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Shareholders' Company Shares

Info: 1755 words (7 pages) Law Essay
Published: 6th Aug 2019

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Jurisdiction(s): UK Law



The inexorable growth of companies and the increased shareholder sophistication in recent years have led to stronger demand for shareholder rights and remedies that safeguard the interests of investors from errant and manipulative management. While disgruntled shareholders of public listed companies have the option of selling their shares in the open market, the same course of action is not open to shareholders of unlisted private companies, since there is no ready market for private company shares. Minority shareholders of these companies in particular are therefore vulnerable to corporate fraud by majority shareholders who are often in control of the company. This essay reviews existing legal avenues for the protection of minority shareholders and presents the functionality and limitations of these legislative and regulatory controls in achieving the intended outcomes.

A case for minority shareholders protection

Minority shareholders are defined as individuals or entities holding less than 50% of the company stocks. Most companies require the capital injection of major and minor investors alike. In private companies, the majority shareholders are normally also the directors or founders of the companies who have direct control over the daily management of the firm. The protection of minority shareholders interests is crucial to encouraging investment. If majority shareholders are permitted to use their power to further other interests at the expense of minority shareholders' interests, then the latter will be discouraged from investing in that market. This can substantially reduce the amount of local and foreign investment. For example, investors who may have purchased 10% of corporations are likely to invest in markets that provide them greater returns and security.

Foss and Harbottle [1843]

The controlling power of majority positions is generally accepted. This is partly due to the popular ruling of Foss and Harbottle (1843) 2 Hare 461, 67 ER 189, a famous English precedent on corporate law. The case involved two minority shareholders who initiated legal proceedings against directors of the company for misappropriation of company assets. The court dismissed the claim and established two rules. Firstly, the “proper plaintiff” rule states “the proper plaintiff in an action in respect of a wrong alleged done to a company ... is prima facie the company itself.” This implies minority shareholders do not have unlimited prerogative to exercise personal legal proceedings against the directors. Secondly, the case also established the power of majority in that “where the alleged wrong is a transaction which might be made binding on the company ... on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that if a mere majority of the members of the company ... is in favour of what has been done then cadit quaestio – the matter admits of no further argument.” Obviously, these rulings do not protect minority shareholders from directors who commit fraud themselves and they have since been developed to provide four exceptions:
    • where the transaction is ultra vires or illegal;
    • where the transaction requires the sanction of a special majority;
    • where the transaction infringes the personal rights of the shareholders; and
    • where the transaction amounts to a fraud on the minority.
Many believed exception (iv) is the principal exception to the rule. Fraud on the Minority Fraud can be interpreted simply as an act of deceiving or misrepresenting. Some precedent cases of such abuse of power by the directors of companies include:
    • Appropriation of corporate property – Cook vs Deeks [1916] 1 AC 554; In this case, the directors diverted business of the company to themselves, and attempted to ratify their dealings by voting their shares at a general meeting in their own favour. The Privy Council held that ratification was not possible because the directors were using their votes to expropriate the minority shareholders.
    • Self serving Negligence – Daniels vs Daniels [1978] Ch 406;
    • Disregard, discrimination and prejudice – Greens vs Sante Fe industries – 90% ownership corporation of subsidiary stock, convert the shares of the minority into cash, through a short form merger without purpose other than to appropriate the shares of the minority as being – the clearest fraud on the minority. [concerns for shareholder]
Although the dominant perspective of majority shareholders is that minority shareholders's real motive is not to protect themselves but to benefit from obstructing majority shareholders' freedom of action, the widespread incidences of minority oppression and manipulation provide compelling need for protection of this vulnerable group.

Statute based protection

Company Law is defined as “the Legislation under which the formation, registration or incorporation, governance, and dissolution of a firm is administered and controlled”. In most countries, a core segment of this law is dedicated to shareholder rights and directors' duties. Although Company Law specifies the rule of majority shareholder under normal circumstances, it also spells out the exception in this rule, one of which is where the majority shareholders are believed to be exercising their votes to perpetrate a fraud on the minority. This provision for minority to sue is key in forming the baseline protection for shareholders against possible abuse of majority power. In this regard, there are three possible modes of action that a minority shareholder can take, namely personal, representative or derivative actions.

Personal Actions

Personal Actions may be taken when personal individual right has been infringed. These rights may include fundamental rights on access to company information, Directors' interests and holdings as well as individual voting rights on decisions concerning corporate changes, all of which are legislated in the Companies' Act. When a company or its directors is in breach of a common law or statutory duty owed to the shareholder, a person can sue on his own accord. Unfortunately, a shareholder is unlikely to be able to establish such a wrong. A complaint that directors of a company are mismanaging the company may well not be sufficient since the standard of care and skill required of honest directors is traditionally very modest. In addition, the duty of care and skill is owed to the company and not to an individual shareholder [Perceival vs Wright (1902)]. Even where the alleged mismanagement consists of irregularity in conducting the affairs of the company, a shareholder may not have had a wrong done to him and thus be able to sue. However, where the wrong complained of consists of breach of a personal right vested in a member, the member can sue. There is no clear test of what is a personal right as opposed to a right to have the business of the company carried out properly breach of which may be ratifiable. Case example

Representative Actions

As a extension of personal action, Representative Actions may be brought on behalf of a group where the same personal right of a number of shareholders has been infringed. The power of unity in representative actions can allow minority shareholders greater leverage in shaping the management to improve its operations (s303, ordinary resolution required) or to instruct the board how to operate (Table A, article 70 or s 9, both special resolution). Case example

Derivative Actions

Derivative action is defined as an action brought by minority shareholders on behalf of a company in respect of a wrong done to the company. Foss and Harbottle (1843) clearly establishes that where a wrong is done to the company, the proper plaintiff is the company. The principal exception to Foss, whereby a minority shareholder can bring a derivative action to enforce a company's rights, arises where there is fraud on the minority by those in control of the company. One difficulty with this exception is that ‘fraud' must be proved. In Prudential Assurance Co Ltd v Newman Industries (1982), the Court of Appeal stressed that a court should not allow a derivative action by a shareholder to commence unless the shareholder can establish a prima facie case that the company is entitled to the remedy claimed and that it is an appropriate case for a person to litigate on behalf of the company. Although the spirit of the law is to ensure equitable treatment of all stakeholders, “the company law has always struggled in its attempt to uphold majority rule and yet respect minority interests.” This is because the law has to delicately balance the interests of both parties, without penalizing either side or subjecting the system to excessive legal proceedings in a bid to take advantage of the provisions. The tendency of majority rules in statute-based regulation, whilst in theory provide minority an avenue for redress, makes it difficult for minority shareholder to prove his case in practice.

Shareholders' Agreement

Alternatively, and perhaps more effectively, minority shareholders can opt to enter a shareholder agreement with the invested company. b.Hong Kong : Company Ordnance – s 168A Securities and Futures Commission Ordnance (SFCO) - s37 2.Civil Law Countries b.Companies Act, Securities Act c.Courts protection Back to free company law essays

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