Foss vs Harbottle Case

Title of the case: Foss vs Harbottle

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

Court: Court of Chancery

Quorum: Wigram VC, Jenkins LJ

Petitioner: Richard Foss and Edward Starkie Turton

Defendants: Thomas Harbottle & Others

The Foss vs Harbottle case is a significant English precedent in company law.

According to the rule established in this case, if the company suffers losses due to its
members’ or outsiders’ negligent or fraudulent actions, legal action can be taken to
address those losses. The company or a derivative action can initiate such action.

This rule gave rise to the principles of majority and minority shareholders’ rights. In
matters of company management, decisions are made through resolutions passed by
a simple majority or a three-fourth majority of the company’s members. The court
generally does not interfere in the company’s internal management and affairs, as
most members decide them. Consequently, the company becomes the appropriate
plaintiff to institute a lawsuit or legal proceedings, and it does not typically allow a
single shareholder to take direct legal action against the wrongdoer. The rule
empowers the company to address irregularities through its internal procedures.

However, there should be a balance between the effective control of the company
and the protection of individual shareholders’ interests. In certain circumstances, an
individual shareholder may also be allowed to bring legal action.

Minority shareholders have often faced challenges, as derivative claims usually cover
them and may not receive equal redress for discrimination. Some researchers have
suggested that the Rule of Foss v Harbottle may have been altered or repealed after
the introduction of current formal derivative actions. However, concerns about
potential overlaps in derivative claims and unequal remedies for prejudice have been
raised. The fundamental values established in the Foss vs Harbottle case remain
critical in modern company law.

Contents hide

1. Facts of Foss vs Harbottle

2. Issues of the Case
3. Arguments of the Petitioner
4. Arguments of the Defendants
5. Judgement in Foss vs Harbottle
5.1. Rule in Foss v Harbottle
5.2. Exceptions to Rule in Foss vs Harbottle
6. Foss vs Harbottle Summary

Facts of Foss vs Harbottle

In September 1835, the Victoria Park Company was established to acquire 180 acres
of land near Manchester (later known as Victoria Park, Manchester, after
incorporation by an Act of Parliament). However, instead of fulfilling the company’s
objectives of developing the land for ornamental and park-like purposes,
constructing houses with gardens and fields and then selling or renting them, certain
individuals, including the directors and others, engaged in unlawful misappropriation
of the company’s property.

Richard Foss and Edward Starkie Turton, both minority shareholders, brought
attention to this matter. They reported that Thomas Harbottle, Joseph Adshead,
Henry Byrom, John Westhead, Richard Bealey (the five directors of the company), as
well as lawyers and architects Joseph Denison, Thomas Bunting and Richard Lane,
along with H. E. Lloyd, Rotton, T. Peet, J. Biggs and S. Brooks (Byrom, Adshead and
Westhead’s assignees), were involved in misapplying and falsely mortgaging the
company’s assets, thus deviating from the company’s intended purpose. They argued
that these wrongdoers should be held accountable for their actions and appointed a
responsible receiver.

Their arguments in Foss vs Harbottle were based on three grounds. Firstly, they
pointed out fraudulent practices that misused the company’s funds. Secondly, they
highlighted the lack of qualified directors on the company’s board. And thirdly, they
emphasised the absence of a company clerk or office. These conditions left the
owners with no recourse but to pursue legal action against the directors instead of
reclaiming their property directly.

Issues of the Case

The central issues at hand were twofold in Foss v Harbottle:

 Whether the company members had the authority to bring a lawsuit on behalf
of the company, in other words, could the shareholders or members of the
Victoria Park Company legally file a lawsuit to address the alleged
misappropriation of the company’s property and funds?
 Whether the individuals responsible for the wrongdoing could be held
accountable for their actions pertains to whether the directors, lawyers,
 architects and other involved parties could be held legally liable and face
consequences for their misapplication and fraudulent mortgage of the
company’s assets.

Arguments of the Petitioner

The plaintiffs in Foss vs Harbottle contended that the Victoria Park Company should
be considered unique and distinct from ordinary companies due to its incorporation
by an Act of Parliament. They emphasised that the purpose of this incorporation was
to benefit the company as a whole, but the directors acted in their self-interests
instead.

The petitioners further asserted that the directors had a fiduciary duty to act as
trustees for the company and that they should be held accountable for
misappropriating its assets. According to the petitioners, the Act of Incorporation
granted the directors the authority to take legal action against those who harmed
the company. Still, it did not provide such rights to the members of the company or
external parties to sue the board of directors.

Arguments of the Defendants

On the other hand, the defendants in Foss vs Harbottle countered the plaintiffs’
claims, arguing that the petitioners lacked the legal right to initiate a lawsuit against
them on behalf of the company. They contended that only the directors, as
authorised by the Act of Incorporation, possessed the standing to bring legal action
against individuals who caused harm to the company.

In their defence, the defendants in Foss vs Harbottle sought to challenge the

petitioners’ authority to sue, asserting that it was outside their rights as company
members.

Judgement in Foss vs Harbottle

In Foss vs Harbottle, Wigram VC, the judge, ruled in favour of the defendants and
dismissed the shareholders’ claims. The court held that individual shareholders or
outsiders of the company could not bring legal action against wrongs done to the
corporation, as the company and its shareholders are considered separate legal
entities. This principle in Foss v Harbottle is supported by Section 21(1)(a) of the
Companies Act, which states that a company may sue and 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.
The court in Foss v Harbottle emphasised that shareholders cannot sue because the
company has suffered the injury, not its individual members. Therefore, the company
should be the one to initiate legal action against those who misappropriated its
property.

The judge based his decision in Foss vs Harbottle on previous judgments regarding
unincorporated companies and stressed that the minority shareholders must
demonstrate that they have exhausted all possibilities for redress within the internal
forum. Suppose the majority of shareholders can ratify the irregular conduct. In that
case, the courts will not intervene, which some consider unfavourable to the minority,
as it restricts their ability to take legal action in cases where misconduct can be
ratified.

Rule in Foss v Harbottle

As a result, the court in Foss v Harbottle established two principal rules.

 The first is the “Proper Plaintiff Rule,” which states that only the company can
sue directors or outsiders for any wrong or loss due to fraudulent or negligent
acts. Members of outsiders cannot sue on behalf of the company because of
the principle of “Separate Legal Entity,” which treats the company as a distinct
legal person from its members.
 The second rule is the “Majority Principle Rule,” where the court will not
interfere if the alleged wrong can be ratified by a majority of members in a
general meeting.
However, these strict principles seemed harsh and unjust for minority shareholders as
they were prevented from seeking justice despite having substantive rights. To
address this, the court in Foss vs Harbottle established four exceptions to the general
principles where litigation would be allowed.

Exceptions to Rule in Foss vs Harbottle

However, there are certain exceptions to the Majority Principle Rule to protect
minority shareholders:

 Ultra Vires: If an action is taken by the company that is beyond the scope of
its Articles of Association, any member can bring legal action against it.
 Fraud on Minority: When the majority oppresses the minority and commits
fraud, even a single shareholder can initiate legal action to protect the
minority’s rights.
 Oppression and Mismanagement: Shareholders have the right to seek legal
action if there is oppression or mismanagement within the company. They can
approach the tribunal or court under specific sections of the Companies Act.
  Individual Membership Rights: Members can enforce their rights against the
company, such as the right to vote or stand in elections.
 Derivative Action: 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.
These exceptions protect minority shareholders and allow them to seek justice in
certain circumstances despite the Majority Principle Rule.

Foss vs Harbottle Summary

Foss vs Harbottle is a significant case in company law where the court ruled that if a
company suffers losses due to the negligent or fraudulent actions of its members or
outsiders, legal action can only be brought by the company itself or through a
derivative action. The court emphasised the separate legal entity principle, which
prevents individual shareholders from suing on behalf of the company.

Majority shareholders, through resolutions, manage company affairs, and the court
generally does not intervene in internal matters. However, a few exceptions allow
individual shareholders to bring legal action as per Foss vs Harbottle rule. The Foss
vs Harbottle case established the “Proper Plaintiff Rule” and the “Majority Principle
Rule.” Despite concerns about unequal remedies for minority shareholders, the core
principles of the case remain vital in company law.