Judgment in Vinelott v. P Case: Control, Fraud, and Derivative Actions in Corporate Law, Slides of Law

Download Judgment in Vinelott v. P Case: Control, Fraud, and Derivative Actions in Corporate Law and more Slides Law in PDF only on Docsity! DIRECTORS' DUTIES AND THE RULE IN FOSS v. HARBOTTLE PRUDENTIAL ASSURANCE CO. LTD. v. NE WMAN INDUSTRIES LTD.1 PRUDENTIAL ASSURANCE CO. LTD. v. NE WMAN INDUSTRIES L TD. (No. 2p,3 1. The Facts B and L were directors of two companies, N and TPG. B and L indirectly held 35 per cent-of the issued ordinary shares in TPG, which in turn held 25.6 per cent of the issued ordinary shares in N. B and L induced the board of directors of N to purchase TPG's main assets, allegedly at an over-valuation. In accordance with Stock Exchange regulations, the consent of N's shareholders was obtained, but by an allegedly "tricky" circular. P, which held 3.2 per cent of N's issued ordinary shares, sued N, B, L and TPG claiming: (a) as representative of itselfand the other shareholders at the time of the action, equitable damages on behalf of the company for breach of the defendants' fiduciary duty to N ("the derivative claim"), and (b) on behalf of itself alone, common law damages for conspiracy against B and L ("the direct personal claim"). Later P sought to amend its originating process to claim: (c) on behalf of itself and the other shareholders at the time of the alleged conspiracy, (i) a declaration of entitlement to damages and (ii) damages ("the direct representative claim"). 2. The Judgments - Overview In Prudential (No. 1)4 Vinelott, J . allowed P to amend its originating process even though each member of the class represented had a separate cause of action in tort. In such a case, however, this had to be for benefit of the class members, those members had to have a common interest and no actionable right could be conferred upon a class member who would not otherwise have been able to assert such a right. This last proviso meant that [1979] 3 All E.R. 507 (Vinelott, J.). 2 19801 2 All E.R. 841 (Vinelott, J.). [I9821 1 All E.R. 354 (Court of Appeal). Supra n. 1 . DIRECTORS' DUTIES 157 usually only declaratory relief was possible, with each individual proving his damage in separate actions in order to obtain damage^.^ Further, in Prudential (No. 2)6 it was held thatjoinder of the direct and derivative actions was permissible, because each was based on the same allegation, viz. that B and L conspired to injure N and its shareholders by procuring the shareholders to vote in favour of a res~lu t ion .~ Vinelott, J. had held that there was a good cause of action in conspiracy in the direct claims. In the second case he allowed the derivative action to succeed for damages of £445,000. The Court of Appeal, comprising Cumming-Bruce, Templeman and Brightman, L.JJ. partly allowed an appeal.8 Firstly (as ratio decidendi), they held that, on the evidence, N had suffered foreseeable loss of only £45,000.9 Secondly (by way of obiter dicta), they decided that the personal action was misconceived. This was because: (a) P's personal action was one to recover damages on the basis that P was interested in N which had suffered loss, P's damages being equal to the decrease in the market value of its shares or of likely dividend flow, but (b) shares are merely a right of participation in the company, and (c) that right was unaffected by a wrong done to N.I0 Such a holding is to be welcomed, for otherwise the rule in Foss v. Harbottle," discussed below, would be circumvented. Their Lordships did not refer to Vinelott, J.'s view on representative actions and on joinder of direct and derivative actions, so they must stand as good law, but the circumstances when the "same allegation" could create personal rights and corporate rights are now fewer. Thirdly, (by way of obiter dicta), their Lordships disapproved of Vinelott, J.'s handling of the derivative action. 3. The Derivative Action In an action in respect of a wrong done to a company, the proper plaintiff is, prima facie, the company (here N), under the "proper plaintiff' limb of the rule in Foss v. Harbottle.12 However, there is an exception where (a) there has been a fraud on the minority shareholders and(b) the wrongdoers were themselves in control of the company: the aggrieved minority (here P) can bring a minority shareholders' suit on behalf of themselves and all others to assert the company's claim.13 - 5 Id. 520. 6 Supra n. 2. Id. 860. 8 Supra n. 3. 9 Id. 374 ff. ' 0 Id. 366-7. 1 1 (1843) 2 Hare 461. 67 E.R. 189. 12 bid. ' '3 Edwards v. Halliwell[1950] 2 All E.R. 1064 a t 1067 per Jenkins, L.J. 160 SYDNEY LAW REVIEW did not mean that Page Wood, V.C. attributed any significance to the action having been fought out to a conclusion. Rather, the true basis for distinguishing East Pant Du United and Atwool is this: in the former, an action had been brought in the company's name, despite a resolution to the contrary, and so was dismissed; in the latter, an action was brought in the name of a shareholder and all other shareholders except the fraudulent directors. Thus only Atwool featured a derivative action and there the locus standi issue was raised but the action succeeded. This supports Vinelott, J.'s interpretation to the extent that the miscreants need not have a voting majority. (However, the cases do not support Vinelott, J.'s view, infra, that "use of wrongdoer's votes" is the fraud upon which to focus: rather Page Wood, V.-C. concentrated upon the fact that "the whole contract is a complete frauC.3') The writer concedes that "justice" is a nebulous criterion. However, Vinelott, J. had given it a concrete meaning in terms of de facto control. It might be said that this would still require more evidence at a preliminary hearing on locus standi than would de jure control and so could make the litigation-saving purpose of the rule in Foss v. Harbottle self-defeating. However, this is partly overcome by only requiring aprima facie case to be made out at the preliminary hearing. This is accepted practice elsewhere anyway, even if the subject-matter is complex, notably in the granting of interlocutory injunctions. If we were to extend to the present context the case law surrounding interlocutory injunctions, then the plaintiffs case must be aprima facie one in the sense that if the evidence remains as it is, there is a "probability" that at the final hearing the plaintiff would be held entitled to relief. However, the degree of probability required would depend upon the nature of the rights asserted and the practical consequences of any court decision; this may be considerably less than an even chance.32 This gives the court some (welcome) flexibility. Vinelott, J.'s view on control should be welcomed, because not to recognise that control is possible with a shareholding much smaller than fifty per cent would make it virtually impossible (short of liquidation and leaving aside statutory remedies), in the case of large public companies, to bring an action for breach of duty by the incumbent board. A board not in de jure control of the company could easily remain unchallenged in de facto control without calling a meeting to ratify what has been done.33 (c) Fraud What sort of "fraud" is required for the "fraud on the minority" exception to Foss v. Harbottle to apply? This question is linked with that of ratifiability by shareholders in general meeting of wrongs done to the company. The traditional view is that ratification is allowed and that an act 31 Id. 467. 32 Beecham Grou&Ltd., v. Bristol Laboratories Pry. Ltd. (1 968) 1 18 C.L.R. 6 18 at 620per Kitto, J., Sherclijjf v. gadme Acceptance Corporation Pry. Ltd. [I9781 1 N.S.W.L.R. 729 at 735-7 per Mahoney, J.A. (Glass and Samuels, JJ.A. concurring). B. A. K. Rider,"Amiable Lunaticsand the Rule in Foss v. Harbottle"[1978] C. L.J. 270 at 274. DIRECTOR'S DUTIES 16 1 is a "fraud" where the directors act malafide or where some "property" (legal or equitable) of the company has been misappropriated.34 The Court of Appeal made no reported remarks on the issue. Vinelott, J.'s observations were obiter, because counsel for the defendants had conceded that P's claim was founded on "fraudulent" acts.35 Vinelott, J. said: . . . there is no obvious limit to the power of the majority to authorise or ratify any act or transaction whatever its character provided that it is not ultra vires or unlawful and that the majority does not have an interest which conflicts with that of the company.36 Where there is a conflicting interest, Vinelott, J . said, the court will disregard the votes of shareholders who had an "interest which conflicts with the interests of the company".37 If there is a conflicting interest, the "fraud" lies in the use of voting power, not in the character of the wrongful transaction,38 reversing the traditional view.39 Vinelott, J. said that minority shareholders would have locus standi to sue (and the miscreant controllers would be unable to use their voting power to ratify a wrong to the company) whenever directors, even if acting in good faith, "are guilty of a breach of duty to the company (including their duty to exercise proper care) and as a result of that breach obtain some benefitW.40 He conceded that ratification of negligence by the wrongdoers using their votes was possible at least where the wrongdoers had not benefited from their breach of duty,41 but did not explain why the character of the transaction should matter here but not elsewhere. With respect, Vinelott, J.'s attempted remoulding of the law is in conflict with the authorities. Vinelott, J.'s view that, prima facie, any transaction (if not ultra vires or unlawful) can be ratified, conflicts with Atwool v. M e r r y ~ e a t h e r ~ ~ (see discussion supra), Re W. & M. Roith Ltd.43 and Mason v. Harris.44 Those cases suggest that majority ratification of "fraud" in the sense of a lack of bona fides is never possible. To assert that the votes of "interested shareholders" would be disregarded in ascertaining whether there was an effective ratification, Vinelott, J. had to explain away a number of cases, including Regal (Hustings) Ltd. v. Gulliver.45 Lord Russell of Killowen had said that the 34 Lord Wedderburn, "Derivative Actions and Foss v. Harbottle" (1981) 44 M. L. R. 202 at 205-6. 35 Supra n. 2 at 869. 36 Id. 862, emphasis added. 3' Id. 874. 38 Id. 862. 39 K . W. Wedderburn, "Shareholders' Rights and the Rule in Foss v. Harbottle" [I9581 C. L. J. 93 at 96. Supra n. 2 at 869. 4' Pavlides V. Jensen [I9561 Ch. 565, although on the facts of that case the directors may well have indirectly benefited -see J. Phelan "Challenging Director's Decisions - Daniels V. Daniels" (1981) 9 Syd. L.R. 447 at 452. 42 Supra n. 26. 43 [I9671 1 W.L.R. 432. I 4 (1879) 1 1 Ch. D. 97. 45 [I9671 2 A.C. 13411, [I9421 1 All E.R. 378. SYDNEY LAW REVIEW directors ". . . could, had they wished, have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting9'.46 Vinelott, J . said this must have meant that the defendant directors of Regal did not control a majority of votes, for otherwise the dicta would conflict with Cook v. Deeks.47 With respect, Vinelott, J.'s suggestion must be rejected. Firstly, the defendant directors of Regal probably did control the majority of votes anyway, in view of the editor's note in the report that this was "doubtless" the c a ~ e . ~ 8 Secondly, if the House of Lords in Rega149 had intended a proviso that the wrongdoers not control the vote, their Lordships would have said so explicitly.50 If not by Vinelott, J.'s method, how then do we reconcile Cook51 and RegaR52 Why was ratification: (a) not possible in Cook, where the (controlling) directors had diverted contracts to themselves, but (b) possible in Regal, where the directors had used corporate information to obtain secret profits? If corporate property includes "advantages" belonging to the c0mpany,~3 the traditional approach cannot provide a satisfactory reconciliation. Alternatively, we could choose"harm" as the test and say that whereas in Cook the directors profited at the company's expense, in Regal they profited without harming it.S4 However, this explanation has the problem of conflicting with Furs Ltd. v. Tornkies,55 where the High Court held that ratification could occur irrespective of whether the company is harmed. Ultimately the courts may have to concede that Cook and Regal are irreconcilable. In choosing between them, and in determining how to deal with "information" and "opportunities", it is to be hoped that the Australian courts will have cognisance of the American "corporate opportunity doctrine", noting however that the doctrine is more concerned with the scope of duties owed to the company than with questions of ratifiability of breach and standing to sue. Under the doctrine: . . . if the corporation has a present interest in the opportunity or an expectancy in the sense that it is an opportunity that it has begun to look for, or is an opportunity in which it has no present interest or expectancy but is one in which it might reasonably be expected to be interested given its present line of business, then the fiduciary must 46 Id. 150; 389. 4'[1916] 1 A.C. 554. 119421 1 All E.R. 378 at 379. 49 Supra n. 45. 50 Supra n. 34 at 210-1. 51 Supra n. 47. 52 Supra n. 45. 53 Burland v. Earle [I9021 A.C. 83 at 93. X4 L.C.B. Gower, Modern Company Law (4 ed . , 1979) at 618. 55 (1936) 54 C.L.R. 583.