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Company Law MT/HT 2014/15

Yu Jie, Wu
Law, Magdalen College
Company Law (4)
Both of these statements concern the enforcement of rights against parties, directors or otherwise,
involved in the well-being of the company, where those parties owe duties to the company, in situations
where the parties either do not owe duties personally to the individual, or do. This is the use of agent
constraints, set up both ex ante (rules) and ex post (standards) depending on the nature of the duty.1
There are three broad kinds of agency conflicts in corporationsbetween shareholders and managers
(AC1); between classes of shareholders or stakeholders (in particular, majority and minority
shareholders) (AC2); and between company and third parties (employees, creditors, etc.) (AC3).2
One role of the law here is to monitor agency conflicts, to ensure that the corporation does not abuse its
position at the unacceptable expense of any group.
Where agent constraints are used, the question of enforcement naturally arises. 3 The law
expresses a desire to ensure an optimal level of litigation that will encourage compliance with these
agent constraints, but also a fear of encouraging suits that are not in the companys best interests and
are instead burdensome.4 In the following discussion, I wish to examine these two statements in the
light of their function as agent constraints. It will be argued that the law here is informed by AC1, but
seeks to regulate AC2 and AC3, and the strategies by which it does so are different pre-2006, post-2006
and in terms of reflective loss.

1. Statement 1the rule in Foss v Harbottle


The rule in Foss v Harbottle5 comprises two principles: (A) that the proper claimant is the party that
has suffered the legal injury6 (read with the principle of separate legal personality7) and (B) that an
individual shareholder cannot bring an action in the courts to complain of an irregularity (as distinct
from an illegality) in the conduct of the companys internal affairs if the irregularity is one which can
be cured by a vote of the company in general meeting.8 The statement provided is an articulation of
one of the exceptions to this rule, the so-called fraud exception, as arrived at by Vinelott J.9 The Court

J Armour, H Hansmann & R Kraakman, Agency Problems and Legal Strategies in R Kraakman et al (eds),
The Anatomy of Corporate Law (2nd edn, OUP 2009) 35, 39.
2
ibid 36.
3
ibid 40.
4
PL Davies & S Worthington (eds), Gower & Davies Principles of Modern Company Law (9th edn, Sweet &
Maxwell 2012) paras 17-4-5; MacDougall v Gardiner (1875) 1 Ch D 13 (CA) 25 (Mellish LJ).
5
(1843) 2 Hare 461 (Ch).
6
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 (CA) 210 (Cumming-Bruce,
Templeman & Brightman LJJ).
7
Salomon v A Salomon & Co Ltd [1897] AC 22 (HL) 31 (Lord Halsbury LC).
8
Prudential Assurance Co Ltd (No 2) (CA) (n 6).
9
ibid 219 (Cumming-Bruce, Templeman & Brightman LJJ).
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Company Law MT/HT 2014/15

of Appeal did not strictly speaking decide on this matter.10 It is not the purpose of this part to sort out
whether this is the common law.11 What we do see is how this statement of law expresses two concerns.
The first concern is that the director(s) need to be kept in line, and the rights of the company
vindicated. This concern was expressed in Foss v Harbottle itself, in terms of the claims of justice.12
Although that is not an operational test, 13 it is a matter of ensuring that the director(s) are not left
unchecked in the exercise of their powers. The fear is that there are acts that constitute breaches of
duties owed to the company, but given that the wrongdoer has control, the company will not enforce
those duties. This would leave AC1 unchecked, and so exceptions are developed to allow claims to be
brought.
The second concern is to balance between the interests of minority and majority shareholders.
If the law did not intervene, we would have a situation where a majority was essentially allowed to
control the company to the companys (and hence the shareholders) detriment, where the majority had
some other source of benefit. This concern was clearly expressed in Vinelott Js expansive notion of
control in terms of manipulation.14 And yet, it is important that the majority is not bullied if such
a rule is in place. Allowing a claim by a minority where a majority has decided not to pursue the claim,
where that decision is taken within bounds, would in effect allow a veto.15 The nature of the regulation
seems to be sporadicit emphasises the boundaries of the activity, but then leaves the rest to the
company itself to resolve. It checks the exercise of powers, but only if the case can be brought within
the relevant exceptions to the rule in Foss v Harbottle,16 and is thus an ex post regulation of AC2.
2. Statement 1Part 11 of the Companies Act 2006 (CA)
We will focus on ss 260-263 as the central case of derivative actions. It will be argued that the boundary
regulation that we have seen above has been replaced by an assertion of third-party control over the
AC2 relationship, thus flattening the conflict structure into AC1.
s 260 defines derivative claims, s 261 provides for applications for permission to continue
said claims, and s 263 provides considerations for the court in deciding on such applications. s 263(2)
mandates a refusal where any of three conditions are met. If none of these bars are found, s 263(3)
provides for factors to be taken into account, paying particular regard to views of independent members
of company (s 263(4)).

ibid 219-20 (Cumming-Bruce, Templeman & Brightman LJJ); GR Sullivan, Restating the Scope of the
Derivative Action (1985) 44 CLJ 236, 239.
11
Although see now, in support, Universal Project Management Services Ltd v Fort Gilkicker Ltd [2013] EWHC
348 (Ch); [2013] Ch 551 [55] (Briggs J).
12
Foss v Harbottle (n 5) 492.
13
Prudential Assurance Co Ltd (No 2) (CA) (n 6) 221 (Cumming-Bruce, Templeman & Brightman LJJ).
14
Prudential Assurance Co Ltd (No 2) [1981] 1 Ch 257 (Ch) 324-5.
15
Armour, Hansmann & Kraakman (n 1) 36.
16
Edwards v Halliwell [1950] 2 All ER 1064 (CA) 1067 (Jenkins LJ).
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The use of the court as such a third-party controller can be seen in a negative and positive aspect.
The negative aspect is clearest in terms of s 263(2)(a), replacing the judgment of directors with that of
a court. It is a high threshold,17 however, because it is not the place for the court to override the views
of hypothetical, duty-complying directors where there may be genuine disagreement. This approach is
broad, however, as it does require assessment of the merits of the claim.18 At base, it is a question of
the best interests of the company.19 AC2 is further managed by the other mandatory bars, read, however,
with CA, s 239, which itself is the legislatures chosen solution for AC2 issues.
In the positive aspect, the court is the forum for channelling all manner of issues which do
engage the AC2 relationship. There is no standard of proofthe court is required instead to consider
factors in reaching an overall view.20 The enumerated considerations do reflect various considerations
addressing the balance between shareholder and company (majority). Good faith (s 263(3)(a)) governs
the intentions of the individual shareholder, and turns on whether the derivative claim is being brought
for the purpose of vindicating the companys rights or for some ulterior purpose unrelated to the subjectmatter of the litigation.21 ss 263(3)(b), (c) and (d) reflect what we have seen above regarding company
and majority interests in litigation. The breadth of considerations under the first indicates an open-ended
inquiry into the best interests of the company.22 s 263(3)(e) again reflects that balance of powers, and
weight is given to views of independent committees.23 The court, on these bases, has to form its own
view on the desirability of the litigation from the companys point of view.24
In this set of considerations, what was wrongdoer control is not directly relevant. This
legislation was meant to provide a more flexible method than the rule in Foss and its exceptions, so we
cannot reduce the provisions to the fraud on the minority exception. 25 However, factors such as
independence, manipulation and fraud no doubt have a place in assessing the weights of the various
considerations.
Firstly, in terms of the mandatory bars, clearly s 263(2)(a) would require, under s 172,
consideration of the benefit of [the companys] members as a whole, thus requiring the court to
consider the potential for AC2 problems. More strikingly, in terms of authorization, s 175(6) removes
the capacity of the director in question or interested directors from affecting the result. This is reflected
in s 239(4) in terms of ratification. Ratification is in fact subject to greater constraints, as recognised in
In my judgment therefore [] section 263(2)(a) will apply only where the court is satisfied that no director
acting in accordance with section 172 would seek to continue the claim. If some directors would, and others would
not, seek to continue the claim the case is one for the application of section 263(3)(b). Many of the same
considerations would apply to that paragraph too: Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch); [2010]
BCC 420 [86] (Lewison J).
18
Eg ibid [99]ff (Lewison J).
19
Davies & Worthington (n 4) para 17-19.
20
Stainer v Lee [2010] EWHC 1539 (Ch); [2011] BCC 134 [29] (Roth J).
21
Hughes v Weiss [2012] EWHC 2363 (Ch) [47] (Judge Keyser QC).
22
Franbar Holdings Ltd v Patel [2008] ECHC 1534 (Ch); [2008] BCC 885 [36] (William Trower QC).
23
Kleanthous v Paphitis [2011] EWHC 2287 (Ch); [2012] BCC 676 [75] (Newey J).
24
Davies & Worthington (n 4) para 17-13.
25
Wishart v Castlecroft Securities Ltd [2009] CSIH 65; [2010] SC 16 [38].
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Franbarit preserves the various rules concerning when acts may be ratified, especially the rule in
Beatty that a company can only ratify provided such affirmance or adoption is not brought about by
unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who
oppose it.26 Thus, the court is enabled to consider these factors under the mandatory bars.
Secondly, the question of control would be relevant to the weight given to each of the
considerations. This is clear enough for provisions (b), (c) and (d), which reflect the mandatory bars. s
263(3)(e), referring to the decision not to pursue the claim, ought clearly to be considered in relation to
the independence of those taking the decision,27 and can therefore incorporate Vinelott Js approach to
control.28 Furthermore, s 263(4) requires assessment of personal interest, direct or indirect, which
would affect the probity of those views. Indeed, even if not entirely independent, they may still be
relevant in the decisions.29
This comports with the overall structure of s 263. The law on derivative actions now does not
seek merely to exclude certain decisions taken or to be taken by the company, but seeks to engage with
these factors in arriving at a decision on what is the most appropriate. Thus, the law now requires the
court to take a place as an independent assessor through which these various arguments on the balance
of powers in the AC2 relationship are channelled, with a view towards the core problem of AC1. In this
way, perhaps, the law might increase the incidence of AC1 enforcement, 30 while at the same time
reaching AC2 resolutions that more closely reflect the interests of the company. The prior law would
only have allowed consideration of factors relevant to the exceptions, which were technical and not
always clear,31 and in any case reflected only the norms of corporate constitutional balance rather than
interests.

3. Statement 2Reflective loss principle


This statement concerns actions based on duties owed personally to the individual shareholder, and is
concerned to emphasise that there must be an independent legal duty owedthere cannot be a claim
simply on the basis of damage done. Tied intimately to this is the reflective loss principle, which
applies not only to dividends or value of shares, but also to other payments the shareholder might have
received, whether in the capacity of shareholder or not.32 It is suggested here that the various rules

26

North-West Transportation Company v Beatty (1887) 12 App Cas 589 (PC) 593-4 (Sir Richard Baggallay);
Franbar Holdings Ltd (n 22) [44]-[45] (William Trower QC).
27
As in Kleanthous (n 23).
28
See n 14.
29
Kleanthous (n 23) [83] (Newey J).
30
Davies & Worthington (n 4) para 17-30.
31
KW Wedderburn, Shareholders Rights and the Rule in Foss v Harbottle (1957) 15 CLJ 194, 205ff. KW
Wedderburn, Shareholders Rights and the Rule in Foss v Harbottle (continued) (1958) 16 CLJ 93.
32
Johnson v Gore Wood & Co [2001] 1 All ER 481 (HL) 532 (Lord Millett).
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reflect management of AC2 and AC3,33 with a view towards AC1. Reflective loss is, as clarified in
Johnson, loss that the individual actually suffers, but which for policy reasons cannot be claimed.34
The core rule is concerned with ensuring the primacy of the companys interests as potential
claimant. At base, there is the rule against double recovery. However, there are multiple ways of
ensuring conformity to this rule.35 This particular solution can be argued to prevent the claimant from
jumping ahead of other creditors of the company,36 and indeed, ahead of the company itself.37 This
precedence also forms the basis of the rule that where duties are owed to company and shareholder, it
is irrelevant that the duties so owed may be different in content. 38 Thus, here, we have both AC2
(between individual and company/majority) and AC3 (between the company and third parties, eg
creditors) engaged. The rule prioritises the latter in each configuration within the bounds of the rule
against double recovery.
There is no exception for settlementsthe shareholder cannot go behind the settlement,39 even
if the company is perhaps generous to the defendant. 40 Lord Millett explained this on problems of
conflicts of duties. First, it may be that directors, who are obliged to act in the companys best interests,
cannot do so because of the threat of shareholders going behind the settlement and challenging it at a
later date, thus preventing them from obtaining what is, in their bona fide view, the best solution for the
company. Secondly, when the company is insolvent, the threat of the shareholder action against the
wrongdoer will reduce the likelihood of the liquidator obtaining a settlement for the creditors generally.
Thus, here, again, we have AC2 problems present (as between minority and majority shareholders, and
between one and other creditors).
But at certain points, other factors, like the desire to monitor AC1 may make an exception
desirable. This may be seen as the motivating factor behind the disabling exception, in which the
wrongdoer by the breach of duty owed to the shareholder has actually disabled the company from
pursuing such a cause of action as the company had.41 This has been doubted in Waddington, but what
is noteworthy is that Lord Millett express sympathy for the underlying policy concern,42 but ultimately
decides that the AC2 problems, that it would allow the plaintiff to obtain by a judgment of the court
the very same extraction of value from the company at the expense of its creditors that it alleged the
defendant had obtained by fraud,43 militated against the exception. This is an expression not of logic,
33

ibid 503 (Lord Bingham of Cornhill).


C Mitchell, Shareholders claims for reflective loss (2004) 120 LQR 457, 460.
35
ibid 463.
36
Johnson (n 32) 528-9 (Lord Millett).
37
As autonomous: ibid 503 (Lord Bingham of Cornhill).
38
Gardner v Parker [2004] EWCA Civ 781; [2005] BCC 46 [33] (Neuberger LJ).
39
Johnson (n 32) 532 (Lord Millett).
40
Gardner (n 38) [60] (Neuberger LJ).
41
Giles v Rhind [2002] EWCA Civ 1428; [2003] Ch 618 [34] (Waller LJ).
42
It is impossible not to share the determination of the Court of Appeal not to allow a defendant who has been
guilty of such conduct to escape liability: Waddington Ltd v Chan Chun Hoo [2008] HKCU 1381; [2009] 2
BCLC 82 [85] (Lord Millett PJ).
43
ibid.
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but of the balance of interestsdoes the imperative to regulate AC1 outweigh the imperative to regulate
AC2? English law answers one way, Hong Kong law answers the other.
The extension of this rule to claimants other than shareholders44 reflects another form of the
AC2 relationshipit is a question then of regulating the interaction between one creditor and the
general body of creditors. While the company is still solvent, this is the same concernthe money
ought to go to the company first, and then distributed by the company. If the company chooses not to
claim, that is its prerogative, unless the exceptions apply, thus reflecting again a balance between AC1
and AC2.
These relationships are regulated in a manner similar to the previous law for derivative actions.
The structure is one of a general rule privileging one party over another, with exceptions. As Mitchell
has argued, the decision in Giles might point the law towards a more policy-sensitive approach,45 that
perhaps may be directed to identify the best interests of the various parties in each of these AC situations.

4. Conclusion
Thus, we have seen how the various relationships of agency conflict can be identified in the solutions
for derivative actions and reflective loss. The law has adopted different strategies to address these
problems, and the substance is ultimately a question of policy that this essay has not engaged with
directly. The emphasis, however, has been on the form of regulation. Where the legislature has
intervened, we have a stronger independent assessor positively regulating AC2. Where it has not,
perhaps the law is moving towards, at the very least, giving the courts scope for balancing the various
interests involved. Depending on the discipline of the courts, this may lead us into a more precise
application of agent constraints, or may dissolve the law into diffuse islands of discretion. By
recognising clearly what interests are being balanced, perhaps we may be able to attain the former.

44
45

Gardner (n 38) [70] (Neuberger LJ).


Mitchell (n 34) 478.
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