Minority Shareholders and Directors' Duties

Author(s): W.
Source: The Modern Law Review, Vol. 41, No. 5 (Sep., 1978), pp. 569-572
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NOTES OF CASES
MINORITY SHAREHOLDERS AND DIRECTORS' DUTIES
TWENTY
years ago
the
present
writer
suggested that,
in the
light
of
Alexander v. Automatic
Telephone Co.,1
" some breaches
[of duty
by directors], open
to sanction
by
disclosure
(and, therefore,
one
would have
thought by ratification),
allow for a
minority [share-
holder's]
action in
spite
of the rule in Foss v. Harbottle." 2 Since
then,
in one limited area at
least,
such
exceptional
cases have been
developed.3
The
purpose
of this
note, however,
is to refute the
suggestion
that Daniels v. Daniels4 has
enlarged
the area of that
exception.5
The
plaintiffs
were
minority
shareholders. Two defendants
(husband
and
wife)
were the
majority
shareholders and the directors. The
company
was also
joined
as a defendant to the action. The directors
unsuccessfully sought
to have the court strike out the statement of
claim as
disclosing
no cause of action-a feature of the decision
which must itself make commentators
pause
before
attributing pro-
found
authority
to
it,
since all the
judge
needed to determine was
whether the
plaintiffs
were bound to fail "at this
stage
of the
game."
6 The
plaintiffs alleged
that the directors had caused the
company
in 1970 to sell land to one of
them,
the
wife,
at what
they
ought
to have known was an
undervalue, namely ?4,250. Indeed,
in
1974 the wife sold the same land for
?120,000.
Fraud was not as such
alleged
in terms.
Thus,
at first
blush,
the decision seems to contravene
the
proposition
that mere
"
negligence
"
by
directors must be rectified
by
an action
brought by
the
company
and not
(since
it is
open
to
ratification) by minority
shareholders
suing
either
personally (since
no
duty
is owed to
them)
or in a derivative action
(which
is confined
to acts done either ultra vires or
by
"
fraud
").7
Further examination of the
judgment, however,
discloses that this
principle
is not
infringed,
nor is
any
extension of
minority rights
in
substance
made, by
Daniels v. Daniels.
Templeman
J. discussed the
leading
authorities which
distinguish,
on the one
hand,
cases of
1
[1900]
2 Ch.
56,
C.A.
2
"
Shareholders
Rights
and the Rule in Foss v. Harbottle
"
[1957]
C.L.J.
194;
[1958]
C.L.J.
93,
105-106.
3
Breach of
duty by
directors under the " collateral
purposes
"
principle: Bamford
v.
Bamford [1970]
Ch.
212; Hogg
v.
Cramphorn [1967]
Ch.
254;
but see
infra,
note 16.
4
[1978]
2 W.L.R. 73, Templeman
J.
5
See, e.g. (1978)
94
L.Q.R. 176,
" a
significant
extension of the
rights
of
minority
shareholders." Such
interpretation
of Daniels v. Daniels
might
lead the incautious
reader to conclude that it lends
authority
to the
argument
in
Gower,
Modern
Company
Law
(3rd ed., 1969), pp. 580-590,
as to the
way
in which
minority
share-
holders'
rights might
be extended in cases of "
negligence
"
by directors;
but the
decision,
it is submitted for the reasons
given below,
does not have
any
such effect.
6
[1978]
2 W.L.R. at
p.
80.
7
Pavlides v. Jensen
[1956]
Ch. 565.
569
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THE MODERN LAW REVIEW
"fraud " where a derivative action
may
be
brought by
the
minority
against
those in control of the
company,8 and,
on the other
hand,
cases where the
minority
has no cause of action
against negligent
directors even if their conduct is "ridiculous and absurd" or if
they
are "an amiable set of lunatics."
9
The ratio decidendi of his
decision was:
" The authorities which deal with
simple fraud
on the one hand
and
gross negligence
on the other do not cover the situation
which arises
where,
without
fraud,
the directors and
majority
shareholders are
guilty
of a breach of
duty
which
they
owe to
the
company,
and that breach
of duty
not
only
harms the
company
but
benefits
the directors.... If
minority
shareholders
can sue if there is
fraud,
I see no reason
why they
cannot sue
when the action of the
majority
and the
directors, though
without
fraud,
confers some benefit on those directors and
majority
share-
holders themselves. . . . The
principle
which
may
be
gleaned
from
[the cases]?1
is that a
minority
shareholder who has no
other
remedy may
sue where directors use their
powers,
inten-
tionally
or
unintentionally, fraudulently
or
negligently,
in a
manner which
benefits
themselves at the
expense of
the
company."
"
It is this formulation which
may
mislead readers to mistake the
essence of the decision for it is couched in
language
which masks a
critical
point.
In Daniels the "benefit" to the directors "at the
expense
of the
company"
was not
just
a secret
profit gained by
them
in the execution of their duties but was an
acquisition
and
disposal
of assets
initially
owned
by
the
company itself.
The nature of " fraud
"
by
directors which allows
minority
shareholders to
bring
a derivative
action has
always
been wider than
"simple
fraud." It includes all
cases where the directors
misappropriate corporate property
or
benefits,
all cases when
they
" are
endeavouring, directly
or
indirectly
to
appropriate
to themselves
money, property
or
advantages
which
belong
to the
company
or in which the other shareholders are entitled
to
participate."
12 The
appropriation
of "
advantages"
even includes
the
filching
of contractual
opportunities
which the
company
should
have
enjoyed.13
The
money
and other
property
of the
company
are
assets of which the directors are constructive trustees and
strictly
8
Atwool v.
Merryweather (1867)
L.R. 5
Eq. 464n.;
Clinch v. Financial
Corpn.
(1868)
L.R. 5
Eq. 450; Gray
v. Lewis
(1873)
L.R. 8
Ch.App. 1035;
Menier v.
Hooper's Telegraph
Works
(1874)
L.R. 9
Ch.App. 350;
Mason v. Harris
(1879)
11
Ch.D.
97;
Cook v. Deeks
[1916]
1 A.C.
554,
P.C.
9
Turquand
v. Marshall
(1869)
L.R. 4
Ch.App. 376, 386;
Pavlides v. Jensen
(supra),
at
p. 570, arguendo.
10
Alexander v. Automatic
Telephone
Co.
(supra);
Cook v. Deeks
(supra);
Pavlides
v. Jensen
(supra).
11
[1978]
2 W.L.R. at
pp.
79-80
(emphasis supplied).
12
Burland v. Earle
[1902]
A.C.
83, 93, per
Lord
Davey.
13
Cook v. Deeks
[1916]
A.C. 554; perhaps
even
opportunities
that the
company
could not have used: Industrial
Development
Consultants v.
Cooley [1972]
1 W.L.R.
443,
sed
quaere
whether that was a case where a
minority
derivative action could be
brought
because ratification of the breach of
duty
was not available, as Prentice
has
suggested: [1972]
C.B.R. 623,
635.
570
[Vol.
41
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liable for breach of
duty
such that
misappropriation gives
both
company
and
minority
shareholders a
remedy.'4
In Daniels the directors had
clearly misappropriated corporate
assets under their control. The land
belonged
ab initio to the com-
pany.
The directors took that
property
at a value which
they
could
not be heard to
say they
did not realise was a
preposterously
low
price. Although, therefore, they
were not
alleged
to be
guilty
of
"
simple fraud," they were,
on the facts
alleged, guilty
of
"
fraud"
in the extended sense that allows for a
minority
shareholders'
derivative action.
But
objection
will
immediately
be made that in Daniels the writ
was not a
derivative,
but a
personal,
action.
True,
the
company
was
joined
as a defendant
(a primary requirement
of the derivative
action);
but the writ was not in
representative
form
"
on behalf of
the
plaintiffs
and other shareholders other than the defendants"
(another
condition which a derivative action must
satisfy). Indeed,
the
judge
went out of his
way
to
interpret
Alexander's case
15
on
which he relied and in which fraud was
"negatived,"
as a case
involving
both a
"personal"
action
by
a shareholder and a
"
corporate
"
or derivative action.16
The
objection, however,
is untenable. Wallersteiner v. Moir
(No.
2)
7
illustrated that where no
objection
is taken to the absence of a
representative
form from the
minority
shareholder's
writ,
the deriva-
tive action can
proceed.l8
Where all the
parties
are before the
court
19
and no such
objection
is
taken,
as
here,
the lack of a
repre-
sentative writ will
clearly
not be a
good ground
for a decision
against
the
plaintiff shareholder,
let alone for
striking
out the statement of
claim.
14
Steen v. Law
[1964]
A.C.
287,
and note
(8), supra;
Wallersteiner v. Moir
[1975]
1 W.L.R.
991;
Wallersteiner v. Moir
(No. 2) [1975] Q.B. 373, explained (1976)
39
M.L.R.
327, 330;
contra
(1975)
91
L.Q.R.
482. Contrast the conventional view of the
acquisition
of secret
profits by
directors in the execution of their office for which
(being
a ratifiable breach of
duty)
the
minority
cannot
sue, though
the
company
can:
Regal (Hastings)
Ltd. v. Gulliver
[1942]
1 All E.R.
378,
H.L. Sed
quaere
whether the
minority
could sue in such a case if the breach were seen as misuse
of a
corporate
"
opportunity
"
or information which was the
"property"
of the
company: [1958]
C.L.J. at
p.
103. The White
Paper
"The Conduct of
Company
Directors
"
(Cmnd.
7037
(1977)), para. 3,
seems to
suggest
that the latter
is,
or should
be,
the correct view. The draft
Companies
Bill set out in
"
Changes
in
Company
Law "
(Cmnd. 7291, 1978)
seems to take that view in clause 44
(3)
and
(4)
which
would make a director liable for an
advantage gained by
use of the
company's money
or other
property
or of
any
"relevant information" or "relevant
opportunity
"
obtained
by
him while he was a director. But the draft Bill
goes
on to
propose
a
striking
relaxation of the
existing
law
by allowing
a director to
escape
from all these
liabilities if his action is
"duly
authorised or ratified ": clause 44
(6).
This would
mean that breach of
duty
as a constructive trustee would become ratifiable!
15
[1900]
2 Ch.
56, 64, 66-67, 69,
C.A.
16
[1978]
1 W.L.R. at p.
77;
see
[1958]
C.L.J. at
pp.
101-102. It is to be noted
that
Bamford
v.
Bamford [1970]
Ch.
212,
must have involved a derivative action
despite
the
availability
of ratification: see Russell L.J. at
p.
242.
17
[1975] Q.B. 373,
C.A.
18 See
(1976)
39 M.L.R. at
p. 330,
note 18.
19 See as to the
importance
of this in actions that involve
representative plaintiffs
and defendants: John v. Rees
[1969]
2 All E.R. 274.
Sept.
1978]
571 NOTES OF CASES
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THE MODERN LAW REVIEW
From this
perspective, then,
there is
really nothing
novel about
the decision in Daniels v. Daniels. It was a
straightforward
case of
directors
misappropriating corporate
assets to
themselves,
albeit at
the best
unwittingly.
That
they
were
"negligent"
in
benefiting
themselves could not
possibly
be a defence. Nor could their actions
have been
effectively
ratified
by
a resolution in the
general meeting
of shareholders. That is the true distinction between this case and
cases like Pavlides v. Jensen where the
negligence
of directors
allowed for
"
absolution and
forgiveness
of their sins
"
20
by
ratifica-
tion. Daniels does
nothing
to illuminate further the
puzzle
still
posed
by
Alexander v. Automatic
Telephone
Co. It
clarifies,
but does not
add
to,
the area of conduct
by
directors which
permits
a derivative
action
by
shareholders to
protect
the
rights
of the
company.
The
extraordinary aspect
of new Government
proposals
to "reform"
company
law is that not
only
would
they
not solve that
puzzle, they
would even seem to exclude the
minority
shareholder's
right
to
challenge
a
misappropriation
of
corporate
assets
by making
that
wrongdoing
ratifiable
by majority
shareholders
21
who under the old
law in Cook v. Deeks
13
were not allowed to
ratify
such a " fraud."
W.
GRUNWICK v. A.C.A.S.
THE Grunwick
dispute
is now one of the causes celebres of labour
relations law. In addition to the
appointment
of a Court of
Inquiry
under the Industrial Courts Act 1919
1
and a claim under Schedule
11 to the
Employment
Protection Act 1975
(E.P.A.),2
it
gave
rise
to a
congerie
of
legal proceedings
of interest to labour
lawyers:
complaints
of unfair dismissal
3;
prosecutions of
pickets4; pro-
ceedings arising
out of the
blacking
of mail5 and action
by
the
Post Office to forestall its threatened
resumption 6; and,
most
important,
an action for a declaration that an
Advisory
Conciliation
and Arbitration Service
(A.C.A.S.)
recommendation for trade union
recognition
under section 12 of the E.P.A. was null and void. This
20
Harman L.J., Bamford
v.
Bamford [1970]
Ch. 212,
238.
21
See Clause 44
(3) (4) (6)
of the draft
Companies
Bill 1978
(Cmnd. 7291),
discussed
supra
note 14.
1
In June
1977,
under the chairmanship
of Scarman L.J. Its
report
in
August
1977,
Cmnd.
6922,
is referred to below as Scarman.
2
The Central Arbitration Committee
(C.A.C.)
decided that the claim was not
well founded: C.A.C. Award No. 329.
3
By employees
dismissed while on strike. C.O.I.T. refs.
40224/76/C
et
seq.
See
The
Guardian,
June 29,
1977.
4
These were
widely reported
in the
press.
N.B. too the refusal of a
High
Court
injunction
to restrain members of the strike committee from
organising picketing
of
chemist's shops.
See The Times and The Guardian, March 12, 1977.
5
An action
brought by
Grunwick
against
the Post Office and the Union of Post
Office Workers. See The Times,
November
6, 1976,
and The Guardian, November
6 and
10,
1976. See too the
parliamentary
debate on this issue. H.C.Deb., Vol. 918,
cols. 1637-1698,
November
4,
1976.
6
Harold
Stephen
& Co. Ltd. v. Post
Office [1977]
1 W.L.R. 1172
(C.A.).
572
[Vol.
41
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