings, Pay dividend when declared, refusal to vote in resolution either by self or proxy, failure to admit duly appointed proxy to company meetings, variation of class rights and other denials that affected the member in his personal relationship with the company.

 Aggrieved member can bring a personal action or representative action against the company, and join the directors if they took any decision or action that necessitate some relief being sought against them. In Pender v. Lushington,  it was held that Articles of Association which gave shareholder voting right entitles a shareholder to sue to compel the company to record his vote.

5. WRONGDOERS IN CONTROL

Even when the firm has been mistreated, the controlling shareholders may refuse to allow legal action to be taken against the wrongdoer. Any member or member may file a suit on the company's behalf in these circumstances to protect the company's interests. In the case of Glass v. Atkin, it was held that control exists if it would be futile to call a general meeting because the wrongdoers would directly or indirectly exercise decisive influence over the result.

These exceptions protect minority shareholders and allow them to seek justice in certain circumstances despite the Majority Principle Rule. The exceptions have been enacted in Section 343 CAMA. According to that section, a member of the company has the right to sue for an injunction or declaration to restrain the company from the following actions, and that shall be without prejudice to the rights of the member as guaranteed under Sections 346-351 and Sections 353 -355 of the CAMA 2020.

CONCLUSION 

The landmark case of Foss v Harbottle (1843) established a key principle in corporate law: when a wrong is committed against a company, the company itself, not individual shareholders, is the proper plaintiff. This rule emphasizes the separate legal personality of a company and the primacy of majority rule in corporate decision-making. It provides a framework for corporate governance and dispute resolution, balancing the rights and interests of shareholders, directors, and the company. Despite evolving exceptions and limitations, this doctrine remains essential in shaping corporate law and governance, influencing corporate law and minority shareholder remedies worldwide.

Credit: Group 6 Company Law Presentation (AAUA)