Case study: Foss vs Harbottle

“The famous English case Foss v. Harbottle established the principles of “proper plaintiff rule” and “majority rule” in company law.”

Citation: [1843] 67 ER 189, (1843) 2 Hare 461

Court: Court of Chancery

Bench: Wigram VC, Jenkins LJ

Petitioner: Richard Foss and Edward Starkie Turton

Respondent: Thomas Harbottle & Others

Facts

• The Victoria Park Company was founded in September 1835 to purchase 180 acres of land close to Manchester; the property would eventually be incorporated by an Act of Parliament and named Victoria Park, Manchester. Nevertheless, some people, including the directors and others got engaged in illegal misappropriation of the company’s property rather than accomplishing the goals of developing the land for ornamental and park-like purposes, building houses with gardens and fields, and then selling or renting them.
• In response to this mismanagement, two minority stakeholders acted as whistleblower and reported the issue of this illegal activities and demanded punishment to wrongdoers and all the same should be held accountable for their actions and appointed a responsible receiver. 

Judgment

• Wigram VC, ruled in favor of the defendants and rejected the petitioner claim and declared that only the firm has legal standing to file a lawsuit when its directors wrong a company. Further the court ruled that any specific shareholders or foreign element of the company is not capable of initiating legal action against illegal activities committed with the corporation, as the company and its shareholders are acting as separate legal entities. 
• This principle in Foss v Harbottle is further bolstered by Section 21(1)(a) of the Companies Act, which stipulates that a company may sue and can be sued in its name, and a member cannot take legal action on behalf of the company. If the company has a right against a party under a contract, it is the company’s responsibility to sue.
• To prove abovementioned point, the court gave reasoning 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, not mere shareholders. 
• Court in this case also laid down two important principles:

1. “Proper Plaintiff Rule”

• First 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 (shareholder), 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 a company as a separate legal entity from all the members of the company, so it can sue and be sued in its own name.
• This is the main reason why only a company can bring legal action or institute legal proceedings, not any member, in order to cover the losses that have been suffered by the company. 
• A member of the company can take a legal action on its behalf against the wrongdoer only if he is authorized to do so by the board of directors or by an ordinary resolution passed in the general meeting. 

2. “Majority Principle Rule” 

• 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.”
• The principles in question, while established to provide a substantive right to minority shareholders, ended up being unjust. These principles, in practice, prevented minority shareholders from seeking and obtaining justice. This was because the majority shareholders, who had control over the company, could impose their will, leaving the minority shareholders powerless due to their smaller voting power or influence. As a result, minority shareholders had to endure the decisions and potential misconduct of the majority, without any effective means to challenge or rectify the situation.
• Therefore, in order to adjust this unjustness, four exceptions to the general principle have been laid down in this case. 

1. The first exception is where the alleged act is ultra vires and illegal. 
2. The second exception to the general rule allows for significant protection of minority shareholders. Specifically, when the majority shareholders engage in oppressive behavior or commit fraud against the minority, even a single minority shareholder has the right to take legal action. 

This exception is crucial because it empowers individual shareholders to defend their rights and seek justice, even if they are the only ones standing against the majority’s wrongdoing.

3. The third exception is that members can enforce their rights against the company, such as the right to vote or stand in elections, which ensure the rights of individual members.
4. Third exception is that shareholders can bring an action on behalf of the company for wrongs done, acting as representatives of other members whose relief is sought. 

This action is called a derivative action, and the company must be joined as a co-defendant so that the company is bound by the judgment given.

Key legal issue discussed

• Whether the shareholders or members of the Victoria Park Company (any company) legally file a lawsuit to address the alleged misappropriation of the company’s property and funds?

No

The court determined that individual shareholders are not permitted to file legal actions against illegal activities conducted within the corporation. This decision is based on the principle that a company and its shareholders are separate legal entities. Consequently, it is the company, not its shareholders, that is considered the injured party when harm is done. Therefore, only the company itself has the standing to sue or take legal action against those who have misappropriated its property. This ruling underscores the legal separation between the company and its individual shareholders, reinforcing that any legal recourse for injuries sustained by the company must be pursued by the company, not by individual shareholders.