COMPANY LAW

Foss vs Harbottle (1843) 67 ER 189 (case comment)

Title of the case: Foss v Harbottle

Citation: [1843] 67 ER 189, (1843) 2 Hare 461
Court: Court of Chancery
Bench: Wigram VC, Jenkins LJ
Parties:
Petitioner: Richard Foss and Edward Starkie Turton
Defendants: Thomas Harbottle & Other’s
INTRODUCTION
A company has a separate legal personality, distinct and separate from the members who
compose it and so it can ‘sue and be sued in its own name’1 . Decisions of a company are
taken by the shareholders and the board members and represent the majority of the company2 .
Each company member is contractually bound by the company’s constitution which mandates
that every member agrees to be bound by the majority’s decisions3 . Courts have long been
reluctant to get involved in the company’s internal management4 as long as directors are
operating under the provisions of the Articles5 . All the above principles coexist in the rule of
Foss v Harbottle (1843)6 . The principle of separate legal personality, the doctrine of majority
rule, the statutory contract and the internal management principle are all translated in the Foss v
Harbottle rule, the ‘rule of procedure governing locus standi’ 7 . This rule is the basis of
‘common law jurisprudence regarding who may bring an action on behalf of the company’8 and
although its existence dates back beyond 150 years, it still constitutes a significant part of the
company law9 . The rule is considered prudent as it recognises that it is pointless to bring an
action to the courts for an issue that a company can resolve on its own, or a wrongdoing that
can be settled within its own internal management10 . Without the rule in Foss v Harbottle, there
would occur a huge amount of superficial litigation which would threaten the normal
performance of a company11 . However, there should be a balance between the efficient
governance of a company and the shareholders’ interest12 . For that purpose, there are
exceptional circumstances where an individual shareholder may bring an action in the interest of
the company to force the company to conform with its constitution and to request a remedy13 .
Apart from the positive critiques regarding the significance of Foss v Harbottle, the rule has
been also described as ‘obscure, complex, rigid, oldfashioned and unwieldy’ and so, in an
attempt to minimise its problems, the Companies Act 2006 (CA 2006) Part 11 came into
force14 . There are, therefore, contradictive views regarding the performance of the rule in Foss
v Harbottle.

Foss vs. Harbottle case is a leading English precedent in company law. According to the rule
laid down in this case, if any loss is suffered by the company by the negligent or fraudulent
actions of its members or outsiders, then the action can be brought in respect of such losses,
either by the company itself or by a way of derivative action.” This rule led to for formation of the
rule of majority and the minority shareholders rights. This rule is related to the management of
the affairs of the company. When a decision must be taken a resolution is passed in the
company by a simple majority or a three forth majority, the resolution becomes binding all the
members of the company.1 The court in ordinary matters does not interfere in the internal
management and matters of the company as it is decide by majority of members. The result of
this makes the company the right plaintiff to institute a suit or any legal proceedings and does
not let a single shareholder take any legal action against the wrongdoer. The rule in this case
allows the company to correct the irregularities by its own internal procedure. However, a
balance must be struck between the effective control of the company and the interests of the
individual shareholders. Therefore in few circumstances an individual shareholder is also
allowed to bring a legal action.” Minorities have often been on the other side of the coin, usually
covered by derivative claims and unequal redress for discrimination. Many researchers
suggested that the Rule of Rules was repealed after the coming into effect of the current formal
derivative actions, that there will also be a rise in shareholder lawsuits and have further voiced
concern over overlaps in both derivative claims and unequal remedies for prejudice. Its basic
values are still of critical significance today.”
FACTS OF THE CASE:

In September 1835, a company called the Victoria Park Company was set up to purchase 180
acres (0.73 km2) of land near Manchester (later became Victoria Park, Manchester, when the
Act of Parliament turned it into incorporation). But counter to the actual work allegedly enclosing
and planting the same in an ornamental and park-like way, and constructing houses thereon
having attached gardens and fields, and then selling, renting or otherwise disposing of them, the
directors of the company along with others were indulging in the misappropriation of the
property that belonged to the company and that may result in the misappropriation of the
property that belonged to the company.” The concern was illustrated by Richard Foss and
Edward Starkie Turton, two minor shareholders. They reported that the five directors of the firm
were Thomas Harbottle, Joseph Adshead, Henry Byrom, John Westhead, Richard Bealey, and
the lawyers and architects (Joseph Denison, Thomas Bunting, and Richard Lane), as well as H.
E. Lloyd, Rotton, T. Peet, J. Biggs and S. Brooks (Byrom, Adshead and Westhead’s various
assignees) misapplied and falsely mortgaged the property of the company, thereby behaving in
contradiction to what the company was formed for. It clearly demands that the wrongdoers be
kept liable for all the transactions and that a responsible receiver be named.” Their argument
was based on the ground below. The first argument was the fraudulent practices by which the
company’s funds were misappropriated. The second ground was due to the inadequacy of
qualified directors in the company who could potentially make up the board and the third ground
was that there was no clerk or office in the company. Because of these conditions, the owners
had no right to remove the property from the directors’ hands and instead had to pursue legal
action against them.”
Richard Foss and Edward Starkie Turton were the two minority shareholders in the “Victoria
Park Company” which was set up in September 1835 to buy 180 acres (0.73 Km per square) of
land near the Manchester in order to transform it into a park, known as “Victoria Park,
Manchester”. Subsequently, in 1837 an act was passed by the Parliament through which the
company was incorporated for the purpose of laying out and maintaining the ornamental park
within the township of Rusholme, Charlton upon Med-lock and Moss Side, in the country of
Lancaster. According to them the property was misappropriated and wasted and also various
mortgages were given improperly over the property of the company. Both the shareholders
decided to take a legal action on behalf of themselves and all the other shareholders or
proprietors of shares in the company, and therefore, filed a claim against the five directors
(Thomas Harbottle, Henry Byrom, John Westhead, Richard Bealey) ,the solicitor (Joseph
Denison), and architects (Thomas Bunting and Richard Lane), and also against H.Rotton ,
E.lloyd, T.peet, J.Biggs and S.Brooks, the several assignee’s of Byrom, Adshead and Westhead,
who became bankrupts. In Simple words In the case of Foss v Harbottle [1843], the two
shareholders commenced an action against the defendants, promoters and directors of the
company. The plaintiff shareholders claimed that the defendants had sold their own property to
the company at an exorbitant price and then improperly mortgaged it.

Their claim was based on the following ground. The first ground was the fraudulent transactions
through which the assets of the company were misappropriated. Second ground was related
with the insufficiency of qualified directors in the company who can actually make up the board
and the third ground were that the company had no clerk or office. Due to these circumstances
the shareholders had no power by which they could take the property from the hands of the
directors and therefore, had to commence legal proceedings against them.

ISSUES:
The issues were whether the members of the company can file suit on behalf of the company or
not and can the guilty parties be held accountable for their wrong deeds or not.”

The issues were whether the members of the company can file suit on behalf of the company
or not and can the guilty parties be held accountable for their wrong deeds or not.
Whether the plaintiff shareholders were allowed to bring an action against the defendants on
behalf of the company?

ARGUMENTS OF THE PETITIONER:

It was argued by the plaintiffs that the company should not be treated as an ordinary company
as it was incorporated by the Parliament. Moreover, the act of incorporation was passed with the
aim to benefit the company, but the directors tried to fulfill their own interests. They further
argued that directors should have acted as the trustees of the company and should be held
accountable for misappropriating the assets of the company. Therefore, this act enabled the
directors to sue those people who cause any harm to the company, whereas it did not give right
to the members of the company or outsiders to sue the board of directors.
ARGUMENTS OF THE DEFENDANTS:
It was argued by the defendants that the plaintiffs do not have any right to bring a legal action
against them on behalf of the company.

JUDGEMENT :
In this case, Wigram VC dismissed the claim of the shareholders and held that an individual
shareholder or any outsider of the company cannot take any legal action against the wrong
done to the corporation as both company and its shareholders are considered as the separate
legal entities. It is also mentioned under Section 21 (1) (a) of the Companies Act that a company
may sue and be sued in its own name and a member may not take any legal action on behalf of
the company ,and if a company has a right against the party under a contact, then it is for the
company to sue. The reason that shareholders of the company cannot sue is that the company
is the one who has actually suffered injury and not its members, so it is on the company to sue
or take any legal action against those members who have misappropriated its property.He
followed the judgements passed in older cases on the unincorporated companies and insisted
the minorities to show that they have exhausted all the possibilities of redressal within the
internal forum as he has stated that the courts will not intervene in those cases where majority
of the shareholders can ratify the irregular conducts, but this rule was considered as
unfavorable for the minorities because it barred them from taking any legal action whenever the
alleged misconduct was in law capable of ratification. Therefore, in effect the two principle rules
were established by the court. First and the foremost rule was the “Proper Plaintiff Rule” which
laid down that if any wrong done to the company or company suffers any loss due to the
fraudulent or negligent acts of directors or  any other outsider , then in such situation only the
company can sue the directors or outsiders in order to enforce its rights. Whereas, the members
of the company or any outsider cannot sue on its behalf because of the principle of “Separate
Legal Entity” which considers company as a separate legal person from all the members of the
company, so, it can sue and be sued in its own name. This is the only reason that why only a
company can bring legal action or institute legal proceedings not any member in order to cover
the losses that has been suffered by the company. A member of the company can take a legal
action on its behalf against the wrong doer only if he is authorized to do so by the board of
directors or by an ordinary resolution passed in the general meeting. The second rule was
“Majority Principle Rule” which laid down that if the alleged wrong can be confirmed or ratified
by a simple majority of members in the general meeting, then in those cases the court will not
interfere. However, the application of these strict principles appeared to be very harsh and
unjust for the minority shareholders, as although a substantive right have been provided to
them, still they were barred from obtaining justice under the rule and have to submit to the
wrongs done by the majority as they were the ones who controls the company and minority
members have no say due to their small strength. Therefore, in order to mitigate this harshness,
four exceptions to the general principle have been laid down where the litigation will be allowed.
The first and the foremost exception is where the alleged act is ultra vires and illegal. Second
exception is concerned with a situation where the alleged act could only have been validly done
or sectioned, in violation of a requirement in the articles by some members of the special
majority. The third exception is related with the alleged acts that cause invasion of the claimant’s
personal and individual rights in his capacity as a member of the company. Last but not the
least, the fourth exception deals with a situation where a fraud on minority has been committed
by the majority who themselves control the company. Therefore, all these exceptions help in
protecting basic minority rights that are necessary to protect regardless of majority’s vote.

Exceptions to the rule

https://thefactfactor.com/facts/law/civil_law/company-law/foss-v-harbottle/5626/
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Oppression and Mismanagement: It is a statutory right granted to the shareholder where if the
functioning of the company is done in a oppressive or mismanagement is being done, the
shareholders can bring an action by applying to the tribunal under section 214 of the companies
act.6 Under section 397 and 3987 of the act the shareholders can approach the court in such
cases.8 4. Individual membership rights: The individual members can enforce their rights
against the company like the right to vote, right to stand in elections etc.9 In a case the plaintiff
moved an amendment to the proposed resolution. The Chairman refused to record the
amendment in spite of the fact that it was seconded, and the original resolution was passed
without amendments. No reasons were given for this decision either. It was held that the
shareholders have a right to move amendments to resolutions.10 5. Derivative action: When
some wrong is done to the company the shareholders can bring an action for the wrong done as
they are not suing under their own right but under the right of other members whose relief is
sought. The company has to be joint as the co-defendant so that the company is bound by the
judgement given. When the action is against a third party it is called a derivative action as
individual member sues under a claim which belongs to the company thus the right is derived
from it.”

Criticism of the Rule in Foss v Harbottle and of its exceptions The law relating to the rule in
Foss v Harbottle and its exceptions has been widely discussed due to the controversy that this
creates in the area of company law. Indeed, the rule and its exceptions have proved to have
both positive and negative contribution to the company law. This section starts by discussing the
significance and the flaws of the rule in Foss v Harbottle. It then explains the real implications of
the exceptions to the rule in Foss v Harbottle and how these led to the introduction of a new
statutory derivative claim, Part 11 of the Companies Act. Finally, it ends by examining the
effectiveness of the Act and the contemporary position of the rule in Foss v Harbottle as it is
formed after the statutory procedure.

4.1. The significance and the flaws of the Rule in Foss v Harbottle and its exceptions On
the one hand, the rule is reasonably based on the perspective that it is not necessary to give
recourse to the courts regarding an issue that a company can resolve or regarding a
wrongdoing that can be sanctioned or ignored through an internal procedure110 . Moreover, it
correctly permits judges to deny any intentions of endeavouring to review matters of corporate
policy and commercial ruling, namely to decide for things that rightly considered out of their
competence and their skills111. This is reasonable and fair. It is a fact that the ruling of Wigram
VC in Foss v Harbottle followed the previous case law regarding unincorporated companies by
persisting that the minority should demonstrate that they had wiped out any likelihood of
resolution within the internal management112 . Some indications of the existence of majority
rule has been implied in the recent case law but Wigram VC was the very first who declared
clearly that the court will not interfere when an irregular conduct has been lawfully authorised by
the majority of the shareholders.

Adding to the above, the rule has been justified by judicial policies and this may be considered
as a confirmation of its successful validity and application. At the end of the nineteenth century,
some judges tried to elucidate the actual principles that were intended to be served by the
rule114. James LJ in Cray v Lewis (1873) rationalised the policy that any ‘body corporate’ is the
appropriate claimant in actions for claiming its property by indicating to the clear threat of a
variety of shareholders’ suits in the non-appearance of such a doctrine as Foss v Harbottle115 .
Another justification, and one which is prima facie much sounder in supporting the rule in Foss v
Harbottle has promoted in MacDougall v Gardine. In that case, Mellish LJ stated that where an
action has been done irregularly and the majority shareholders were authorized to do it
regularly, ‘or if something is done illegally which the majority of the company are entitled to do
legally, there can be no use having litigation about it the ultimate end of which is that a meeting
is called and them ultimately the majority gets its wishes’

CONCLUSION
A company is a legal entity that is given a different legal body rather than the members who
create it, i.e., the company’s owners. The company’s decisions are made on behalf of the
company by the Member-Owners and the Board of Directors. The group also makes decisions
on seeking lawsuits. As per the Companies Act 1956, the corporation is governed by
shareholders who own most of the shares. This majority theory is accepted in Foss v Harbottle,
a ground-breaking case. The majority of the shareholders’ vote was binding on the minority. This
theory has since been replaced and under the Companies Act 2013, minority owners have been
granted more control.” In order to protect the rights of minority owners, there are provisions
under the Companies Act, 1956 but because of lack of time, redress or capacity, the minority
was unable or unable, financial or otherwise. Hence, there have been several instances of
minority shareholder discrimination. The Companies Act, 2013 has provided for the protection of
the interests of minority shareholders which can be called a game-changer in the battle between
majority and minority shareholders.” This rule strikes a balance as it prevents frivolous and
large-scale litigation, but it also enables to take legal action for the specified exceptions. The
shareholders can raise issues for mismanagement and can communicate regarding their issues.
It allows the company to figure out the individual responsible for the harm caused to the
company. Once a shareholder has tried to get the issues resolved within the company, then he
can take a legal action if it comes within the exceptions.

By taking everything into consideration, the obvious conclusion to be drawn is that the rule in
Foss v Harbottle is indeed remarkably significant in company law. Its importance can be realised
by considering that it involves four of the most fundamental doctrines of company law: the rule
of separate legal personality, the internal management rule, the statutory contract, and the
doctrine of majority rule. However, the rule in Foss v Harbottle gives great power to the majority
shareholders and the controllers of the board. Thus, unfair results occur when the wrongdoers
are at the same time members of the board capable to bar an action from being claimed by the
company in order to gain redress for their wrongdoings. For that reason, there have been
established four exceptions to the rule in order to allow minority shareholders to bring an action
to the court against an infringement occurred by the majority. Although there are four exceptions
to the rule, the only real one is the forth exception which requires two elements to be satisfied:
the ‘fraud on the minority’ and the ‘wrongdoers control’. The particular exception introduced the
very crucial derivative action in common law and so the rule along with its exception can be
seen as the initial attempt for providing minority remedies. This illustrates that although the
courts tried to mitigate the restrictive approach of Foss v Harbottle, they are yet reluctant to
interfere with the internal management of the company and so they are careful not to largely
differentiated from the rule in Foss v Harbottle. At that point, it is reasonably argued that a rule
for which the courts introduced many exceptions in order to fill its gabs, is inevitably
inappropriate with many shortcomings. In the case of Foss v Harbottle, the fact that there is only
one actual exception underlines the significance of the rule. Last but not least, the statutory
derivative claim did not manage to replace the rule in Foss v Harbottle as the courts do not
strictly follow the statutory procedure and the sections in the Companies Act 2006. Therefore, it
is observed that despite the shortcomings of the rule, there is a silent acceptance of continuing
to use the common law procedure. This is an evidence that the rule of Foss v Harbottle still
useful for the courts today and justifies why this rule is still alive 160 years after its existence…
LINKS
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%20Foss%20v%20Harbottle%20(1843,the%20company%20was%20misapplied%20and
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v-harbottle-such-an-important-one-2018.pdf
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https://thefactfactor.com/facts/law/civil_law/company-law/foss-v-harbottle/5626/#:~:text=In
%20Foss%20v%20Harbottle%20(1843,the%20company%20was%20misapplied%20and