According to the Foss v Harbottle rule, Company is the proper claimant where a wrong has been done to the company. It is known as proper claimant principle. The justifications lay behind this ruling is that- it upheld the principle of majority rule and it prevents multiplicity legal proceedings being brought in respect of the same issue. A clear application of the rule illustrates how it fits with the principle of majority rule is MacDougall v Gardiner. The classical statement has formulated in Burland v Earle by Lord Davey. He sated that the court will not interfere with the internal management companies acting within their powers. Again, it is clear law that, in order to redress a wrong done to the company, the action should be brought by the company itself.
As a result it is the directors of the company, who will have the right to bring a proceedings against third party who has committed a wring against the company or, on the other hand, to defend an action brought against the company falls within the remit of the board. However, problem arise where the majority shareholder misappropriate the property belonging to the company and are not willing to bring an action. They can use there majority to prejudice of minority shareholders.
To counter such abuse there are, therefore, certain exceptions to the rule whereby a shareholder is permitted to sue on behalf of the company. Jenkins LJ in Edwards v Halliwell considered that circumstances in which it will not operate to prevent a shareholder from suing. In essence, he stated that there were four exceptions to the rule in Foss v Harbottle:
a) Where the act complained of is illegal or is wholly ultra vires to the company
b) Where the matter in issue requires the sanction of a special majority, or there has been non compliance with a special procedure
c) Where a member’s personal rights have been infringed
d) Where fraud has been perpetrated on the minority and the wrongdoers are in control.
Wedderburn in his frequently cited article, “shareholder’s rights and the rule in Foss v Harbotttle” has argued that in reality there is only one true exception, namely the fourth exception in Jenkins LJ’s list. He reasons that the first two are not exceptions because the rule is directed towards preventing a minority from challenging acts that can be legitimized by a simple majority and conduct falling within theirs first two grounds cannot be sanctioned by an ordinary majority. The third so called exception covers a wrong by the company and not a wrong to the company. The exception is where a fraud has been perpetrated on the minority and the wrongdoers are in control and this is truly a derivative action. Now question arise what is mean by derivative action?
S.260 (1) Company Act 2006 define derivative action as proceedings brought by a member of a company in respect of a cause of action vested in the company and seeking relief on behalf of the company. The grounds for bringing a derivative claim are laid down by s.260 (3) which provides that such 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.
Before 2006 it was necessary to show “fraud on minority” and “majority in control” in case of common law derivative action. Firstly, I will discuss about fraud on minority. Here first question arise whether it will restricted upon common law fraud. In case of Eastmanco fraud means common law and equitable fraud. There is considerable doubt whether at common law a derivative claim could be brought for a negligence claim by the company against directors. In Pavlides v Jensen a shareholder sought to bring a derivative action to recover damages for the company. Mere negligence is not fraud even in the equitable sense and Dankwerts J. held that no derivative action will lie in such case. However in Daniels v Daniels Templeman J. in a strike out application allowed a claim to go forward that included a negligence claim. The judge seems to have been very much influenced by the fact that, unlike the facts in Pavlides v Jensen, a director made a considerable profit at the expense of the company. That issue, the 2006 Act puts beyond doubt so that the derivative action will be available for breach of the duty to exercise reasonable care, skill and diligence. This will be so even if the director has not benefited personally as a result of the breach.
Furthermore, it was also required to show that “majority in control”. In one interpretation the majority in control means de jure control. However in Prudential assurance co ltd v Newman industries it was accepted that the action can be brought even though the two directors whose conduct was in question did not have majority of shares. This relaxation of the test of majority in control is subsequently limited in Smith v Croft (no 2) where it was stated that if the majority of remaining shareholders who are not wrong doers did not desire to initiate proceeding from disinterested reasons, the member seeking locus standi will be denied so. Under 2006 Act it is not required to show that majority in control.
Other grounds of action are default. The words “default” in addition to the words “negligence” and “breach of duty”. What are referred to as “breach of duty” and “breach of trust” are also included as causes of action for which a derivative action may lie.
Section 261 states that once a derivative claim has been brought, the member must apply to the court for permission to continue it. This is the first step in a two stage process. A paper hearing will take place where the court considers the member’s evidence. The onus is on the member to establish that they have a prima facie case for permission to continue the derivative claim. If this is not demonstrated the court will dismiss the application. If the application is dismissed at this stage, the applicant may request the court to reconsider its decision at an oral hearing, although no new evidence will be permitted at this hearing from either the member or the company. The Practice Direction 19C, Derivative Claims, which amends Part 19 of the Civil Procedure Rules (CPR), provides that this stage of the application will normally be decided without submissions from the company. If the court does not dismiss the application at this stage, the application will then proceed to the full permission hearing and the court may order the company to provide evidence at this stage.
S.263 (2) sets out detailed criteria as to whether permission is to be given. The Court must refuse permission if it is satisfied that a claimant would not seek to continue a claim, that where a cause of action arises from an act or omission that is yet to occur, that the act or omission has been authorized by the company or that where the cause of action arises from an act or omission that has already occurred that the act or omission was authorized by the company before it occurred or has been ratified by the company since it occurred. The list of factors to be taken into account for determining the refusal of permission is supplemented by S.263 (3).
The first of these is that the Court should have regard to whether the member is acting in good faith in continuing the action. The fundamental reason for derivative actions is that they are brought in the interests of the company. In having a good faith criterion presumably the Statute will enable to Court to judge whether there is any bad motive in bringing the action or whether the member has an ulterior motive. Of course there may be mixed motives but it is thought that this will not necessarily amount to lack of good faith if all the other circumstances indicate to the Court that the action should be continued.
Moreover, in Smith v Croft (no 2), the court continued to develop strict conditions for shareholder-claimants to meet. Thus, the view was taken that since the origins of the derivative action are rooted in equity, its availability was a matter within the discretion of the court, and in exercising its discretion the court would have regard to all circumstances, including the claimants conduct, his motives in seeking to sue and the availability of alternative remedy. This is disappointing because of by S.263 (4) the effect of Smith v Croft (no 2) still retain as law.
Provision is also made for an alternative member of the company to apply to the court to continue a derivative claim originally brought by another member but which is being poorly conducted by him or her. Section 264 provides that the court may grant permission to continue the claim where the manner in which the proceedings have been commenced or continued by the original claimant amounts to an abuse of the process of the court, the claimant has failed to prosecute the claim diligently, and it is the appropriate for the claimant to continue the claim as a derivative claim. Similarly, by virtue of s 262, where a company has initiated proceedings and the cause of action could be pursued as a derivative claim, a member may apply to the court to continue the action as a derivative claim on the same grounds listed in s 263. This addresses the situation where directors fearing a derivative claim by member seeking to block it by causing the company to sue but with no genuine intention of pursuing the action diligently.
In assessing the statutory reforms it is noteworthy that there is little or no change of emphasis in terms of formulation. The focus of the rule laid down in Foss v Harbottle and its jurisprudence was on prohibiting claims unless one of the exceptions to the rule was satisfied. The statutory language similarly proceeds from the rather negative standpoint that the court must dismiss the application or claim in the circumstances specified in SS. 261(2), 262(2), 263(2)-(3) and 264(3).
I think if the statutory Derivative claims can be brought by registered shareholder it will have some good effect. In New South Wales in Hooker Investments Pty v Email Ltd this was held to be the common law position and after reviewing the English case law in the area the Court of Appeal of the Cayman Islands in Svanstrom v Jonasson confirmed that only a registered shareholder could bring the action.
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