[FAQs] on Shareholders Democracy

In Pavlides v. Jensen (1956) Ch. 565, a minority shareholder brought an action for damages against the directors and the company on the ground that they have been negligent in selling a mine owned by the company for £ 82,000, whereas its real value was about £ 10,00,000. It was observed that if the directors were negligent in selling the mine then it was open to the majority of the company to vote against such sale. However the majority did not oppose this transaction of sale. And it was held that the action was not maintainable against the directors.

The management of the company is based on majority rule as pointed out in Foss v. Harbottle. The matters relating affairs of the company are decided upon by an ordinary or special resolution of shareholders.

In the present case A being a minority shareholder, cannot bring action against the company or directors on the above mentioned ground. The action taken by minority shareholders will not be maintainable in the court.

Democracy in general means government by the people especially the rule of majority. It’s the rule of people, by people and for people. In that context shareholders democracy means the rule of shareholders, by the shareholders’, and for the shareholders’. Precisely it is rights to speak, vote, congregates, and communicates with co-shareholders and to learn about how the affairs of the company are being carried on.

As per the Companies Act, 2013 the powers to govern the company have been divided between the Board of Directors and the shareholders. The shareholders have the authority to appoint directors at the Annual General Meetings so that affairs of the company can be managed by the Board of Directors.

The Directors exercise their powers through meetings of Board of directors and shareholders exercise their powers through Annual General Meetings/General Meetings.
Even if shareholders are capable of transacting all business in General Meetings, most of the powers are delegated to the Board of Directors through Memorandum and Articles of Association of the Company. However certain businesses cannot be delegated to the Board of Directors. The Companies Act, 2013 demarcates between the power of the directors as well as that of shareholders. Some of the businesses which can be transacted only at the meeting of shareholders by passing ordinary/special resolution are as under:

1. Alteration of Memorandum of Association and Articles of Association.
2. Further issue of share capital.
3. To reduce the share capital of the company.
4. To shift the registered office of the company outside the state in which the registered office is situated at present.
5. To appoint auditors.
6. To approach Central Government for investigation into the affairs of the company.
7. To appoint directors.
8. To remove directors.
9. To increase or reduce the number of directors within the limits laid down in.
10. Articles of Association.
11. To cancel, redeem debentures etc.

The general principle of company law is that every member holds equal rights with other members of the company in the same class. For smooth functioning and governance of the company the rights of the members of the same class must be held evenly.

In case of difference(s) of opinions amongst the members the issue is decided by a vote of the majority. Thus a company is governed by the majority shareholders. Due to this the minorities of shareholders are often oppressed.

The company law provides for adequate protection for the minority shareholders when their rights are trampled by the majority such Class Action Suit under section 245 or an application under section 241 for oppression and mismanagement. However such protection is available only in special circumstances. Such protection of the minority is not generally available when the majority does anything in the exercise of the powers for internal administration of a company. The court will not usually intervene in matters of internal administration so long as the majority shareholders and directors are acting within the powers conferred on them under the articles of the company. In other words, the articles are the protective shield for the majority of shareholders who compose the board of directors for carrying out their object at the cost of minority of shareholders.

This basic principle of non-interference with the internal management of company by the court is laid down in a landmark case of Foss v. Harbottle 67 E.R. 189; (1843). Thus no minority shareholder can bring action against directors of the company if they are acting within the powers given to them by the Articles of Association. Only company can bring action against them. Thus articles are the protective shield of majority shareholders.

The majority rule endorsed in FOSS v. HARBOTTLE extends to cases in which companies are competent to ratify managerial misdeeds. There are certain acts and incidents which no majority can ratify. The following are exceptions to the Foss v. Harbottle:

• Ultra Vires Acts: Where the directors representing the majority of shareholders perform an illegal or ultra vires act for the company, an individual shareholder has right to bring an action.
• Fraud on Minority: Where an act done by the majority amounts to a fraud on the minority; an action can be brought by an individual shareholder. There is no clear definition of the expression “fraud on the minority”, but the court decides a particular case according to the surrounding facts. The general test applied by courts is: Whether resolution passed by the majority is “bona fide for benefit of the company as a whole”.
• Wrongdoers in Control: If the wrongdoers are in control of the company, the minority shareholders’ representative action for fraud on the minority will be entertained by the court [Cf. Birch v. Sullivan]. The reason for it is that if the minority shareholders are denied the right of action, their grievances in such case would never reach the court.
• Resolution requiring Special Majority but is passed by a Simple Majority: A shareholder can sue if an act requires a special majority but is passed by a simple majority. [Nagappa Chettiar v. Madras Race Club (1948)]
• Personal Actions: Individual membership rights cannot be invaded by the majority of shareholders. A member entitled to all the rights and privileges appertaining to his status as a member. A shareholder can insist on the strict compliance with the legal rules, statutory provisions. Provisions in the MOA & AOA are mandatory in nature and cannot be waived by majority.
• Breach of Duty: The minority shareholder may bring an action against the company, where although there is no fraud, there is a breach of duty by directors and majority shareholders to the detriment of the company. The directors have following duties

1. 1. To act bona fide (not to work for personal gain) in the interest of the company
   2. To take utmost care and employ skill in managing affairs of the company

• Prevention of Oppression and Mismanagement: The minority shareholders are empowered to bring action with a view to preventing the majority from oppression and mismanagement u/s 241 of the Companies Act, 2013.

A company is an artificial person with no physical existence. It functions through the Board of directors who are guided by the wishes of the majority, subject to the welfare of the company as a whole. It is, therefore, a cardinal rule of company law that prima facie a majority of members of a company are entitled to exercise the powers of the company and generally to control its affairs.

The basic principal relating to the administration of the affairs of a company is that “the will of the majority prevails or majority is supreme”. The overall powers of controlling the company are with the shareholders which are exercised in the general meeting of a company except for the powers vested in the Board of Directors.

Usually the general rule is that the decision of majority shareholders in a company binds the minority. Therefore, it is only majority of members who can control the board of directors. The majority maintain their rights without considering the interests of minority. This may result in misuse of their power to exploit the rights of minority. In such a case, Oppression of minority or mismanagement by majority can occur.

However, the Companies Act, 2013 has laid down certain provisions which restricts supremacy of majority and confer rights on minority to apply to the National Company Law Tribunal or Central Government in case of Oppression or Mismanagement.

According to Section 47 of the Companies Act, 2013, every member of a company, which is limited by shares, holding any equity shares shall have a right to vote in respect of such capital on every resolution placed before the company. Member’s right to vote is recognised as right of property and the shareholder may exercise it as he thinks fit according to his choice and interest. A special resolution, for instance, requires a majority of 3/4th of those voting at the meeting and therefore, where the Act or the articles require a special resolution for any purpose, a three-fourth majority is necessary and a simple majority is not enough.

The resolution of a majority of shareholders, passed at a duly convened and held general meeting, upon any question with which the company is legally competent to deal, is binding upon the minority and consequently upon the company.

Thus, the majority of the members enjoy the supreme authority to exercise the powers of the company and generally to control its affairs. But this is subject to two very important limitations. Firstly, the powers of the majority of members is subject to the provisions of the Company’s memorandum and articles of association. A company cannot legally authorise or ratify any act which being outside the ambit of the memorandum, is ultra vires of the company. Secondly, the resolution of a majority must not be inconsistent with the provisions of the Act or any other statute, or constitute a fraud on minority depriving it of its legitimate rights.

The general principle of company law is that every member holds equal rights with other members of the company in the same class. The matters relating to affairs of the company are decided by a vote of the majority. Since the majority of the members are in an advantageous position to run the company according to their command, the minorities of shareholders are often oppressed. The company law provides for adequate protection for the minority shareholders when their rights are trampled by the majority. But the protection of the minority is not generally available when the majority does anything in the exercise of the powers for internal administration of a company. The court will not usually intervene at the instance of shareholders in matters of internal administration, and will not interfere with the management of a company by its directors so long they are acting within the powers conferred on them under the articles of the company. In other words, the articles are the protective shield for the majority of shareholders who compose the board of directors for carrying out their object at the cost of minority of shareholders.

The basic principle of non-interference with the internal management of company by the court is laid down in a celebrated case of Foss v. Harbottle 67 E.R. 189; (1843) 2 Hare 461 that no action can be brought by a member against the directors in respect of a wrong alleged to be committed to a company. The company itself is the proper party of such an action. Thus Foss v Harbottle highlights two main rules governing company law:

• Majority Rule Principle: If alleged wrong is confirmed by majority then courts won’t interfere.
• Proper Plaintiff Rule: Wrong done to the company can be vindicated by the Company only.

Facts of the Case: Foss v. Harbottle

• Richard Foss and Edward Turton were the Plaintiffs (Minority shareholders)
• Thomas Harbottle and others (4 Directors, Solicitors, architects etc.) were the defendants (Majority shareholders)
• The company purchased 180 acres of land near Manchester for developing plantations, landscaping, gardens and constructing houses.
• These properties were to be sold or leased by the company.

Allegations made by Plaintiffs

1. Properties of the company were misapplied and wasted.
2. Improper mortgages were given over the property committing non-compliance of law relating to transfer of property.

Judgment

The allegations made by the plaintiffs were dismissed on the following grounds:

1. Victoria Park is a company.
2. The injury is not only to plaintiffs exclusively but to the Company as a whole.
3. The breach of duty by directors is a wrong done to the company and company alone can sue. Individual members cannot sue in the name of the Company. Proper Plaintiff is the company and not the shareholders.
4. Injury was caused by those individuals whom majority trusted/elected. Where the alleged wrong is confirmed by majority then courts won’t interfere in the internal functioning of the company. Thus majority rules.