Membership and Minority Protection
Governance
Membership and Minority Protection
Syllabus tag: KASNEB CPA | Intermediate Level | CA21 Company Law | Topic 4 Membership and Minority Protection
Lesson objectives
By the end of this topic, you will be able to:
- Explain how membership is acquired and ended
- State the rule in Foss v Harbottle and its rationale
- Explain when a derivative action may be brought
- Explain the unfair prejudice remedy
- Describe the just and equitable winding-up remedy
Why this matters
Company decisions are taken by majority. That is efficient and it leaves a minority exposed, so the law supplies a set of remedies. Knowing which remedy fits which complaint is the whole of this topic.
Becoming and ceasing to be a member
Membership is acquired by subscribing to the constitution on formation, by agreeing to become a member and being entered in the register, or by transfer or transmission of shares.
It ends on transfer, on forfeiture or surrender, on death — when the shares pass to the personal representative — or on the company being dissolved.
Entry in the register of members is what makes a person a member. A purchaser of shares is not a member until registered, however complete the sale, which is why registration disputes matter.
The rule in Foss v Harbottle
Where a wrong is done to a company, the proper claimant is the company itself.
Two propositions follow:
- An individual member cannot sue for a wrong done to the company
- The court will not interfere in a matter the company could ratify by majority
The rationale is practical rather than doctrinal. The company is the person injured; multiple actions by individual members would be unmanageable; and where the majority could simply ratify the act, litigation achieves nothing.
The rule is sound and it leaves an obvious gap: what if the wrongdoers are the majority? The company will never sue itself. The remedies below exist to fill that gap.
Derivative actions
Part XI of the Companies Act 2015 allows a member to bring proceedings on behalf of the company in respect of a cause of action vested in the company.
The claim may arise from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director. Note how wide that is: the director need not have benefited personally, and mere negligence suffices.
Permission of the court is required. The court considers whether a person acting to promote the success of the company would pursue the claim, whether the act has been or could be authorised or ratified, the member's good faith, and the views of members with no personal interest.
The essential feature: any recovery belongs to the company, not to the member who sued. A derivative action is not a route to personal compensation, which is why a member with a personal grievance should look to unfair prejudice instead.
:::checkpoint A director sells company assets to his wife at an undervalue. The board, which he controls, refuses to sue. A minority member wishes to act. Identify the appropriate proceedings and say who receives any recovery. :::
Unfair prejudice
A member may petition the court on the ground that the company's affairs are being conducted in a manner unfairly prejudicial to the interests of members generally or of some part of them.
The conduct must be both unfair and prejudicial. Conduct that harms a member but is entirely proper — a rights issue that dilutes a member unable to subscribe — is prejudicial without being unfair. Conduct that is improper but causes no harm fails the other limb.
Typical grounds:
- Exclusion from management in a quasi-partnership company
- Non-payment of dividends over a long period while directors take large salaries
- Diversion of business to a company the majority controls
- Excessive remuneration paid to controlling directors
- Serious mismanagement, though ordinary commercial misjudgement is not enough
Remedies are at the court's discretion and are wide: regulating the conduct of affairs in future, requiring the company to do or refrain from an act, authorising proceedings in the company's name, and — most commonly — ordering the purchase of the petitioner's shares, usually by the majority.
The share purchase order is the practical remedy in most cases, because it lets the minority exit at a fair value rather than remain locked into a company they cannot influence.
The contrast with a derivative action is the point. A derivative action vindicates the company's right and recovers for the company. Unfair prejudice vindicates the member's own interest and remedies their position.
Just and equitable winding up
A member may petition for the company to be wound up on the just and equitable ground.
It has succeeded where there is deadlock between equal shareholders, where the substratum — the main purpose of the company — has failed, where the company was formed for a fraudulent purpose, and where a member has been excluded from management in a company that is in substance a partnership.
The remedy is drastic: the company ends. A court will usually refuse it where a lesser remedy such as a share purchase order would meet the case, so a petitioner is generally expected to have considered unfair prejudice first.
:::checkpoint Two equal shareholders in a quasi-partnership have fallen out completely and neither will sell to the other. Compare the outcomes available under unfair prejudice and under just and equitable winding up, and say which the court would prefer. :::