Minority shareholders

Bill and Fred going into business together ought to be aware of how they can share a business together and be protected legally. An insight into the theory of business relationships would be a good introduction. A partnership refers to a relationship that exists between persons who are carrying on a business in common with a view to making profit (Partnership Act 1890 s 1(1)).Each partner contributes some skill, work or financial investment. Each partner has the right to participate in the running of the business and is also an agent of the firm, which means that he has the power to form a business contract at any time. A partnership is not recognised as an entity in law (Sadler v Whiteman [1910]), so the partners have unlimited liability, meaning the individual partners can be personally sued and be liable for any company debts. When Bill and Fred decide to incorporate their business into an Ltd they gain unlimited liability, the business is a now a separate entity; so Bill and Fred will not be personally liable for the company debts.

Shareholders own private limited companies. Members of the public cannot buy the shares as they cannot be sold on the stock exchange and any sale of shares must be agreed by the members. As Bill owns more than 50% of the shares he in fact controls the business. However Bill cannot run the company however he likes. By law he has to follow the directors duties as set out in companies act 2006.

In recent years there has been continuous growth of companies. This has lead to a stronger demand for shareholder rights and remedies that safeguard the interests of investors from manipulative management. In public listed companies unhappy shareholders have the option of selling their shares on the market. The same course of action is not available for Fred the owner of an unlisted company, since it is difficult to find a buyer for private company shares as there is no ready market. Fred is a minority shareholder, as he owns less than 50% of the companies' shares therefore he is vulnerable to corporate fraud by Bill the majority shareholder who is in control of the company.

The position of the minority shareholder is not improved by the rule in Foss V Harbottle (1843) 2 Hare 461, a famous English precedent on corporate law. The case involved two minority shareholders, who claimed the directors of the company had misappropriated the company's assets. The court dismissed the claim and held that when a company is wronged by its directors it is only the company that has standing to sue. The court established two rules. The “proper plaintiff rule' which states that the plaintiff in an action in respect of a wrong alleged to a company, may only be vindicated by the company alone. This implies that minority shareholders do not have unlimited rights to exercise personal proceedings against the directors, the main benefit of this is that it prevents the huge number of legal actions which would inevitably arise if any member of a company had the power to sue on the company's behalf. Secondly the ‘majority rule principle' was established which states that if company members are in disagreement, they should resolve this at a general meeting, then the court will not interfere. http://en.wikipedia.org/wiki/Foss_v_Harbottle

These rulings do not protect the minority shareholders from directors who commit fraud; however four exceptions are recognised by common law. The courts would be prepared to intervene where the transition is ultra vires or illegal; where the transaction requires the sanction of a special majority; where the personal rights of a member have been infringed; and if there has been a fraud on the minority. The last of these exceptions (fraud on the minority) was believed to be the principal exception to the rule before the introduction of the statutory derivative claim.

Fraud on the minority is not precisely defined but it can be interpreted simply as misrepresentation or an act to deceive. A precedent case of such abuse of power by the directors of a company such as Bill did, is in Daniels vs Daniels (1978). This case is about self serving negligence, where a profit is made by one of the directors by a negligent act. The majority shareholders forced the company to sell land to one of them for very much less than it was worth. The minority shareholders could have brought a claim against the company for this negligent act and it would have been very likely that such a claim would have been allowed to proceed. This case is very similar to that of Fred and Bill, where Bill purchases new premises from his good friend Jane that he is living together with at an inflated price. Fred could bring a claim on behalf of the company for this negligent act. As it seems that Bill has caused loss to the company, a derivative claim might be brought by Fred under s.260. Bill undoubtedly breached the statutory duty set out in s.174 (the duty to exercise reasonable care, skill and diligence). Ewan Maclntyre

a. (2000) Khan v Mia. House of Lords.

b. (1979) Saywell v Pope. High Court.

c. (1897) Salomon v Salomon and Co Ltd. House of Lords.

d. (1933) Gilford Motor Co Ltd v Horne. Court of Appeal.

e. (1956) Pavlides v Jensen. Chancery Division.

f. (1978) Daniels v Daniels. Chancery Division.

g. (1972) Ebrahimi v Westbourne Galleries. House of Lords.

h. (2006) Irvine v Irvine. Chancery Division.