[On 6 March 2021, the Jindal Global Law School (JGLS) organised a JGLS Virtual Discourse titled “Action by Minority Shareholders and the Rules in Foss v. Harbottle (1843) 2 Hare 461”. It was structured as a comparative discussion, with James d’Apice discussing the Australian position and me the Indian position. In this post, I summarise the key points I made during the session.
My thanks go to Divyangana Dhankar, Shaun Star and Prateek Bhattacharya from JGLS for conceptualising, designing and implementing this very interesting idea and format, to James for a fascinating presentation and analysis of the Australian position and to Nityesh Dadhich for excellent research assistance]
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Nearly 180 years old, the celebrated case of Foss v Harbottle (183) 2 Hare 461 has received ubiquity around the Commonwealth. Along with Salomon v. Salomon [1896] UKHL 1, [1897] AC 22, it has been served as staple diet for students of corporate law in these jurisdictions. My aim here is to identify the extent to which Foss continues to hold sway under Indian corporate law and, in particular, as compared to other Commonwealth jurisdictions.
Foss laid down two important rules. The first is the ‘proper plaintiff rule’, which is premised on the separate legal personality of a company. It states that where a wrong is alleged to have been done to the company (such as when the directors have breached their fiduciary duties), it is only the company that can initiate the legal action, and not the shareholders. The second is ‘majority rule’, which provides that it would be futile to allow a shareholder to commence legal action for an irregularity which can be cured by way of an approval of the shareholders (such as through ratification). Although the jurisprudence and literature tend to treat these as distinct rules, they are nothing but two dimensions of the same concept.
However, over the years, courts around the Commonwealth have found these rules to be rigid and have carved out a few exceptions to this rule. Primary among the exceptions is a situation where a wrong done to the company amounts to a ‘fraud on the minority’. Although the concept of a ‘fraud’ could lend itself to different meanings, it has generally been accepted in the context of Foss to be a scenario where the directors of a company have, through their acts or omissions, benefited themselves to the detriment of the company. In addition, fraud on the minority arises only when the wrongdoers (e.g., errant directors) are in control of the company, making it unlikely that they would exercise their control to cause the company to initiate a legal action against themselves.
Here, it is also important to make a key distinction between corporate wrongs and personal wrongs. A corporate wrong is one where the company is the victim of the wrongdoing, thereby providing it with a cause of action against the wrongdoer. If the company fails to bring such as an action, for instance due to the existence of wrongdoer control, a shareholder may bring a derivative action on behalf of the company. This must be contrasted with a personal wrong, where the shareholder is the victim of the wrongdoing and may bring a legal action personally (rather than through the company). This is an instance of a direct action brought by a shareholder. Examples include actions for oppression, prejudice and mismanagement contained in sections 241 and 242 of the Companies Act, 2013 as well as class actions in section 245 of the legislation.
With this background, I make two assertions in relation to the applicability of the Foss rules in India. First, these rules and their exceptions continue to operate with full force in India, more so than other well-known Commonwealth jurisdictions. Second, despite the availability of these rules in India, they are hardly used due to several constraints in their implementation. I elaborate on each of these assertions.
Continuation of the ‘Common Law’ Derivative Action in India
The fraud on the minority exception to Foss undergirds the ability of shareholders to bring derivative actions on behalf of the company either against directors or other wrongdoers. However, in recent decades, most Commonwealth jurisdictions have codified the derivative action mechanism into their corporate law statutes. India, however, remains an outlier. Even after the extensive revamping exercise that fructified in the Companies Act, 2013, shareholder derivative actions do not find any mention whatsoever in the legislation. Hence, derivative actions in India continue to be premised on the Foss rules and the fraud on the minority exception. Such actions are popularly referred to common law derivative actions (CLDAs).
Moving to other Commonwealth jurisdictions, the strength of the Foss rules and exceptions have either diminished or disappeared. The first category constitutes the law in Hong Kong, which is perhaps closer along the spectrum towards India. Although the Companies Ordinance has created a statutory derivative action (SDA), the CLDA is expressly preserved in section 732(6). Hence, to the extent that a shareholder can bring a CLDA in Hong Kong, Foss continues to play a role.
The second category comprises jurisdictions such as the United Kingdom (Companies Act 2006, Part 11, Chapter 1), Canada (Canada Business Corporations Act, Part XX) and Singapore (Companies Act, s. 216A), which have codified the SDA, but are silent as to whether CLDA is nevertheless available. This is usually left to the courts to decide based on an interpretation of the relevant statute. Some case law in this regard includes Universal Project Management Services Ltd. v. Fort Gilkicker Ltd. [2013] 3 All ER 564 (Ch) (UK) and Petroships Investment Pte Ltd v. Wealthplus Pte Ltd., [2106] 2 SLR 1022 (Singapore). In such cases, the applicability of Foss is substantially diminished, but arguably not eliminated.
The third category constitutes jurisdictions such as Australia (Corporations Act 2001, Part 2F.1A: section 236(3)), South Africa (Companies Act, 2008, Chapter 7, Part B: section 165(1)) and New Zealand (Companies Act 1993, Part 9: section 165(6)), which have codified the SDA, but have also gone as far as to explicitly exclude any applicability of the CLDA. In these circumstances, the relevance of Foss is arguably either minimal or non-existent, given that the codified SDA constitutes the entire universe for shareholder derivative actions. These jurisdictions represent the opposite end of the spectrum from India.
This short sojourn therefore clearly establishes that Indian remains steadfast in its adherence the Foss rules and exceptions, which has not eroded in any way, shape or form, as compared to other Commonwealth jurisdictions. This is because of the lack of a mechanism for SDA in India and the availability of only the CLDA.
Constraints in Implementing Foss in India
Despite the availability of the CLDA, evidence suggests that it is used rarely, as compared with other shareholder remedies such as oppression, prejudice and mismanagement. There are a number of reasons for this situation, as more fully discussed in a book chapter that Professor Vikramaditya Khanna and I authored a few years ago. A CLDA is brought before the regular civil court, usually as a representative suit under Order 1 Rule 8 of the Civil Procedure Code, 1908, thereby suffering from the associated delays and costs. Unlike other remedies, a pure CLDA claim may not gain access to the separate machinery for corporate law disputes, such as the National Company Law Tribunal and the National Company Law Appellate Tribunal. Moreover, the absence of clear codified rules regarding derivative actions leaves considerable discretion with the courts to decided using common law principles. This generates greater uncertainties in the resolution of such disputes. All of these reduce the incentives of shareholders to bring derivative actions, which explains their low incidence in India.
From a practical perspective, available case law in India indicates a lack of clarity in distinguishing between corporate wrongs and personal wrongs. Quite often, judicial time and energy are spent in identifying the nature of the claims brought before courts to sift out claims for corporate wrongs (e.g. derivative action) from those for personal wrongs (e.g. oppression, prejudice, mismanagement). This would also place a greater onus on the legal fraternity to discern the various types of suits to ensure that the right types of claims are agitated before the appropriate forums.
Conclusion
In all, as demonstrated above, the strength of the rules in Foss has not been dissipated in India. The celebrity status of the case continues to hold sway in the annals of Indian corporate law. However, for reasons briefly enumerated above, several constraints continue to mar its operation in the Indian legal milieu. One way to address the issues is by adopting an SDA, as other Commonwealth jurisdictions have done, but there does not seem to be any perceptible momentum in that directions. Hence, status quo is likely to be the order of the day.
Despite the status of Foss, it would be useful to bear in mind the observations of the Delhi High Court in The Industrial Credit & Investment Corporation of India Limited v. Parasrampuria Synthetics Ltd., (1998) I ILR 136 (Del):
A mechanical and automatic application of Foss vs. Harbottle rule to the Indian situations, Indian conditions and Indian corporate realities would be improper and misleading. The principles in the countries of its origin, owes its genesis to the established factual foundation of shareholder power … [which] is vastly different than the ground realities in our country. …
Therefore, the principle of Foss vs. Harbottle cannot be applied mechanically …
Indian courts, regulators and practitioners would do well to heed this caution.