Case Summary: Foss vs. Harbottle, 1843

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This post has been written by Shivangi Khattar pursuing 2nd Year BBA LLB from JIMS School of Law, IP University  

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

FOSS v 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.

FACTS OF THE CASE:

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.

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.

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.

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