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Minority Shareholders

Basic: the protection of minority shareholders interests in England and Wales are
safeguarded by a small selection of remedies for either their own personal losses, or
losses to the company (e.g. diverting company contracts to the directors
themselves). The former is the most common and available under s994 of CA2006,
a petition for unfairly prejudicial conduct (UPC), or by a court order requesting the
winding up of the company under Part IV of the Insolvency (IA) 1986. The latter is
protected by the derivative claim, codified and refined by ss26 to 265 CA2006.
However, the shifting boundaries of these remedies illustrate the courts dilemma in
balancing the competing interests of minority shareholders and the companys
rights to manage itself without court interference.
There are several methods by which the law protects the members
(Directors) of a company. However, problem arises where the company or the
members are wronged by the acts or omissions of the directors or majority
shareholders. In such case, the persons who cause the harm are also the persons
who have standing to obtain redress. Without the laws aid, members especially
minority shareholders, who sustain loss due to the actions of the directors or
majority shareholders would be left without a remedy.
Therefore, the concept of protection of minority shareholder concerns how
the rights and claims considered in relation to one another and placing the rights
and claim in context. The rule that the company is the proper claimant in
proceeding in which a wrong is alleged to have done to a company and limits of that
rule. Circumstances in which shareholders may commence and will be permitted to
continue a Derivate Claim.
Personal Rights: of a shareholder to sue in his own name for legal
wrongs done to him in a personal capacity, to make good losses he is suffered,
including, potentiality reflective losses. The law uses a number of legal
mechanisms/instrument to protect companies from poor management and selfinterested action by those in control, including of general and specific directors
duties. If the inadequate behaviour of director causes losses to the company, the
company can sue to recover losses cause by breaches of the duty.
The company and the company alone have the right to sue for breach
of directors duties because directors duties are owed to the company. Difficulties
arise where wrongdoers are directors they potential exist for wrongs to be
overlooked and no remedies pursued by the company because it is the wrongdoer
who are managing the company. (When the directors are in control of the company,
the company lack to bring a claim because the directors are the member of the
company).
The difficulty may be overcome by the shareholders becoming the decisionmaking organ of the company for the purposes of ensuring legal action is brought
against the directors. The problem is more difficult to overcome, however, when
wrongdoer directors also own a majority of a companys share.
Shareholder decisions are largely based on majority rule. Without more, then
the potential would exist for the holders of a majority of the shares in a company to
have no procedure by which to assert the rights of eh company when directors who
were also majority shareholders acted in breach of duty to the detriment of the
company. The derivative claim procedure has been developed to assist minority
shareholders who find themselves in such a position to protect the company.

Rather than being concerned to protect the company, a minority


shareholder in such a position is usually more concerned to protect himself
personally from the adverse consequences of being a shareholder in a company
with a majority shareholder managing the company in his own best interests rather
than for the benefit of all shareholders.
The main procedure available to a shareholder to protect himself personal is
to petition the court for a remedy pursuant to the CA2006, s994 based on the
companys affairs having been conducted in a manner that is unfairly prejudicial to
the interest of the minority shareholder.
If the company suffers loss caused by a breach of duty owned to the
company its shareholders also usually suffer loss because the value of their shares
is not as great as it would be otherwise. The shareholders loss of share value merely
Reflects the loss suffered by the company, and for this reason, is called Reflective
Loss. Shareholders are unable to sue wrongdoers who beach duties owed to the
company, because those duties are not also owed to the shareholders.
Even where a wrongdoer owes a separate and additional duty to the
shareholder, the shareholder may be unable to sue for breach of that duty and
recover losses they have suffered. This is because insofar as the shareholders
losses are reflective losses, to allow recovery could result in the wrongdoer being
ordered to compensate more than one person for the same loss: the company (for
the loss to the company) and individual shareholders (for the reduction in share
value they suffer which is a reflection of the loss to the company). As a matter of
public policy, the law has set its fact against allowing shareholders to recover
reflective losses except in one very limited circumstance.
Three Principle Remedies:
(1)The Derivative Claim under Statutory
(2) The Unfair Prejudice Remedy (UPC)
(3) The Petition for Winding up the Company
Relationship between Shareholders and the Company. CA 2006 s33
Effect of company's constitution
(1)The provisions of a company's constitution bind the company and its members to
the same extent as if there were covenants on the part of the company and of each
member to observe those provisions.
(2)Money payable by a member to the company under its constitution is a debt due
from him to the company.
In England and Wales and Northern Ireland it is of the nature of an ordinary contract
debt.
The Proper Claimant Principle
The company is a separate legal entity from its shareholders and consequently has
legal rights and liabilities. If its rights are infringed/trespassed, by a person failing to
perform a contract they have entered into with the company, for example: the
company may sue to enforce its rights under the contract. The decision to litigate
rest with the board of directors as part of the general powers of management of the
company. From this perspective, it makes perfect sense to have a basic rule, known
as the rule in Foss v Harbottle, that in any legal proceedings in which a wrong is
alleged to have been done to a company, the proper claimant is the company.
Foss v Harbottle 1843

The C, Foss and Turton, were shareholders in a company formed to buy land for use
as a pleasure park. The defendants were directors and shareholders of the company.
The C shareholders alleged that the D had defrauded the company in number of
ways including some of the Ds selling land belonging to them to the company at an
exorbitant price. The C sought an order that the Ds make good the losses to the
company.
Held, dismissing the action: in any action in which a wrong is alleged to have been
done to a company, the proper C is the company and as the company was still in
existence, it was possible to call a general meeting and therefore there was nothing
to prevent the company from dealing with the matter.
The Rule in Foss v Harbottle:
The rule in Foss v Harbottle is a cardinal/fundamental principle of company law. In
the case of Foss v Harbottle, the court established three principles such as:
(1)The Proper Claimant Principle: This provides that only the company, and not
the members, can commence proceedings for wrongs committed against it.
This principle is a corollary/result of a companys corporate personality.
(2)The Internal Management Principle: this provides that where a company is
acting within its powers, the courts will not interfere in matters of internal
management, unless the company itself commences proceedings. This
principle is a corollary of the courts long-established reluctance to become
involved in the internal affairs of business.
(3)The Irregularity Principle: this provides that where some procedural
irregularity is committed, an aggrieved member cannot commence
proceedings where the irregularity is one that can be ratified by a simple
majority of the members. This principle is a corollary of principle of majority
rule.
The irregularity principle applies both to rights vested in the company and to rights
vested personal in the members. Accordingly, even where the right to commence
proceedings is vested personally in member, the member will be unable to
commence proceedings if the members can ratify the irregularity by passing an
ordinary resolution.
Limits to the Proper Claimant Principle: the courts were compelled to recognise
limits to the rule in Foss v Harbottle. The rule was not applied, for example: if a
minority shareholder complained to the court about action by the company for
which more than a simple majority was needed, as in Edwards v Halliwell 1950
which is a trade union case, but the principle is applicable to companies.
Edwards v Halliwell 1950
The constitution of a trade union provided that contributions were not to be altered
until a ballot vote of members had been taken and a two-thirds majority in favour
obtained. Contributions were increased following a resolution supported by a simple
majority. Two members sued seeking a declaration that the resolution was invalid.
Held, where a matter cannot be sanctioned by a simple majority of the members of
the company but only by some special majority, an individual member is not
prevented from suing by the rule in FvH.
The principle area where the rule presented difficulties was where those who
control the company, and in particular, the decision to sue or not sue a person who
has legally wronged the company, are themselves the wrongdoers. The most

important limit to the rule which is the only true exception to the rule,, came to be
referred to as fraud on the minority/ where directors who were also majority
shareholders had perpetrated a fraud on the company, a minority shareholder was
permitted to commence an action based on a wrong done to the company to secure
a remedy for the company. The action was called a Derivative action.
Proper Claimant Principle
(a)Directors as Wrongdoers: it is helpful to illustrate how the proper claimant
principle and the exception to it, works by analysing a hypothetical scenario.
Consider a company with two directors. They find out informally that planning
permission will be granted for a piece of land from the company at a price
representing permission. In these circumstances, the directors cannot act as a
decision making organ of the company and decide to sell the land to themselves
because they are conflicted out.
Articles normally provide that they cannot vote on the decision of the
company to sell the land to them, and even if the articles did not say this, and the
directors cause the company to sell the land to them, they are in breach of ss172,
175 and 190, such as:
they have not acted to promote the success of the company s172,
they have used information obtained as director to personal advantage s175
and
they have failed to obtain the approval of the shareholders s190
Consequently, the transaction will be voidable by the company, the directors will be
liable to account for any profits they have made and must indemnify the company
against any losses caused by the breach of duty. Although the directors, as the
board, ordinarily have the power to decide whether or not to commence any legal
action, in these circumstances control of the decision to litigate transfers to the
shareholders and the shareholders, as a decision making organ of eh company,
decide whether or not the company will sue the directors. The legal proceedings are
still brought by the company, in the name of eh company, seeking a remedy for the
company.
(b)Majority shareholders as wrongdoers: staying with h hypothetical situation,
the company has three shareholders each owning one third of the shares. Two of the
shareholders are the directors. Because the wrongdoers are directors, who are not
going to decide to sue themselves, the decision to litigate or not has reverted to the
shareholders.
Shareholders take most decisions by ordinary resolution, which
encompasses majority rule. In our hypothetical, the wrongdoers own a majority of
the shares and as majority shareholders, they are able to pass or defeat ordinary
resolutions.
Are they, therefore, permitted to:
Question 1: pass an ordinary resolution approving the sale of the land
pursuant to s190?
Question2: pass an ordinary resolution ratifying the breach pursuant to
s239?
The answer is no, on a resolution to ratify his breach of directors duty, the
votes of both the director/shareholder and nay person connected with him

are disregarded s239(4). Curiously, there is no similar provision in s190


requiring the votes of the director to be discounted on a resolution to approve
a substantial asset transaction which leaves the matter moot and the answer
to question 1 dependent upon the approach the court takes to statutory
interpretation. A literal approach would suggest that all shareholders can
vote, as the section does not state otherwise, whereas s239 does state
otherwise.
Question 3: defeat a proposed resolution to sue the directors to recover
the land?
A resolution to sue the directors, if defeated, could be characterised as an
indirect decision of the company to ratify a breach of duty, thereby bringing
it within s239 which requires the directors votes to be disregarded. It is
surprising that the answer to these questions is not clear-cut.
Question 4: have any legal action commenced by the minority shareholder
stopped because he is not the proper claimant?
Provided the minority shareholder brings the legal action as a claim under
s260, a statutory derivative claim, the action will not be stooped based on him not
being the proper claimant. He will, however, need to secure the permission of the
court to continue the claim.
The Majority Rule
The principle of the majority rule is a general and sensible rule, which is a fact of
business life. A company is bound by the decisions of the majority that applies to
decisions in pursuing business activities. Therefore, the practice of proper majority
rule sometimes specifically leads to a special maladministration purpose i.e. not to
pursue corporate wrongdoers specially directors. The fact that the members of a
company controlling more than half of votes at a meeting do not owe any duty
infers that they have quite substantial power and can vote for their own
advantage. [1] Even the well-recognized restrictions based on bona fide and proper
purpose principles goes unrestrained allowing majority rule to operate lawfully. For
instance, even the fiduciary duties of directors does not prohibit them acting in their
own selfish interest. [2]
Statutory protection like need for a special resolution instead of simple majority
vote, courts sanction in some of the matter like reduction of capital, attempts in
striking a balance in the conflicting interests of minorities and controllers. On the
other hand, to prevent the abuse of power members can also bring petition for
compulsory winding up and unfairly prejudicial conduct in order to exercise other
statutory provisions that are provided
Grounds for the Rule of FvH
Howard Smith Ltd v Ampol Petroleum Ltd 1974
s a leading UK company law case, concerning the duty of directors to act only for
"proper purposes". This duty has been codified into the Companies Act 2006section
171, and arises particularly in cases involving takeover bids.
RW Millers was embroiled in a hostile takeover bid, by a large petrol company
called Ampol. Ampol already controlled (with an associated company) 55% of the
shares. The directors did not want Ampol to buy the shares of RW Millers as Howard
Smith had bettered terms for take over by offering employment to the directors
even in the future. So the directors of RW Millers issued $10m of new shares. They
said it was to finance the completion of two tankers. The shares were given to

Howard Smith Ltd who were going to take over RW Millers, and that blocked Ampols
rival bid. Without the issue, Howard Smith Ltd had no hope of succeeding in taking
over the company. But with the new issue, Ampol could not complete its acquisition.
Street J said that the argument of the directors that the tanker purchase was the
dominant purpose was unreal and unconvincing.
Lord Wilberforce held that the issue was intra vires but that it was exercised for an
improper purpose. To define in advance [what that means is] impossible. It must
be adjudged in the light of modern conditions, and referred back to Hogg v
Cramphorn Ltd. His judgment continued.
In MacDougall v Gardiner, [1875] Mellish LJ, pointed out a situation in which an
action for minoritys right could be initiated before the court that is to say if they are
deprived by the majoritys abuse of power (e.g. Fraud), whereas situations where
majority are entitled to do something, only the company have a right to set it aside.
Hence, the court following the principle laid down in Foss v Harbottle and Mozley v
Alston stated that in compelling the directors for a general meeting the court lacked
jurisdiction.
Therefore, without being affected by the irregularity principle in Foss v Harbottle,
the difficulty remains with the issue of deciding whether a personal right exists for a
member. As Macdougall v Gardiner and Pender v Lushington, shows instances
of being inconsistent with each other.
CA2005 on the Rule:
The Company Act (CA) 2006 introduced some changes to the rules on the minority
members remedies and actions in pursuing company claims after the Law
Commission and the Company Law Review suggested and recommended a new
statutory derivative procedure with modern, accessible and flexible criteria while
studying the issues. [9] Consequently, reforms were brought for a statutory
derivative action in replacing the common law exceptions to the rule in Foss v
Harbottle by few statutory conditions without affecting the underlining principle of
the rule. However, many of the prerequisites that were imposed by common law still
have a link with the conditions imposed by the reforms introduced by CA 2006.
Directors Duty under section 172
Directors duty under s. 172 precisely defines his legal obligation to promote the
success of the company for the benefit of its members. [10] Hence, interpreting the
companys objectives in making decisions and to act in good faith to promote
success that is calculated for long-term benefit remains with the directors. [11]
Section 172 in relation with Section 170 expresses that duties imposed also
regards (without owing a direct duty) the interest of employees, suppliers,
customers, community i.e. persons other than the company. Section 172 assumes
the enlightened shareholder value principle of the Law Commissions and Company
Law Review (CLR). [12] Directors acting in accordance with Section 172 must have
regard to the consequence of his decisions in the long term, the need to promote
companys business relationships, companys reputation for business conduct,
impact on the community and environment. [13] Therefore, director is likely to be in
breach of these duties if it is found that the basis of his actions could not reasonably
promote the success of the company. [14] In Fassihi, the issue that the breach of
directors duty is extended to his duty to disclose the breach to the company under

the equitable duty to act bona fide in the interest of company was also put forward
for consideration.
Types of Action:
a) Personal Action
Edwards v Halliwell 1950
Quin and Axtens Ltd v Salmon 1909
Quin & Axtens Ltd was set up as a business of drapers, furnishing and general
warehousemen at 422 to 440Brixton Road, Brixton. Williams Axtens was the
chairman. Joseph Salmon and another man, Arthur Way, were managing directors.
Mr Boys-Tombs replaced Way in 1906. Axtens and Salmon held the majority of
shares. The constitution said no resolution would be effective if either Axtens or
Salmons dissented (art 80). The directors were otherwise to manage the company
(art 75). Axtens and Boys-Tombs wanted to buy and let some properties (buy 426
Brixton Road and let out 252 Stockwell Road), but Salmon disagreed. Then an
extraordinary general meeting was held, where the same resolution was passed by
a majority of shareholders
HideJudgment
Warrington J held that the motions were not inconsistent with the articles, and
distinguished Automatic Self-Cleansing Filter Syndicate Co, Ltd v Cuninghame.[1]
Cozens-Hardy LJ and Farwell LJ,[2] said that the resolutions were inconsistent with
the articles, which clearly said that a directors .
b) Representative Action: CPR 19.6
c) Derivative Actions
Derivative Action: the rule in F v H, however is not absolute. If it were, wrongs
committed by the directors would rarely be subject to litigation. Accordingly, the
courts crafted four so called exceptions, to the rule, whereby members could
commence an action on the companys behalf. Such actions were known as
derivative actions because the member was bringing an action based on rights
derived from the company. This derivation is reinforced by the fact that, if the action
succeeded, the remedy was granted to the company. With the creation of the
statutory derivative claim, the derivative action was abolished, but knowledge of
the common law exceptions will be of aid should an essay question require the
common law derivative action to the statutory derivative claim.
Derivative Claim:
Section 260(1) of the CA 2006 explains the meaning of the term derivative claim
as an action brought by a member of a company in a court deriving the right of
action from the company in seeking relief or to enforce a right of the company.
Derivative claims acts as an exception to the proper claimant principle i.e. when a
wrong is done to a company only the company may sue for a remedy. In addition
when it is not possible to bring the claim in the companies own name the name of
the member of a company is taken in a derivative claim for a remedy that will
accrue to the company. To begin with a derivative claim only a cause of action that
emerge from directors [15] actual or proposed act or omission involving negligence,
default, breach of duty or trust are recognized. [16] As a proceeding in derivative
claim recognizes breach of directors duty it is inferred remedies that are available
in such a claim would be the same as those, which might be claimed in proceedings
brought by the company.

If A sustains loss due to the actions of B, then generally only A can sue B to obtain
redress. A third party C could not sue B on As behalf. As companies have separate
personality, this principle applies equally in the corporate context. If a company
sustains loss due to the actions of another, then generally only the company can
sue to obtain redress. However, where the company sustains loss due to the actions
of tis directors, problem arises in that the powers of the company are usually
delegated to the directors, and this would include the authority to determine
whether or not the company will commence litigation. Clearly, in such a case, the
directors will not cause the company to initiate litigation against themselves. The
question that therefore arises is can the members commence litigation on the
companys behalf. Due to three principle known collectively as the rule in F v H the
answer is generally no. (The Proper Claimant, The Internal management, The
irregularity principle).
Exceptions to the Rule in Foss v Harbottle (4 exceptions)
Derivative Actions in common law: still relevant in order to help the courts how
to apply sections 260 to 264
The Foss v Harbottle rule reflects the principle that where damage is done to the
company itself, it is the company that should bring any claim. There are exceptions
to the rule and in order for a minority shareholder to bring a derivative action on
behalf of the company; it must show (1) that the company is entitled to the relief
claimed, and (2) that the action falls within the proper boundaries of an exception to
the rule in F v H.
There are four exceptions to the F v H rule, such as
1. an act which is illegal or ultra vires to the company
2. an irregularity in the passing of a resolution which requires a qualified
majority/ when special majorities are unobserved
3. an act purporting to abridge or abolish the individual rights of a
member/shareholders personal rights have been violated
4. an act which constitutes a fraud against the minority and the wrongdoers are
themselves in control of the company/ fraud is committed against the
company and the wrongdoers are in control
1) When the act complained of was illegal or ultra vires, a member
could commence a derivative action.
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982]
is that a shareholder cannot sue to recover damages for themselves in
relation to wrongs done to the company. The proper course is to bring a
derivative action on behalf of the company. Any recovery will flow through to
the shareholders in the form of an increase in the value of their shares. The
primary justification for the rule is said to be to avoid double recovery.
Smith v Croft (No 2) 1988
This is a UK company law case concerning derivative claims. Its principle that
in allowing a derivative claim to continue the court will have regard to the
majority of the minority's views has been codified in Companies Act 2006,
section 263(4
Minority shareholders claimed to recover money paid away contrary to

the financial assistance prohibition (now found at section 678 of the


Companies Act 2006) and being ultra vires. They had 14% of the company's
shares, the defendants held 63%, and other shareholder, who did not want
litigation, held 21%.
Knox J held that if the claimants were a minority even after the wrongdoers
were taking out of the equation, then there is no right to sue, even with
a Foss v Harbottle exception. Independence is a question of fact. He
followed Burland v Earle in Lord Daveys dicta that shareholders cannot have
a bigger right to sue than the company with its procedural and substantive
limitations.
Simpson v Westminster Palace Hotel Co 1870, may set aside an unlawful act
by bringing a derivative action.
2) When
special
majorities
are
unobserved:
where
the
act
infringed/trespassed the personal rights of a member, a derivative action
could be brought. Rights breached could include a failure to provide sufficient
notice of general meetings, a failure to pay dividends in accordance with the
articles, or the improper rejection of a members votes.
Edwards v Halliwell 1950
Quin and Axtens Ltd v Salmon 1909
3) Shareholders personal rights have been violated: where the act
complained of could only be done or sanctioned by the passing of a special
resolution, a derivative action could be brought.
Edwards v Halliwell 1950
MacDougall v Gardiner 1875
Lord Cottenham LC in Mozley v Alston, abstaining himself from expressing an
opinion deduced that even the courts are reluctant to interfere in internal affairs
of corporations. Hence, the proper claimant remains the company in an action for
a wrong and not the shareholders individually (proper claimant principle).
Moreover, the rule also states that minorities are not allowed to bring legal
actions about a wrong done in the company except if the action falls within the
exceptions to the rule. To prevent multiple actions the rule also acknowledges
existence of a company as a separate legal personality.
Choudhury and others v Bhatter and others 2009
The claimants (C and R) sought declaratory and injunctive relief in respect of
resolutions made at general meetings of the company, which was the third
defendant in the proceedings. C and R were the company's directors. The
only other director was the first defendant (B). The company had its
registered office in England but was situated in India. Up to December 2008,
the company's rules stipulated that the convening of a general meeting and
the passing of a resolution at such a meeting required the approval of two
directors. In a series of company meetings held in that month, C and R were
removed as directors and replaced with five others. The company's rules were
also altered to require that all further resolutions and decisions be approved
by five members of the board. In addition, certain company shareholdings
were forfeited and its secretary was replaced. B had conducted the meetings
at which each of those resolutions were passed. C and R, who were not
present at any of them, sought declarations that the resolutions were void on

the grounds that they had approved neither the convening of the meetings
nor the resolutions purportedly passed at them. Instead, they maintained that
B had forged their signatures on the convening notices and the resolutions in
order to move majority ownership and control of the board to the second
defendant. B's position was that C and R were well aware of what had
happened and had participated in the events up to and including their
resignation from the Board. B argued that (1) the proceedings were
misconceived because many of C and R's complaints were no more than
defects in internal management, which could be rectified at a general
meeting; (2) the court lacked jurisdiction on the ground that India was the
forum conveniens.
Held (1) As the composition of the body of shareholders was a central issue in
the case, a general meeting would resolve nothing, MacDougall v
Gardiner (1875-76) LR 1 Ch D 13 CA distinguished. Even if there were
not dispute as to shareholdings, the court would have jurisdiction to
make an appropriate order regulating the conduct of the company's
affairs until such time as a general meeting could be convened.
Moreover, a director could sustain an action in his own name against
the other directors if he was wrongfully excluded from acting as a
director, including a claim for an injunction to restrain that exclusion,
Pulbrook v Richmond Consolidated Mining Co (1878) LR 9 Ch D 610 Ch
D applied. (2) B had overlooked the impact of Regulation 44/2001
art.22, which provided a basis of jurisdiction regardless of domicile in
proceedings concerning the constitution or internal management of the
company, Speed Investments Ltd v Formula One Holdings Ltd (No2)
(2004) EWCA Civ 1512, (2005) 1 WLR 1936, considered. Where
jurisdiction existed under the Regulation, the court on which it was
conferred was obliged to hear and determine the claim even where the
potential alternative court was not that of a Member State, Owusu v
Jackson (t/a Villa Holidays Bal Inn Villas) (C-281/02) (2005) QB 801 ECJ
applied, Harrods (Buenos Aires) Ltd (No2), Re (1992) Ch 72 CA (Civ Div)
superseded. (3) The substantial disputes of fact in the instant case
could not be determined on an interlocutory application or without a
trial. In the interim, it was necessary to make orders which preserved
the status quo. More specifically, it was necessary to restrain the
parties from doing anything detrimental to the interests of any other
party. Accordingly, B was ordered to act in relation to the management
of the company's business only as directed or authorised by C and R,
or as ordered by the courts of India. In addition, B was restrained from
taking any step to convene a general meeting or to procure a decision
of directors to alter the composition of the board or the shareholding in
the company. C and R were to give an undertaking to the same effect.
4) Fraud is committed against the company and the wrongdoers are in
control: this exception is more complex and much important, and occurred
where those persons who controlled the company had committed some sort
of fraud on the minority. The fraud included actual fraud (breach of the Theft
Act 1968 or the Fraud Act 2006) and equitable fraud (Conduct tainted by
impropriety). Negligence, even gross negligence, would not suffice (Pavlides
v Jensen 1956), but where the negligence benefited those who control the

company, this would suffice/be enough as the negligence would be tainted by


impropriety (Daniels v Daniels 1978). The courts would not allow a claim
based on fraud on the minority to succeed if it would not serve the interests
of justice (where the independent members had indicated that they did not
wish the claim to proceed (Smith v Croft (no 2) 1888)
Fraud on the minority
Cook v Deeks 1916
Deeks and Hinds were the directors of a construction company. They negotiated a
lucrative construction contract with the Canadian Pacific Railway. During the
negotiations, they decided to enter into the contract personally, on their own
behalves, and incorporated a new company, the Dominion Construction Company to
carry out the work. The contract appeared to be taken over by this company, by
whom the work was carried out and the profits made. A shareholder in the Toronto
Construction Company brought a derivative action against the directors and the
Dominion Construction Company. Because this was a derivative action, the Toronto
Construction Company was also joined as a defendant. Held: Deeks and Hinds were
guilty of a breach of duty in the course they took to secure the contract, and were to
be regarded as holding it for the benefit of the Toronto Construction Company:
while entrusted with the conduct of the affairs of the company they deliberately
designed to exclude, and used their influence and position to exclude, the company
whose interest it was their first duty to protect. This led to the legal conclusion
that: men who assume the complete control of a companys business must
remember that they are not at liberty to sacrifice the interests which they are bound
to protect, and, while ostensibly acting for the company, divert in their own favour
business which should properly belong to the company they represent.
An example of a case involving negligence in a situation where the result is a
personal advantage to the wrongdoer is Daniels v Daniels (1978), where three
minority shareholders claimed that mr. & mrs.Daniels (two directors and majority
shareholders) had acted negligently in making the company sell land to Mrs.Daniels
at a very low price although it was worth a lot more money, it was held that the
plaintiffs had the right to sue in such circumstances. In contrast, where a minority
shareholder claimed that the directors had acted negligently in selling an asbestos
mine to another company at a fraction of its true value in Pavlides v Jensen
(1956), it was held that as no fraud or personal advantage was evident from the
facts of the case it appeared that the minority shareholder had no right to sue in
such circumstances.
The wrongdoers control the company:
In Smith v Croft no. 2(1988), where the minority shareholders claimed for the
recovery of sums given away in transactions which were both in breach of the
statutory prohibition on financial assistance and ultra vires, it was held that as it
appeared to be a prima facie case of ultra vires and illegality, thus the plaintiffs had
the right to bring a derivative action, provided that majority shareholders had no
objection to the continuation of the action.
What the law needs to do is strike a balance. It can neither give more support to the
majority (as the minority will then be prejudiced) and nor to the minority (who
would then object on every action, resulting in the floodgates argument). However,
it seems quite evident from these four exceptions and the various case law flowing
as a result of them that under common law minority shareholders have been given

protection to quite an extent and the law seems to have provided some remedies to
meet those cases in which majority power has been abused.
The Three actions:
1) The Statutory Derivative Action:
Status?
A derivative claim can be brought under the
CA2005
Source of law?
CA 2006 Pt 11
Grounds for claim?
Negligence
Default
Breach of duty
Breach of trust
Omission committed by?
Directors (only)
Claims can be brought by?
A member or a person who is not a member, but to
whom shares have been transferred o transmitted
by operation of law.
Claim can be brought against? A director of the company or another person (or
both)
Claim for negligence?
Claim can be brought, irrespective of whether or
not a director benefited personally.
The statutory derivative claim is the only proceeding by which a minority
shareholder, notwithstanding h slack of control over company decision-making, can
commence legal action in respect of a cause of action vested in the company,
seeking relief on behalf of the company, to remedy a wrong done to the company
(s260 CA 2006). The 2006 act has expanded the grounds on which a derivative
claim may be brought but requires court permission for the continuation of claims.
The consequences of introduction the new statutory procedure were not easy to
predict.
Grounds for the claim: a statutory derivative 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. The cause of action may be against the director or another person or both
(s260(3)).
The exposure of Third Parties to a s260 claim will depend upon dishonest
assistance and knowing receipt as the courts have developed these concepts in the
context of breaches of duty by directors (these concepts are usually addressed in
trusts courses when examining the liability of strangers to the trust in the event of a
breach of duty by one or more trustees).
Claims cannot be brought under s260 against third parties based on causes
of action arising independently from the directors legal shortcomings.
Procedure of the Claim:
The parties: the claimant in a s260 derivative claim is the shareholders, because
the shareholder is bringing the action to secure relief for the company, the company
must be made a defendant to the claim along with the directors and any third
parties against whom relief is sought.

Application for permission to continue DC s 261: an application to continue a


DC by a majority shareholder was rejected in Cinematic Finance Ltd v Ryder
2010, the court accepted that a DA could be brought by a majority shareholder but
stated that permission to continue would be given to a majority shareholder ONLY in
very exceptional circumstances and it was difficult to envisage what such
circumstances might be. In Stimpson v Southern Private Landlords
Association 2010, the question of the importance of wrongdoer control of the
members arose, although the comments in the case on this issue were obiter.
Once the claim form has been drafted and either before or after it has been
issued, an application must be made to eh court for permission to continue the
claim (s261(1)). The shareholder is precluded from taking any further step in the
proceeding until the court has given permission for the claim to continue. There is a
two-stage process by which the court decides whether or not to permit the claim to
continue.
Stage one: a Prima facie case: (prima facie-at the first instance/face) the
court must be satisfied that the particulars of the claim and the evidence submitted
to support it disclose a prima facie case for giving permission to continue. If not
prima facie case is disclosed, the court must dismiss the application and make any
consequential order it considers appropriate (s261(2)). If the court does not dismiss
the application, the application goes to stage 2, where the claimant will submit
written evidence with his application for permission to continue, supporting his
statement of claim, and there is no requirement to involve the defendant.
The burden of proof imposed on a claimant and the range of issues
necessarily considered at this stage define the process within which the courts
balance protection of the company from the cost and distraction of bogus actions on
the one hand, and minority shareholders from unacceptable excesses of majority
shareholder rule on the other hand. If a heavy burden is imposed, many claimants
will have to be denied permission to continue.
Iesini Westrip Holdings Ltd 2010 and Franbar Holdings Ltd v Patel 2008,
these two cases imply that the claimant must present evidence rather than simply
asserting the relevant breach of duty in the statement of claim. Stimpson
(Burden of proof and to what extent it is satisfied.)
Iesini Westrip Holdings Ltd 2010 claimants asserted that defendants in breach
of their duty deprived the company of its assets. Court considered the derivative
procedure laid down under Section 260, 263 in conveying that the case was one for
the application of Section 263(3)(b), as it was inferred that some directors would not
seek to continue the claim. Moreover, it was found that the board took advise on
technical matters from eminent counsels before acting. Hence, the permission to
continue the claim was refused.
Franbar Holdings Ltd v Patel 2008 certain extent to which director acting in a
manner conforming to Section 172 were interpreted. At the same time, some
judicial guidance were given by the court on matters such as - likelihood of success
of the claim, companys ability to recover from an award of damage, disruption
caused by proceedings on development of companys business, costs of
proceedings, damage to companys reputation - while assessing the importance of a
derivative claim.

Stage2: it involves a hearing of the application for permission to continue the claim
and the defendant and, if it wishes, the company take part. At this stage, the court
MUST refuse permission to continue if:
A person acting in accordance with the s172 duty to promote the success of
the company would NOT seek to continue the clam (s263(2)(a)) Iesini v
Westrip Holdings Ltd 2010
The act or omission has been authorised (a ahead of time) or ratified (after
the event) by the company (s263(2)(b) and (c) or 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.
If the con