Rights and remedies available to minority shareholders

TheLawStudent

There are a number of rights and remedies available to minority shareholders:

  • “Membership rights” – enforcement under s.33 CA 2006
  • Derivative actions:
    • exceptions to the rule in Foss v. Harbottle
    • under s.260 CA 2006
  • Unfair prejudice actions under s.994 CA 2006
  • Just and equitable winding up under s.122 IA 1986
  • Other benefits under CA 2006

These remedies are not necessarily used frequently in practice but their existence and the threat of claims being brought will be ever present in the directors’ minds and may have an impact on their conduct.

“Membership rights” – enforcement under s.33 CA 2006

It has long been the case that the articles of association of a company regulate the relationship between the members and each other and between the members and the company. They act as a contract. This is enshrined in s.33 CA 2006, which provides as follows:

“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.”

The effect of this provision is that members can sue under s.33 if their membership rights are infringed. The usual remedy for breach of s.33 is damages.

The meaning of “membership rights” is far from clear and we have to turn to decided case law in order to establish what rights have been considered to be membership rights in the past.

Examples of membership rights that have been enforced under s.33 CA 2006 (or the corresponding section of CA 1985):

  • the right to a dividend once it has been lawfully declared;
  • the right to share in surplus capital on a winding up;
  • the right to vote at meetings; and
  • the right to receive notice of GMs and AGMs.

These rights are limited and rights of members which are not membership rights are not enforceable under s.33.

The most commonly referred to case on this matter is Eley v Positive Government Security Life Assurance Co Limited [1876] 1 Ex D 88, CA. In this case the company’s articles contained a provision that the plaintiff would be appointed as the company’s solicitor. He was never appointed as such although he did become a member. The court held that the plaintiff could not sue under the equivalent of s.33 as the right to be appointed as the company’s solicitor was not a membership right.

In order to protect members, it is important, therefore, that any of their rights which are not membership rights are set out in a separate contract (such as a shareholders’ agreement) and not in the articles of association.

It should also be noted that a company’s articles are deemed to be a complete contract and the court will not imply any terms into them whether to create business efficacy or otherwise (see Bratton Seymour Service Co. v Oxborough [1992] BCC 471).

Derivative actions

A derivative action is one where the shareholder’s right of action is not one which is personal to that shareholder but instead it is one which is derived from the company’s right of action, which the company has not exercised.

Since 1 October 2007, the only procedure for bringing a derivative action is under s.260 CA 2006. However, we have included examples of the common law principles established before then as they may still be followed by the court and you may hear them referred to in practice.

In addition, Foss v Harbottle (and associated cases) will continue to be
relevant where shareholders seek to enforce a right which is vested in
themselves rather than the company, since this line of authority will not be
affected by the introduction of s.260 CA 2006.

Exceptions to the rule in Foss v Harbottle

The rule in Foss v Harbottle [1843] 2 Hare 461 has long provided that, in situations where a wrong has been done to a company, the company is the proper claimant (acting through the board or in some circumstances the majority shareholder(s)). In other words, a member would not be the proper claimant. Accordingly, the court will not interfere in the internal management of a company acting within its powers. The effect of this rule is that, in general, under the common law a minority shareholder is not allowed to sue for a wrong committed against a company of which he is a member, even if the company is refusing to take action.

However, over the years the courts recognised that, in order for justice to be done, there needed to be some circumstances in which a shareholder could bring a claim on a company’s behalf if the company would not do so. It was as a result of this recognition by the courts that various exceptions to the rule in Foss v Harbottle established the right of a minority shareholder to bring an action as follows:

  • Where the majority exercise their votes in such a way as to defraud minority shareholders. For example, in a situation where there has been a fraud on the minority, the wrongdoers (usually the directors) are in control of the company and the claimant is being improperly prevented by the wrongdoers from bringing an action in the name of the company.
  • Where directors who are in control of a company have been guilty of a breach of fiduciary duty, provided that breach of such duty is not ratifiable by the majority. See the cases of Pavlides v Jensen [1956] 2 All ER 518 and Multinational Gas and Petrochemical Co Ltd [1983] 2 All ER 563.
  • Where the company (usually as a result of a decision of the board) is proposing to act ultra vires or illegally. See Edwards v Halliwell [1950] 2 All ER 1064 and North-West Transportation Co v Beatty [1887] 12 App Cas 589.
  • Where the company has purported to pass an ordinary resolution in circumstances where a special resolution, or some other special procedure is required. These special procedures are in force in order to protect the minority and the rule in Foss v Harbottle is not allowed to defeat this purpose. See Edwards v Halliwell [1950] 2 All ER 1064.
  • Where the company proposes to act on the authority of a resolution which is defective because inadequate notice was given. See Kaye v Croydon Tramways [1898] 1 Ch 358.

Derivative claims under s.260 CA 2006

Section 260 was a new provision introduced by CA 2006. It provides an express right to bring a derivative claim in certain circumstances. It is therefore a statutory exception to the rule in Foss v Harbottle.

S.260 CA 2006 allows shareholders to bring a derivative claim where directors have breached their statutory duties. This provides a wider range of circumstances in which a derivative claim may be brought by a shareholder compared with the common law rules described above. This is especially the case since directors’ duties were expanded under CA 2006. The statutory right to bring a derivative claim supports enforcement of the directors’ wider duties.

Definition of derivative claim under s.260 CA 2006

Section 260(1) defines a derivative claim brought under s.260 CA 2006 as one initiated by a member of a company, rather than by the company itself:

  1. in respect of a cause of action vested in the company; and
  2. seeking relief on behalf of the company.

When a derivative claim may be brought

Section 260(3) provides that a claim: “… may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.”.

Note that a “breach of duty” will also encompass breaches of common law duties not falling within CA 2006.

Importantly, there is no requirement that the director has to have benefited personally from the breach before a derivative claim can be brought. Section 260(5) sets out the definition of director for the purposes of s.260 and includes shadow directors as well as former directors. Note that s.260(3) extends to all statutory duties of directors under ss.170-177 CA 2006 (including, for example, the s.174 duty to exercise reasonable care, skill and diligence).

Against whom the derivative claim may be brought

Under s.260(3) the cause of action may be brought against “the director or another person (or both)”. However a cause of action will only arise in respect of the actions or omissions of a director.

Therefore, provided the cause of action is in respect of a relevant breach by a director, third parties may be defendants to the derivative claim, either in lieu of the director or in addition to the director. According to the Explanatory Notes to CA 2006, derivative claims against third parties are only to be permitted in very narrow circumstances, for example against a third party to a contract entered into in breach of the director’s duties, where that third party knew about the breach. The cause of action against a third party is not set out in CA 2006, but derives from the common law rules relating to the concept of ‘knowing assistance’ in respect of a breach of duty by a director.

Who may bring a derivative claim

Derivative claims brought under s.260 must be brought by a member. However, pursuant to s.260(4) it is immaterial whether the cause of action arose before or after the person bringing the claim became a member of the company.

A member may, therefore, bring a claim in respect of events that occurred before they became a member of the company. This underlines the fact that the cause of action is vested in the company, rather than the member. By contrast, a former member cannot bring a claim even in relation to events which occurred when they were a member.

Requirement for court approval

There are two stages to bringing a derivative claim. The first stage is that the member must obtain the permission of the court to continue a derivative claim (i.e. once the claim form has been issued) – s.261(1). The onus is therefore on the member to make out a prima facie case in order to obtain permission.

There are certain circumstances set out in s.263(2) where permission to continue the claim must be refused by the court. These include where the court is satisfied that a person acting in accordance with s.172 (the duty to promote the success of the company) would not seek to continue the claim.

If the circumstances are not such as to be an absolute bar to the continuation of the derivative claim, the court must then take in to account the factors listed in s.263(3) in determining whether to allow the claim to continue. These include whether the member is acting in good faith and whether the act or omission which gave rise to the cause of action would be likely to be ratified by the company.

If the application is not dismissed at the first stage then the court will consider the claim at the second stage, when it must consider particular criteria. The court must have “particular regard” to any evidence it has before it as to the views of the members who have no “personal interest, direct or indirect, in the matter” – s.263(4). This provision was introduced to make it harder for a single member to bring proceedings against the wishes of the general body of shareholders and is considered to be an important safeguard against the bringing of tactical litigation by disgruntled shareholders.

The requirement to obtain court permission to continue a derivative claim and the safeguards built into s.263 were designed as a counterbalance to the extension of the rights to make a derivative claim under s.260. It was thought that the new statutory provisions would be easier to use than the exceptions to the rule in Foss v Harbottle and thus lead to more tactical action by minority shareholders. However, the anticipated increase in successful derivative claims has not materialised. The courts have generally adopted a restrictive approach in denying permission to continue derivative claims in a large number of cases (see Stimpson & Ors v Southern Landlords Association [2009] EWHC 2072 (Ch), Mission Capital plc v Sinclair [2008] EWCH 1339 (Ch) and Franbar Holdings Ltd v Patel [2008] EWHC 1534 (Ch)).