People Innovation Excellence

PROTECTION OF MINORITY SHAREHOLDERS IN AUSTRALIA

By AGUS RIYANTO (October 2016)

In Australia, the concept of legal protection of minority shareholders had its genesis in the case of Foss v Harbottle (1843) 2 Hare 461. In this case, Foss and Turton brought an action on behalf of themselves and all other shareholders against the defendants who consisted of five directors, a solicitor and architect of the company alleging that by concerted and illegal transactions they had caused the company’s property to be lost. It also alleged that there was no properly constituted board of directors. The plaintiffs claimed damages from the defendants to be paid to the company and asked for the appointment of a receiver. The court held that the action would not be the responsibility of the shareholders when there was nothing to prevent the company itself bringing the action.

According to Baxt[1] the ruling in Foss v Harbottle generates two principles, namely, the Internal Management Rule and the Proper Plaintiff Rule. Internal Management Rule, any irregularity or breach of duties by majority shareholders in their conduct of internal affairs must be settled within the company itself, through the GMS. The court refuses to intervene in such matters and therefore minority shareholders cannot forward the case to court. However, cases that cannot be ratified by the GMS will be subject to litigation. Proper Plaintiff Rule, any damage done to the company will mean that the company itself, as the victim, is the proper plaintiff for any legal proceedings. Unless the breach falls under any exception or exclusively affects shareholders’ personal rights, whereby the shareholders are entitled to take court action, the proper plaintiff would be the company.

Clearly, the rule in Foss v Harbottle works to the advantage of directors as majority shareholders. As a remedy, the courts developed a set of statutory and common law exceptions to the rule.

Common Law Exceptions to the Rule in Foss v Harbottle.

Legal action against the management of a company is permitted in the following circumstances.

  • Illegal or Ultra Vires.

If the management acts or proposes to act illegally beyond the company’s stated power, shareholders have the ability to take court action against them. This breaks the limitation of the proper plaintiff rule. Furthermore, the GMS cannot ratify such cases.

  • Special Majority

If the company’s written law (or the Corporations Law) requires a special majority resolution in a GMS to solve a matter where shareholders rights have been abused, and this majority is not met, then shareholders may seek relief through the courts. This necessary prerequisite of a special majority constitutes a greater than simple majority.

  • Members’ Personal Rights

If minority shareholders’ personal rights have been infringed, an exception to Foss v Harbottle is granted. Personal rights are those particular individual rights which are the result of  shares held or other legal contracts or documents.

  • Fraud on the Minority

Another exception to the rule in Foss v Harbottle occurs when an act of the majority shareholders results in an unexpected expense on the part of the minority.  This expense must be irreparable by the GMS. The act might not necessarily be a deceitful, dishonest or discriminatory one, but it would have to be either unfair, or regarded as fraudulent or oppressive towards the minority shareholders.

  • Justice requirement

This has been a controversial subject and still remains an open exception to the rule in Foss v Harbottle. As a consequence, it bears an uncertain status. Technical rules of a company may impede any legal proceedings for similar conduct by majority shareholders. In such conditions, claims of justice can rule out the impediment and interfere in the matter.

  • Statutory Derivative Action (SDA)

However the introduction of Statutory Derivative Action in CLERPA99 abolished the common law exceptions to the Foss v Harbottle rule as of March 2000[2]. These exceptions have been replaced by SDA under section 236(1), which states:

“A person may bring proceedings on behalf of a company, or intervene in any proceedings to which the company is a party for the purpose of taking responsibility on behalf of the company for those proceedings, or for a particular step in those proceedings (for example, compromising or settling them), if:

  • the person is: (i)    a member, former member, or person entitled to be registered as a

member, of the company or of a related body corporate ; or (ii)   an officer or former officer of the company; and

  • the person is acting with leave granted under section 237”

Consequently, the members’ personal rights exception under section 236(3) has been abolished. Section 236(3) states that: “The right of a person at general law to bring, or intervene in, proceedings on behalf of a company is abolished”.

It is clear that the new SDA significantly effects the power of shareholders to take action on behalf of the company. It also provides more certainty and gives all shareholders greater protection against breaches by directors of their fiduciary duty’s and actions which are not in the best interest of the company. The development of the SDA will be dependent upon the support of judges and solving the  practical issue of awarding costs to the minority shareholders.

Statutory Exceptions to the Rule in Foss v Harbottle.

The common law exceptions above appear impractical from the shareholders’ viewpoint. They require the shareholders to qualify for one of the five conditions prior to making any legal action. Another set of exceptions are thus provided, that is, the statutory exceptions; sections 232[3], 247, 461, and 1324 Corporations Law.

  • Section 232 : Oppression or Injustice.

The most powerful remedy for shareholders who are oppressed and unfairly treated in Australia is contained in section 232. Under this section, which is divided into two major branches, the court has extensive power to intervene in the running of the company if a member believes:

  • that affair of the company are being conducted in a manner that is oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member, or in a manner that is contrary to the interests of the members as a whole; or
  • that an act or omission, or a proposed act or omission, by or on behalf of the company, or a resolution, or a proposed resolution, of a class of members, was or would be oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or members or was or would be contrary to the interests of the members as a whole.

To be classified as unfairly prejudicial and unfairly discriminatory, the act must affect one or several shareholders, or members of the company. Note, however, that there must be proof of the unfairness involved[4], as, if it were only a simple act of prejudice and discrimination, it would not be classified in the above category of prejudicial and unfairly discriminative behaviour. This is demonstrated in Re Dalkeith Investments Pty Ltd (1985) 9 ACLR 74, where the company issued shares with the intention of diluting Smith’s shareholding and not for the purpose of the benefit of the company as a whole. In the final decision, the Court held that Inglis, his wife and the Smiths acted oppressively by excluding Smith from an opportunity to participate in, or oppose, their decisions.

Section 246AA(2) empowers the Court with wide discretion to make such orders “as it thinks fit”[5], including, but not limited to, one or more of the following:

  1. an order that the company be wound up;
  2. an order for regulating the conduct of affairs of the company in the future;
  3. an order for the purchase of the shares of any member by other members;
  4. an order for the purchase of the shares of any member by the company and for the reduction accordingly of the company’s capital;
  5. an order directing the company to institute, prosecute, defend or discontinue specified proceedings, or authorising a member of the company to institute, prosecute, defend or discontinue specified proceedings in the name and on behalf of the company;
  6. an order appointing a receiver, or a receiver and manager of property of the company;
  7. an order restraining a person from engaging in specified conduct or from doing a specified act or thing;
  8. an order requiring a person to do a specified act or thing.
  • Section 247: Inspection of Books  

Under section 247A(1)(a)(b), shareholders of a company, in their capacity as members or as registered management of an investment scheme, can be granted the right by the court to examine the company’s books or scheme, or to authorise another person (whether a member or not) to inspect the books of the company or scheme on the applicant’s behalf. The definition of books is taken to include:

  • a register;
  • any other record of information;
  • financial reports or financial records, however compiled, recorded or stored; and
  • a document

Section 247A Corporations Law states that the order for inspection will only be granted if the court is able to justify that the member is acting in good faith and that the inspection is to be made for a proper purpose. A further consequence of section 247A(2) Corporations Law is the authority granted to make copies of the books unless the court orders otherwise. The court should first justify the underlying reason for the examination prior to granting this right.[6] However, the Court may also make any other orders it considers appropriate, including either or both of the following:

  • an order limiting the use that a person who inspects the books may make of information obtained during the inspection
  • an order limiting a person who inspects the books to make copies in accordance with subsection 247A(2).

It is legislated that the information gathered must not be disclosed to other parties during the inspection unless the disclosure is to ASIC or the applicant. In relation to the GMS regulated in section 247D, the directors of a company or the company, by a resolution passed at a general meeting, may authorise a member to inspect books of the company.

  • Section 461: Winding Up

This particular section provides grounds for the Court to wind up the company. In practice, the most common grounds for a company to be wound up are, if :

  1. directors have acted in affairs of the company in their own interests rather than in the interests of the members as a whole, or in any other manner whatsoever that appears to be unfair or unjust to other members (section 461(1)(e));
  2. affairs of the company are being conducted in a manner that is oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or members, or in a manner that is contrary to the interests of the members as a whole (section 461(1) (f))
  3. an act or omission, or a proposed act or omission, by or on behalf of the company, or a resolution, or a proposed resolution, of a class of members of the company, was or would be oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or members or was or would be contrary to the interests of the members as a whole (section 461(1)(g));
  4. the Court is of opinion that it is just and equitable that the company be wound up (section 461(1)(k)).

The just and equitable rationale has been used in different circumstances based on traditional categories. There are four principal grounds in the just and equitable category including:[7]a) breakdown in the mutual trust and confidence of members; b) failure of substratum; c) deadlock in the operation or management of the company d) fraud, misconduct or oppression in the conduct and management of the company.

  • Section 1324: Injunctions

This section empowers the court to grant an injunction restraining a person from engaging in conduct that constituted, constitutes or would constitute:

  • a contravention of the Corporations Law;
  • attempting to contravene this Law;
  • aiding, abetting, counseling or procuring a person to contravene this Law;
  • inducing or attempting to induce, whether by threats, promises or otherwise, a person to contravene this Law;
  • being in any way, directly or indirectly, knowingly concerned in, or party to, the contravention by a person of this Law; or
  • conspiring with others to contravene this Law;

The court may on the application of the Commission, or of a person whose interests have been, are or would be affected by the conduct, grant an injunction, on such terms as the Court thinks appropriate, restraining the first-mentioned person from engaging in the conduct and, if in the opinion of the Court it is desirable to do so, requiring that person to do any act or thing. Application for injunction may be forwarded without having to prove any direct impact or special injury to the applicant. The only thing that must be proved is that the affair violates the interests of the shareholders or members.

In addition, under section 1324(10), the Court has power to grant an injunction restraining a person from engaging in particular conduct, or requiring a person to do a particular act or thing, either to or in substitution for the grant of the injunction, or to order that person to pay damages to any other person, if that person is acting in contravention of the Corporations Law.

In conclusion, the legal protection of minority shareholders in Australia is derived from  Foss v Harbottle (1843) 2 Hare 461. The judgment handed down in this case has been tremendously influential and has been developed by interpretation, intervention and decisions from the courts. It has also had a major impact on the legislation and statutory remedies which are available to minority shareholder under the Corporations Law. It is noteworthy that the Australian legal system continues to be influenced by historical connections with the long tradition of the British legal system. It is interesting to see that a case that is a century and half old is still applicable to the modern corporate world. From March 2000 this principle will be refined by the introduction of statutory derivative action (section 236 Corporations Law) which removes the common law requirement of a shareholder’s application for a derivative action (section 236(3)). Furthermore, this principle has been enhanced by the removal of the common law exceptions to the rule in Foss v Harbottle. Thus with the implementation of SDA, the legal standing and rights of minority shareholders in Australia are more secure, subject to the judicial interpretation of the statutory derivative action and the practical issue of awarding minority shareholder’s costs. (***)


REFERENCES:

[1] Baxt, R, Fletcher, K and Fridman, S, Afterman and Baxt’s Cases and Materials on Corporations and Associations, 7th Edition, Butterworths, 1999, at 573-574.

[2] Section 236(3) Corporations Law.

[3] Section 246AA (“Oppression or Injustice”) has been renumbered and is currently contained in sections 232-235 Corporations Law. These sections come into force and will apply in Australia after March 2000. Generally the content of these sections are substantially the same to the previous 260/246AA.

[4] See: Dosike Pty Ltd v Johnson (1997) 15 ACLC 181; Thomas v HW Thomas Ltd [1984] 2 ACLC 610.

[5] It should be noted that the wording “as it thinks fit” (is defined as considered to be appropriate for the circumstances) has been changed to new term as “it considers appropriate”, but the substance is  still the same. See: section 233 Corporations Law.

[6] Norman, PJ,’ Access to Corporate Information’ (1986) 4 Companies and Securities Law Journal 149; Sinnott, P and Duns, J, ‘Shareholders’ Rights of Access to Corporate Books’ (1990) 8 Companies and Securities Law Journal 73.

[7] Ford, HAJ, Austin, RP and Ramsay, IM, Ford’s Principles of Corporations Law, 9th Edition, Butterworths, 1999, at 534.


AR


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