TITLE OF THE CASE: Foss v Harbottle
CITATION:  67 ER 189, (1843) 2 Hare 461
COURT: Court of Chancery
BENCH: Wigram VC, Jenkins LJ
PETITIONER: Richard Foss and Edward Starkie Turton
DEFENDANTS: Thomas Harbottle & Other’s
INTRODUCTION: The case of FOSS v HARBOTTLE is a key precedent in English corporate law. According to the ruling established in this case, if the company suffers a loss as a result of the negligent or fraudulent activities of its members or outsiders, the action can be initiated on behalf of the company or as a derivative action.
FACTS OF THE CASE: Richard Foss and Edward Starkie Turton were two minority partners in the “Victoria Park Company,” which was founded in September 1835 with the goal of purchasing 180 acres (0.73 km per square kilometer) of property near Manchester and converting it into “Victoria Park, Manchester.” An act passed by Parliament in 1837 established the company for the purpose of laying up and maintaining the picturesque park within the townships of Rusholme, Charlton upon Medlock, and Moss Side in the county of Lancaster. They claim that the company’s property was plundered and wasted, as well as that numerous mortgages were provided improperly over the company’s property. Both shareholders decided to pursue legal action on behalf of themselves and all other shareholders or stockholders in the company, and 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), as well as H.Rotton, E.lloyd, T.peet, and J.Bishop). The following was the basis for their claim: The primary reason was that the company’s assets were misappropriated through fraudulent activities. The second cause was that the company lacked qualified directors who could genuinely make up the board, and the third ground was that the corporation lacked a clerk or office. As a result of these conditions, the shareholders had no option but to file legal action against the directors in order to wrest control of the company from them.
ISSUES: The questions were whether or not company members could file suit on behalf of the company and whether or not the guilty people could be held liable for their wrongdoings.
ARGUMENTS OF THE PETITIONER: The plaintiffs asserted that because the firm was created by Parliament, it should not be recognized as a regular corporation. Furthermore, the act of incorporation was passed with the intention of benefiting the firm, but the directors acted in their own best interests. They further claimed that the directors should have functioned as the company’s trustees and should be held liable for misappropriating the company’s assets. As a result, this act allowed the board of directors to sue those who harm the firm, but it did not allow members of the company or outsiders to sue the board of directors.
ARGUMENTS OF THE DEFENDANTS: The defendants maintained that the plaintiffs do not have the legal authority to pursue a lawsuit on behalf of the firm.
JUDGMENT: Wigram VC invalidated the shareholders’ claim, holding that because the firm and its shareholders are regarded as independent legal entities, an individual shareholder or any outsider of the company cannot pursue any suit against the damage done to the corporation. A corporation may sue and be sued in its own name, and a member may not initiate legal action on behalf of the company, according to Section 21 (1) (a) of the Companies Act. If a company has a right against a party under a contract, the company must sue. The reason shareholders cannot sue is that the corporation, not its members, has incurred injury, hence it is up to the corporation to sue or pursue legal action against all those members who have misused the company assets. He followed previous unincorporated company decisions and insisted that minority groups show that they have depleted all internal possibilities of redress, stating that the courts will not intervene in cases where a majority of shareholders can ratify unconventional conducts, but this rule was seen as unfavorable to minority groups.
As a consequence, the two primary rules were gradually established by the court. The “Proper Plaintiff Rule” stated that if a corporation is injured or sustains a loss as a result of the deceptive or irresponsible conduct of directors or any other outsider, only the corporation has the right to sue the directors or outsiders to reclaim its rights. Members of the corporation or anybody else cannot sue on its behalf because of the “Separate Legal Entity” principle, which treats the company as a separate legal entity from all of its members, allowing it to sue and be sued in its own name. This is the only reason why only a corporation, not any of its members, can file a legal action or initiate legal proceedings to recover losses sustained by the firm. Only the board of directors or an ordinary resolution made by the general meeting can authorize a member of the corporation to pursue legal action on the company’s behalf against the wrongdoer. The second rule was the “Majority Principle Rule,” which specified that the court would not interfere if an alleged infringement could be proved or affirmed by a simple majority of members in a general assembly.
However, the application of these strict principles appeared to be extremely harsh and unjust for minority shareholders, as despite having a substantive right, they were still barred from seeking justice under the rule and were forced to accept the majority’s wrongdoings because they controlled the corporation and minority members had no say due to their small numbers. As a result, in order to soften the blow, four exceptions to the general concept have been established under which litigation will be permitted.
The first and most important exemption is when the alleged behavior is illegal and ultra vires. The second exemption concerns a circumstance in which the claimed act could only have been legitimately done or sectioned by some members of the special majority in breach of an article requirement. The third exception concerns claimed conduct that infringes on the claimant’s personal and individual rights while he is a member of the corporation. Last but not least, the fourth exemption pertains to a circumstance in which a majority of the company’s stockholders commit a deception on the minority. As a result, all of these exclusions aid in the protection of fundamental minority rights, which must be protected regardless of the vote of the majority.
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