MAJORITY RULE AND
MINORITY PROTECTION
By S N NGARE
INTRODUCTION
• The first example of the majority rule is seen in ordinary
and special resolutions.
• The second example of majority rule is the rule in Foss v
Harbottle (1843)67 E.R.189. The rule is to the effect that,
subject to certain exceptions, if a wrong to a company is
alleged, or if there is an alleged irregularity in its internal
management which is capable of confirmation by a simple
majority of the members, the court will not interfere at the
suit of a minority of the members.
EXERCISING MAJORITY CONTROL
• Although the directors of a company owe fiduciary duties to the
company, shareholders do not. When voting, a shareholder may
consult his own interests. A share is a piece of property which is to be
enjoyed and exercised for the owner’s personal advantage. Thus a
shareholder may bind himself by contract to vote in a particular way.
• This right to vote has, however, always been subject to the doctrine of
fraud on the minority so that the majority cannot waive a breach of a
director’s fiduciary duty by approving a misappropriation by him of
the company’s property which would be a fraud on the minority.
Cont…
• That is what the majority tried to do in Cook v Deeks [1916]
1 A.C.554.
• Also, members cannot, by resolution in general meeting,
expropriate the company’s property.
• Controlling majority shareholders of a company do owe a
duty to the company to act bona fide for the benefit of the
company as a hole and not to commit a fraud on the minority.
Thus, the majority do not have unrestricted voting rights if it
is “unjust” in the particular circumstances.
Cont…
• The majority shareholders duties may not be limited to just fraud on
minority but can extend to “ unjust voting rights” depending on the
particular circumstances. In Clemens v Clemens Bros Ltd [1976] 2 ALL
E.R.268 the defendant owned 55 per cent of the issued shares of a
family company. She was one of the five directors and proposed to
give the other directors shares and to set up a trust for long-service
employees. The plaintiff, who was the defendant’s niece, held 40 per
cent of the shares and was not a director. The defendant proposed
resolutions to increase the capital so that the plaintiff’s shares would
fall below 25 per cent of the total and her right to veto special
resolutions would be lost.
Cont…
• It was also clear that she would never now obtain control of the
company. It was held that the defendant was not entitled to exercise
her majority votes as an ordinary shareholder in any way she pleased.
That right was subject to equitable considerations which could make
it unjust to exercise them in a particular way. In this case such
considerations applied and the resolutions would be set aside.
• In Estmanco (Kilner House) Ltd v Greater London Council [1982]1 ALL
E.R.437 Megarry V.C., accepted the general proposition that …
Cont…
• … the shareholders do not owe any fiduciary duties but affirmed that
in altering the articles they are subject to the doctrine of fraud on the
minority, i.e. they must act in what they believe to be in the best
interests of the company as a whole. In that case the majority
shareholder wished to deprive the company of a right of action under a
contract and proposed, and carried, a resolution to that effect. A
minority shareholder sought to bring an action on behalf of the
company to prevent this. Megarry V.C. considered the situation thus:
Cont…
“ Plainly there must be some limit to the power of the majority to pass
resolutions which they believe to be in the best interests of the company
and yet remain immune from interference by the courts. It may be in the
interests of the company to to deprive the minority of some of their
rights or some of their property, yet I do not think that this gives the
majority an unrestricted right to do this, however unjust it may be, and
however much it may harm shareholders whose rights as a class differ
from those of the majority,”
Cont…
• In Re Swindon Town Football Club Ltd [1990]B.C.L.C.467. Harman J.
said that the general rule that shareholders are entitled to vote in their
own interest remains the law and is the correct proposition, even
though it has not been followed on every modern occasion, notably in
Clemens v Clemens Bros LTD [1976] 2 ALL E.R. 268. The judge also
accepted the proposition that “ the company is entitled to consider
lawful resolutions, however silly, and, if thought fit, to pass them, and
it is not for the court to tell the company that it should not be
silly.”[1990] B.C.L.C. 467 at 469.
Cont…
• On the other hand, the courts do retain an
inherent power to grant an injunction to prevent a
shareholder from voting with his shares if there
would otherwise be substantial injury to the
company, or to protect secured creditors from
destruction of the secured assets. See Standard
Chartered Bank v Walker [1992] B.C.L.C.603.
DERIVATIVE SUITS(ACTIONS)
• The general rule as to who should bring a claim when
a company is wronged is that the company itself is the
proper party. The company as an artificial person has
no mind or hands of its own and thus can only take
proceedings with the aid of a natural person even if
that natural person must use the name of the company
while instituting or defending a suit.
11
Cont…
• The company acts through its directors who have
specific powers bestowed upon them by the articles
and who also oversee implementation of resolutions
passed in general meetings. Resolutions passed in
general meetings are basically decisions by the
majority of the members of the company. Thus in the
landmark case of Foss v Harbottle[1843]2 Hare, 461
the court laid two principles …
12
Cont…
…namely, (a) the proper plaintiff principle who is the
company and(b) the majority principle, or the indoor
management principle by which the company operates
under the will of the majority shareholders.
• The proper plaintiff principle is justified on grounds
that it avoids floodgates of litigation/multiplicity of
suits.
13
Cont…
• The majority principle is justified on grounds that the
majority can rectify any wrongs done to the company by way
of resolutions.
• Problems arise where a company suffers harm or is likely to
suffer harm by reason of actions of the directors or the
majority shareholders. In this instance it would be futile to
expect the directors to take action to safeguard the company
since they would be incriminating themselves.
14
Cont…
• It is for this reason that courts allow an
individual shareholder to sue as a representative
of other shareholders, other than those who have
wronged the company, and which is an exception
to the rule in Foss v Harbottle and this was
recognized in the landmark case of Edwards v
Halliwell[1950]2 ALL ER 1064.
15
CONT…
• While it was initially an exception to the rule in Foss v
Harbottle, the derivative action has now been codified
under part XI of the companies Act 2015. The Act
borrows heavily from the UK Act of 2006. The
companies Act has basically borrowed the common
law exceptions to the rule in Foss v Harbottle but it
can now be said that the Act has limited the exceptions
to the instances laid down in the Act.
16
Cont…
• The Act defines a derivative claim as proceedings
brought by a member of a company in respect of a
cause of action vested in the company and seeking
relief on behalf of the company. To have locus standi
one must be a member but it does not matter whether
one was a member or not at the time when the wrong
alleged was committed. The cause of action must be
vested in the company.
17
Cont…
• This means that while it is a member who brings the
derivative claim, such member will be seeking relief on
behalf of the company for a wrong that was suffered by the
company. Consequently any awards made by the court will
go to the company itself and not the member who brought the
derivative action. The member may be indemnified by the
company for the costs of the suit. The suit must be seeking
relief on behalf of the company.
18
Cont…
• Under common law the exceptions are as follows:
1. Ultra vires acts.
• While a company, through the general meeting of
shareholders, can ratify the acts of directors, the
ratification cannot be extended to acts that are
outside the scope of the company’s powers as
provided by its articles and the Companies Act.
19
Cont…
2. Requirement of a special majority.
• This exception applies when the articles provide for
anything to be done by a special majority but the
company purport to act pursuant to a resolution of a
simple or ordinary majority. If this is done a member
can sue in his own name to safeguard violation of the
company’s constitution.
20
Cont…
3. Fraud by those in control.
• Just as in the case of ultra vires acts, fraud cannot be
ratified by the majority. Those in control of the
company may commit fraud against it and in that case
they will either not bring any proceedings on behalf of
the company or they may institute a sham claim so as
to shield themselves from personal liability.
21
Cont…
• In cases of fraud by those in control of the company, who are
basically directors, individual members can sue for the
benefit of the company. Read Prudential Assurance Company
v Newman Industries[1980]2 ALL ER 341.
4. The personal rights exception.
• The personal rights exception arises where a company
infringes the rights of a member or members of the company
where such rights are provided for by the company’s
constitution.
22
Cont…
• In such instances, as the company is unlikely to bring a suit
on behalf of the aggrieved shareholder, the aggrieved
shareholder can bring an action for his own behalf or for his
own behalf and also on behalf of other aggrieved
shareholders whose rights have been infringed by the
company.
• The above common law exceptions are incorporated in the
Act which provides that a …
23
Cont…
…derivative claim may only be brought in respect of a cause
of action arising from an actual or proposed act or
omission involving negligence, default, breach of duty, or
breach of trust by a director of the company.
• A member must seek leave of court in order to continue with
a derivative claim. The Uk statute of 2006 provides that leave
must be sought before instituting the derivative action…
24
Cont…
…but the Kenyan Act is silent as to the time of applying
for leave i.e. whether before lodging the suit or after
lodging the suit or both procedures are equally correct.
The courts decisions are contradictory- some insist
leave must be obtained before filing the derivative
claim – see Atlaf Abdulrasul Dadani v Amini Akberazi
Manji & 3 others[2004]eKLR .
25
Cont…
• Others hold that leave should be obtained after filing the
claim -see
In the Matter of CMC Holdings Limited[2012]eKLR &
Jane Wambui Weru v Overseas Private Investment
Corporation[2012]eKLR.
• The application for leave is made ex parte and the applicant
must demonstrate a prima facie case .
26
Cont…
• A members application for leave to continue with a derivative
claim would be denied where the actual or proposed breach
of duty has been authorized or ratified by the company or
where a person exercising independent judgment would not
seek to continue the claim-s241.
27
Cont…
• A member can apply for leave to continue a claim
brought by the company on grounds that the manner in
which the company commenced or continued with the
claim amounts to an abuse of the court process; the
company has failed to prosecute the claim diligently
and it is appropriate for the member to continue the
claim as a derivative claim.
28
CRITIC OF THE PROVISIONS OF THE ACT IN RESPECT
OF DERIVATIVE SUITS.
1. Requirement of a prima facie case before leave is granted
may create unnecessary barrier to members who intend to
bring a derivative claim. The evidential threshold required
to establish a prima facie case is not indicated in the Act.
2. A director is mandated under the act to make independent
judgment in promoting the objects of the company- s 144.
The repealed Companies Act did not have this provision.
29
Cont…
• If a company suffers loss as a result of exercise
of such independent judgment then the director is
not liable provided he acted in good faith and no
derivative action can be entertained. What
constitutes good faith here is not clear and a
director with always seek refuge on this
provision to defeat a derivative action.
30
Cont…
3. The requirement of good faith in bringing a derivative action is
another shortcoming in the Act. Good faith is not defined in the Act
and hence it is left to the discretion of the judge in deciding the
application for leave. Discretionary powers are prone to abuse .
4. In respect of costs the Act does not make provision on who should
pay the costs of a derivative suit. This may deter members in bringing
derivative suit for lack of certainty as to whether the court would order
the company to meet such costs.
5. Failure to stipulate the time of seeking leave, i.e. whether before or
after filing suit.
31
PROSPECTUS,STATEMENTS IN LIEU OF PROSPECTUS AND
INFORMATION MEMORANDUM
• The Companies Act,2015 does not define the term
“prospectus” or provide for their form or content.
Nonetheless the term refers to any notice, circular,
advertisement or other invitation offering to the public
for subscription or purchase of any shares or
debentures of a company. It includes any document
containing offer of shares or debentures for sale.
32
Cont…
• A public company may raise capital by either selling its
shares to the public or borrowing money from the public by
issuing bonds.
• The company’s offer for shares to the public is once accepted
constitutes a binding contract governed by the general law of
contract.
• The prospectus ought to disclose inter alia information on
the issuer’s assets and liabilities, its financial position, profit
and losses e.t.c.
33
Cont…
• The current Act , unlike the repealed Act does not prescribe
the form and contents of a prospectus, but it is expected that a
prospectus would :
(i)Every prospectus be dated, failing which the date
may(unless the contrary is proved) be presumed to be the
date of publication of the prospectus to lend clarity to the
particular date on which the invitation was made and of the
subsequent offer and acceptance resulting in the contract of
allotment;
34
Cont…
(ii) Names of directors and their remuneration and other
benefits;
(iii) The profits made by promoters in their pre-incorporation
contracts;
(iv)The amount of capital required by the issuing company to
be subscribed;
(v)The amount actually received or to be received in cash;
35
Cont…
(vi)The company’s obligations under any existing contracts;
(vii)The voting rights of every class of shareholders; and
(viii) The company’s financial status.
• Every prospectus should be signed by all directors or
proposed directors of the company and delivered to the
Registrar for registration before the date of its publication
and issue, failing which registration may be denied.
36
Cont…
• In case of a foreign company the prospectus should disclose:
(i)The instruments constituting or defining the constitution of
the company;
(ii)The legislation or provisions having the force of law by or
under which the company was incorporated;
(iii) The address in Kenya at which such instrument and
legislation or provisions, or copies thereof, can be inspected;
37
Cont…
(iv) The date on which, and the country in which, the company
was incorporated and
(v) Whether the company has established a place of business in
Kenya and,if so, the address of its principal office in Kenya.
• The contents of a prospectus must be true otherwise the
company issuing and its officers can be liable in criminal law
for fraud or in tort for negligent misstatements or deceit.
38
Cont…
• In case of a false prospectus an allottee may also apply to
repudiate the contract.
• If an allottee suffers damage as a result of relying on the false
prospectus he can sue for damages.
• It is immaterial in the first instance whether the
misrepresentation was innocent or motivated by malice or
bad faith. It is not the allottee’s duty in any case to verify the
truth or accuracy of any statement contained in the
prospectus.
39
Cont…
• Liability does not accrue under a false prospectus if an
allottee knew of the falsity. The false statement must also be
material in inducing the allottee to enter into the contract.
• A private company can be converted into a public company
and once that is done it can issue a statement in lieu of a
prospectus inviting subscriptions from the public for its
shares or debentures. The contents are the same as those of a
prospectus and there is no prescribed format of such a
statement.
40
Types of debentures
(i) From the point of view of security.
(a) secured debentures-refer to those debentures
where a charge is created on the assets of the issuer
company to pay its creditors in case of default. The
charge may be fixed or floating. A fixed charge is
created on a specific asset whereas a floating charge
is on the general assets of the company.
41
CONT…
• The fixed charge is created against those assets which are
held by a company for use in operations not meant for sale
whereas floating charge involves all assets excluding those
assigned to the secured creditors. A fixed charge prohibits a
company from selling or dealing with the charged asset
without permission from the charge holder/debenture holder.
(b)Unsecured debentures
They do not have a charge on the assets of the company.
42
CONT…
• ii) Fromthe point of view of tenure
(a) redeemable debentures- are those which are
payable on the end of the specified period either in
lump sum or in installments during the lifetime of the
issuer company.
(b) irredemable debentures- also known as perpetual
debentures are payable on the winding up of a
company.
43
CONT…
From the point of view of convertibility
(a)Convertible debentures – are debentures which are
convertible into equity shares or in any other security
either at the option of the company or the debenture
holders. The debentures are either fully convertible or
partially convertible.
(b) Non-convertible debentures
44
CONT…
• These are debentures which cannot be converted into shares
or in any other securities. Most debentures issued by a
company fall in this category.
(iv) From coupon rate point of view.
(a) Specific coupon rate debentures
These debentures are issued with a specified rate of interest,
which is called coupon rate. The specified rate may either be
fixed or floating. The floating interest rate is usually tagged
with the bank rate.
45
CONT…
(b)Zero coupon rate debenture
These debentures do not carry a specific rate of interest.
In order to compensate investors, such debentures are
issued at substantial discount and the difference
between the nominal value and the issue price is
treated as the amount of interest related to the duration
of the debentures.
46
Power to appoint a receiver
• If a company defaults under the terms of a debenture, the debenture
holder’s right to recover the money owed to them may include
appointment of a receiver in accordance with the terms of the
debenture.
• The receiver’s task is to take possession of the assets that are subject
to the charge and may dispose them to pay what is due to the
debenture holder, together with interest and costs. Once this is
achieved the receiver retires from office and the company is allowed
to carry its business again.
47
