Company should be governed by the will of the majority of the shareholders or members. Discuss & also illustrate if there is any exceptions to it.
Introduction
A shareholder derivative suit is a lawsuit brought by a shareholder on behalf of a corporation against a third party. Often, the third party is an insider of the corporation, such as an executive officer or director. Shareholder derivative suits are unique because under conventional corporate law, management is in charge for bringing and defending the corporation against suit. Shareholder derivative suits allow a shareholder to initiate a suit when management has failed to do so. Becausederivative suits vary the traditional roles] of management and shareholders, many jurisdictions have implemented various technical requirements to derivative suits.
General rule
Shareholders may not sue individually to put into effect rights of corporation or of all shareholders, as a group.
As a general rule, a shareholder may not sue a third party directly to enforce a right held by the corporation.
All authorities agree that a stockholder, as such, cannot uphold an action against a third party, either for a breach of contract between such third party and the corporation of which he is a stockholder, or for an injury to the corporation or its property. All such wrongs must be redressed by the corporation itself and in the corporate name.
The Majority and Minority Shareholder issues
The majority shareholder often wants very much avoid the minority shareholder. The concerns of the majority shareholder may include the following:
· The majority shareholder doesn’t want to reveal financial information to the minority shareholder. If the corporation is doing very fine, the majority shareholder may feel susceptible by the prospect of giving financial information to the minority shareholder. He or she doesn’t want the minority shareholder to know how well or how deficiently things are going, or know how much the majority shareholder has taken in salary and bonus. If the majority shareholder is engaged in any financial impropriety, he or she certainly doesn’t want to reveal such information.
· The majority shareholder wants to devote more money in the business, but doesn’t want to make supplementary investment in the business while there is the other shareholder involved.
· The minority shareholder does not run the corporation. . Unless other directors vote with you, being a director offers nothing to the shareholder, except the capacity to be more of a nuisance to the majority shareholder. The minority shareholder often does not have sufficient shares to elect himself or herself to the Board of Directors. Even if he or she does have the voting ability to maintain a seat on the Board, being one director on a Board of 3 or more is not a powerful position
· Relatives of one shareholder would be keen to invest or lend money for the business – if the business belonged only to their shareholder. This feeling is even stronger if the other shareholder is a fifty percent shareholder and actively involved with the business. Too much of the support benefits this other shareholder. Even worse, the active other shareholder may be a poor business manager, increasing the risk of loss of the funds loaned by the relatives.
· A shareholder’s voting rights are limited to electing directors and voting on certain actions which require a shareholders’ vote. Because the minority shareholder is outvoted by the majority, the power of the actual vote is usually limited. If the shareholder can be the swing vote between disagreeing factions of shareholders, this voting power can be strong rather than weak.
· The majority shareholder is working hard to build value and increase net worth. To have a minority shareholder who is not working for the business or who is not working as hard, means that the majority shareholder’s efforts benefit the minority shareholder as well as the majority. The minority shareholder is “dead weight” to the majority shareholder
· While a minority shareholder’s involvement in a corporation may be limited to voting for directors, the minority shareholder is often a thorn in the side of management. There are actions that can be taken by the minority shareholder to make the majority shareholder desire more strongly to offer a buyout. First, the minority shareholder needs to understand the pros and cons of his or her situation.
· The stock of a closely held corporation has no real market, other than the other shareholders. First, it’s not publicly traded stock. Second, any purchaser of the stock merely inherits the minority shareholder situation of the seller of the stock.
· If the minority shareholder is a director, he or she has a right to attend meetings of the Board of Directors. Just as important is the corporation’s need to give notice of meetings. If the insiders don’t have a good relationship with this “outside” director, it becomes necessary for the corporation to provide formal notice to the outside director to comply with state corporation law. In order to have a valid meeting, notice requirements must be met. The majority shareholder is best advised not to take the risk that the minority shareholder objects to the lack of formal notice.
Scopes for minority shareholder
A minority shareholder is not completely powerless. The Companies Acts have always contained requirements giving a minority shareholder power to restrain the excesses of the majority. However, generally they are slight use against a majority shareholder determined to implement his plans. In these circumstances, the minority shareholder will need to apply to the court for defense and relief.
- Derivative Claims – In many conditions, a minority shareholder may be affected by a erroneous done, not to him personally but to the company by the majority. For example, distraction of contracts from the company to the directors personally. The minority shareholder faces an unfeasible task in attempting to force directors into bringing an action against themselves. In certain situation the courts will allow a minority shareholder to bring a claim in the company’s name. The minority shareholder has no superior right to respite than the company would have were it to bring an action itself.
- Personal Claims – All shareholders have rights that they can impose against the company and other shareholders whether or not a strict shareholders’ agreement has been reached. These include protest to alteration to the Memorandum and Articles of Association, the giving of financial assistance, the variation of class rights and the enforcement of directors’ duties and in relation to certain take-over offers.
- Unfair prejudice claims – You can make a petition to the court under section 459 of the Companies Act 1985. The criteria for making the petition are:
Proposition in minorities’ favor
· Minority shareholders are frequently the victims of both negligent and intentional misconduct by officers and directors. This misconduct can greatly impair the value of the shareholder’s investment. It is imperative that shareholder have a basic understanding of their rights and an appreciation of what can reasonably be expected of officers and directors. First, recognize that might does not make right. Just because those who made the decisions own the majority of the stock does not mean that the minority shareholder has no recourse.
· The most common factor that gives rise to shareholder litigation is the failure of the decision makers to keep in mind that the corporation is a separate legal entity. Frequently, when corporate officers or directors waste corporate assets, engage in self-dealing or usurp corporate opportunities, it is because they view the corporation as their personal piggy bank. That is wrong and when it damages the corporation the minority shareholder has recourse.
· Conduct can breach the duty of good faith even if harm was not intended. Officers and directors must act as reasonable and prudent people in making decisions in their corporate capacity. If not they breach the duty of due care which does not require intentional misconduct. For instance, a corporate officer who executes an important document may have breached the duty of due care even if he personally lost money as a result of executing document. Directors must exercise independent judgment and cannot allow themselves to become rubber stamps. The duty of reasonable care is similar to the duty of a person driving a car. If the driver fails to pay attention and hurts someone the driver is responsible even though he did not stand to gain and by his negligence.
· Waste can occur either by accident or on purpose. When the decision makers are simply not paying attention and the corporation is paying too much for a product of service they are wasting corporate assets. On the other hand, when the corporation is paying for assets that benefit themselves, their families or friends instead of the corporation they are guilty of – among other things – wasting corporate assets. This frequently happens when the corporation allows an insider to operate another business and use corporate space, phone system, equipment or services without fair compensation to the corporation.
· Normally, shareholder suits do not arise when the decision makers simply made a mistake or were not paying adequate attention. Shareholders sue most frequently – not when the officers or directors were asleep at the switch but – when the decision makers have breached their duty of loyalty. When the decision makers engage in self dealing, usurpation or have tried to squeeze out a minority shareholder consultation with an attorney is always appropriate.
· Self-dealing often overlaps with wasting and occurs when the decision makers select themselves to provide goods or services for the corporation for a fee. The duty of loyalty requires that these relationships be fair to the corporation. If, for instance, the corporation chooses to hire an insider when it could have gotten the same or better product from a third party a self-dealing is charge must be evaluated. Usurpation of corporate opportunity happens when officers or directors essentially steal a business opportunity from the corporation. Instead of the corporation hiring the insider the deal never reaches the corporation. For instance, if a corporate client needs a product or service that the corporation could provide for a profit that is a corporate opportunity. If an officer or director decides to do the deal himself the charge of usurpation must be evaluated. That happens a lot more often than we would like to think.
· The wrongs we have been discussing so far are generally claims that must be made on behalf of the corporation. When a claim must be brought in the name of the corporation it is called a derivative claim. A derivative claim is one that damages the corporation, as opposed to an individual shareholder. Recovering for this type of misconduct inures to the benefit of the corporation and indirectly to the benefit of all of the innocent shareholders. In a derivative suit the shareholder must make demand upon the board of directors and/or corporate officers before initiating a suit in behalf of a corporation. Frequently, however, corporate management is the ones who engage in the suspect activity in the first place. In such a case the demand would be futile and a demand to cure the situation is generally not necessary.
Utility of favoring minority shareholders
At first glimpse it would appear that majority shareholders have a discrete advantage in that company funds can be used to wrestle the majority shareholder’s battle. On the contrary a minority shareholder even with a case of substantial value will have limited funds to fight the case. The courts have shown however that in authentic shareholder disputes they will not allow this disparity to triumph and will grant injunctions to check company monies to be used to fund the majority shareholder’s battle.
A key purpose of shareholder litigation is that of achieving managerial answer ability. Shareholders derivative suits are a fundamental support to the free enterprise economy. Derivative suit are the major policemen of managerial uprightness. Consequently, shareholder litigation can be seen as a mechanism for maintaining investor confidence.
Another benefit of shareholder litigation is that, in many respects, private enforcement achieved via shareholder litigation may be preferable to public enforcement. Thus, the execution of a statutory derivative action would add greatly to the depth of enforcement action in the area of directors’ duties and corporate practices”. In addition, the American Law Institute has examined the role that statutory derivative actions play in the United States and has stated that the substitution of public enforcement through state-initiated actions for a private.
Opinions of experts
Opinion on the utility of shareholder litigation varies widely. One author has argued from an economic analysis that a litigious model of corporate governance is difficult to support.3
However, many other commentators have suggested that – in spite of its limitations – shareholder litigation has a significant role to play in effective corporate governance. Giving shareholders successful remedies maintains investor confidence, by punishing improper corporate conduct.
The derivative action must grant a balance between giving an effective remedy to shareholders while at the same time allowing the directors of a company sound liberty from shareholder intrusion. This is based on the principle that, generally speaking, shareholders should have little say in the usual management of a corporation.
It is a foolproof mechanism rather than a weapon of first option. It is important to remember that the costs are paid not to individual shareholders but to the company itself, and yet it is the shareholders, the members who bring the action, who may be required to bear serious legal costs.
The shareholder may take legal action, either where the company suffers failure but has no right of action, or where the shareholder has a self-governing right, separate from any right belonging to the company, and where the loss to the shareholder is split from that caused to the company.
In what conditions will a minority shareholder be able to dispute that a director is, or is about to be, careless or in breach of his responsibility to the company, thus enabling the shareholder to bring a derivative action on behalf of the company? Whatever the legal position, a shareholder will have to triumph over significant realistic complexity, ranging from the informational to the financial, and will still require the permission of the court to carry on. The English Attorney-General, Lord Goldsmith, pointed out in a very full statement during the Parliamentary debate on the Bill that the new form of derivative action:
We have to strike a careful balance between protecting directors from vexatious and frivolous claims and protecting the rights of shareholders. It would be dangerous to move to far against either of those interests. Have the Government got the balance right?
Conclusion
If the minority shareholder is able to establish that management has engaged in guilty delinquency such as misuse, self-dealing or usurpation, she is entitled to force a sale of her shares to the corporation for their net asset value. This is a considerable advantage to the minority shareholder and should always be thoroughly investigated. The reason for this rule is fundamental fairness. Why should Bob and John be allowed to bilk the corporation and then when Mary complains buy her interest for .50 cents on the dollar?
Minority shareholders have the right to be treated fairly and they can enforce that right if they are diligent and willing to protect themselves. The starting point is an understanding of what is allowed and what is not.
The minority shareholders will say that they have an belief of being involved in the management of the company; that the company was a quasi-partnership (i.e. the way that they joined together to form the company and the way that it has been run since has given rise to an understanding that each of the shareholders would participate in management). They will argue that it is unfair to leave out them. They will also say that this means that their shares should be purchased by the majority without a discount. The outcome will depend on the facts of each individual case. What is certain is that shareholder disputes are costly pieces of litigation.
Bibliography
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S. Beck, “The Shareholders’ Derivative Action” (1974) 52 Canadian Bar Review 159