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Citation: 45 Cambridge L.J. 219 1986

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Cambridge Law Journal. 45(2), July 1986, pp. 219-246Printed in Great Britain

THE RELATIVE NATURE OF ASHAREHOLDER'S RIGHT TO ENFORCE THE

COMPANY CONTRACT

R. R. DRURY*

A. INTRODUCTION

1. The Company as a Contract

It may be rather misleading' to those wanting a practical definition toconclude, as Frank Evans rather hesitantly did in 1910, that2 "Acompany is an association of two or more individuals united for one ormore common objects." Nevertheless such a description can be usefulto a legal theorist searching for the bonding force which unites theparticipants in a company. Companies are voluntary associations, inthe sense that nobody can make you join one, and the hallmark of suchassociations, where a legal relationship exists between their members,is contract. The mechanics for creating such a contract are found in thewords of section 1(1) of the Companies Act 1985, which provides that,

Any two or more persons associated for a lawful purpose may, bysubscribing their names to a memorandum of association andotherwise complying with the requirements of this Act in respectof registration, form an incorporated company.

Once registered, these documents undoubtedly do have contractualforce because section 14(1) of that Act provides,

Subject to the provisions of this Act, the memorandum andarticles, when registered, bind the company and its members tothe same extent as if they respectively had been signed and sealedby each member, and contained covenants on the part of eachmember to observe all the provisions of the memorandum and ofthe articles.

3

Lecturer in Law, University of Exeter.Just how misleading can be judged from the comments in Gower's Principles of Modern CompanyLaw, 4th ed., (1979) at pp. 9-1I.

2 Frank Evans, "What is a Company?" (1910) 26 L.O.R. 259 at p. 263. The reason for his hesitationcan be seen both in the enormity of his question, and from the full text of his conclusion which is asfollows, "A company is an association of two or more individuals united for one or more commonobjects, which, whether incorporated or unincorporated, is (a) in the Act or charter by or underwhich it is constituted, called a 'company' or (b), if it is not so constituted and called, is not anordinary partnership, or a municipal or non-trading corporation, or a society constituted by orunder a statute, but an association whose members may transfer their interests and liabilities in orin respect of the concern without the consent of all the other members."The wording of s. 14 reproduces with very minor modifications that of s.20 Companies Act 1948,with reference to which most of the learned articles cited in this work were written.

The Cambridge Law Journal

The contract embodied in these documents, which in this work willbe referred to as the "company contract," is central to ourunderstanding of the internal workings of companies. Relationshipsbetween shareholders inter se, and between shareholders andcompany, can all be seen as depending essentially on this contract.Certainly, statute and the common law intervene, by supplementing orregulating incidents of these relationships in specific and possiblyunrelated instances. But nevertheless it must be the case that no othermodel as satisfactorily describes the relations within a company as theclassical contractual model.

Very little has been written on the contractual foundations ofcompanies in English law, but in other jurisdictions, particularly theFrench, there is an extensive literature.4 Indeed, the form ofassociation common to French companies and partnerships alike, thesociete, is described in Article 1832 of the Civil Code as a contract.However, to take account the increasing incursions of the legislatureinto the freedom of choice inherent in contract, the French havedeveloped the theorie de l'institution as a model to explain the juridicalform of the public company and, to a somewhat lesser extent, theprivate company. 5 However, lacking such refinement in our own legalwritings, it will suffice for the purposes of this article to assert that thelegal structure of English companies can be represented as beingfounded on contract.

2. The Use of Contractual Techniques

Having described the company as a contract, it is then necessary toask whether it is entirely safe and accurate to use normal contractualtechniques as an analytical tool in relation to companies. It has beenforcefully argued by Professor Macneil that what we can call basic orclassical contract law is geared to regulating what it perceives as"discrete transactions, -'' -that is, single instance contracts viewed inisolation. He describes the function of litigation in such a system asbeing, 7 "to put an end to the dispute; and, since resolution of the

See for example Droit Commercial-G. Ripert. par R. Roblot, 8th ed. (1974) at pp. 422-425. 456et seq., 622-626 and the works there cited.See Roblot, op. cit., at pp. 423-425; R. R. Drury, "Legal Structures ofSmall Busincsses in Franceand England Compared" (1978) 27 I.C.L.Q. 51) at pp. 517-520. Sec also F. Derrida. "De ]anature juridique des socidtds par int6rfts depuis la loi du 24 juillct 1966", in MWanges Audinet(1968) at p. 43; Derrida, Melanges Cabrillac. at p. 125; Hamel ct Lagarde, Trait de DroitCommercial No. 385; Cour d'appcl de Paris, 26 mai 1966, R.T.D. Com. 1966. 349, obs. Houin.Indeed, some French thinking has gone further still and developed a wider "thorie delentreprise. "Not pure discrete transactions in an economist's sense, but at least transactions regarded as beingof a "one-off" nature. See pp. 856-859 of the work next cited.I. A. Macneil, "Contracts: Adjustment of Long-Term Economic Relations Under Classical,Neo-Classical. and Relational Contract Law," (1978) 72 North Western University Law Review854 alp. 891.

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A Shareholder's Right

dispute is all that remains of the discrete transaction, the process is arelatively simple and clean one. This process is rather like the discretetransaction itself: sharp in (by commencing suit) and sharp out (byjudgment for the defendant or collection of a money judgment byplaintiff)." He refers to the work of Professor Chayes who, indescribing the traditionally accepted model of civil litigation said,8

"The lawsuit is bipolar. Litigation is organised as a contest betweentwo individuals or at least two unitary interests, diametrically opposed,to be decided on a winner-takes-all basis." Macneil concludes, 9

"Naturally, no such model will do when the relation is supposed tocontinue in spite of the dispute, and where a main goal must always beits successful carrying on after the dispute is resolved or otherwiseeliminated or avoided."

Other writers have seen the significance of this for businesscontracts. Macaulay, on the basis of an empirical survey of contractsbetween manufacturers in Wisconsin, states that,"' "A breach ofcontract lawsuit may settle a particular dispute, but such an actionoften results in a 'divorce' ending the 'marriage' between the twobusinesses, since a contract action is likely to carry charges with at leastovertones of bad faith." The remedies that the law provides for breachof contract, such as damages, specific performance and injunction, donot really take account of the fact that the contracting parties may wishto do business with each other again. Therefore resort to theseremedies may well be an available option only if future businessrelations between the parties are not contemplated, or have been givenup.

The result of this has been that many commercial firms just do notconsider taking legal action to resolve a dispute with another company.Beale, partly on the basis of his study of engineering manufacturers'contracts in the Bristol area,'' offers one explanation for thisindifference among manufacturers to the use of contractual remedies.He says that,' 2 "while the law regards each contract as a separate thingnormally irrelevant to any other contract, in practice an individualcontract may be just one small part of a much larger commercialrelationship between manufacturers who are doing business with eachother on a regular basis." He points out that the existence of along-term relationship limits the usefulness of some contract

Prof. A. Chaycs, "The Role of the Judge in Public Law Litigation, (1976) 1l1av.L.Rcv. 1281 atp. 1282.Op. cit., at p. 891.S. Macaulay, "Non-Contractual Relations in Business: a Preliminary Study," (1963)28 AnericanSociological Review 55.Beale and Dugdale, "Contracts between Businessmen: Planning and the Use of ContractualRcmcdies," (1975) 2 British Journal of Law aind Society 45.

1_ Hugh Beale, Remiedies for Breach of Coniract (1980). at p. 5.

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remedies, 13 "For instance terminating a contract or claimingunliquidated damages for delay may be so costly in terms of thedisruption and ill-feeling caused, as to be not worthwhile except in veryserious cases." Hence there has been a need to develop othercontractual and non-contractual remedies to resolve disputes, whichdo not risk terminating the long-term relationship. Thus expresslyplanned remedies, such as withholding performance, incentiveprovisions and liquidated damages, assume a greater prominence inthis area than they do in the general run of contracts. The existence of along-term relationship, therefore, brings with it the need for a specialapproach to contracts in which less reliance is placed upon litigation asa means of resolving disputes, and correspondingly greater emphasis isput upon other methods.

3. The Company as a Long-Term Relationship

The concept of a long-term contractual relationship exactly fits thecontract that underlies the workings of companies. The parties arebound up in the same enterprise, and thus have to "do business" witheach other over a long period of time. They thus have an interest in thecontinuance of this relationship. In addition, the respective rights andinterests of the parties to the contract may change considerably duringits existence. For example, a majority shareholder may sell part of hisholding and recede into the minority, amalgamation may bring in newshareholders with different interests, and so on. Accordingly,therefore, any analysis of the company contract which says that itsobject is to give the parties inviolable rights which can be protected bylitigation, as if they were involved in a discrete transaction, completelyfails to take account of the long duration and changing nature of therelationships involved.

Company law has had to have, as one of its primary functions, theprovision of machinery to adjust the changing rights and interests ofthe participants. One example, which emphasises the overwhelmingneed for flexibility, is the fact that the very .provisions of the contractitself are not sacrosanct and immutable. Company law has developed away in which the terms of the contract can be altered to meet changingcircumstances. Alteration of the articles of association is madepossible, not by scrapping the old contract and making a new one withthe consent of all the participants, as a classical contract model mightsuggest, but by machinery which in this country requires theagreement of only three quarters of those shareholders present at aparticular meeting. Flexibility therefore is built in, but with certainsafeguards such as rules governing variation of class rights, entrenched

"3 Ibid., at p. 213.

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clauses and rules relating to the oppression of the minority, to preventor limit in some way what is perceived to be taking undue advantage ofthe contract-changing machinery. The resolution of other disputes,too, is catered for by the general principle of majority rule, offset in itsturn by exceptions to the Rule in Foss v. Harbottle14 and by certainstatutory protection for minority shareholders. 15

One can therefore properly understand the functions of and thelimitations on the company contract only when it is considered as along-term relationship and placed in its company law setting. Certainlythis contract gives rights and imposes obligations, but these are subjectto some limitations in respect of enforcement in a court of law for thereasons indicated above. This is demonstrated by two cases in which aclassical contract remedy was refused because of the special nature ofthe company contract. In Evans v. Chapman16 a printing error was bymistake included in the articles of a company. An action was broughtseeking rectification of the document, but the court held that it had nojurisdiction to rectify a document of this nature, and that the correctway to put the matter right was to alter the articles by the company lawmachinery provided to that effect. This decision was upheld in the latercase of Scott v. Frank F. Scott (London) Ltd 17 where again the specialnature of this contract was recognised. In a long-term relationshiparising under such a contract it can be argued that providing a forumfor the dispute, such as the general meeting, and leaving the decisionon whether to litigate to be settled according to the will of the majority,is in many cases ultimately going to be more effective in promoting thecontinuance of that relationship than allowing an individualshareholder unlimited access to what might be described in trans-Atlantic terms as the "discrete transaction oriented dispute-solvingmachinery" of the courts. 18

B. THE EXTENT OF A SHAREHOLDER'S RIGHT TO ENFORCE THE

COMPANY CONTRACT

1. The Relational Approach

We arrive therefore at a position where the contract underlying thecompany, manifested in its memorandum and articles, is one whichforms the basis for a long-term relationship. It is the theme of this

v (1843) 2 Hare 461; see infra.Such as ss.517(l)(g) and 459-461. Companies Act 1985.

'6 (1902) 86T.L.R. 381.

'7 119401 Ch. 794."s See Roshier and Teff. Law and Society in England (1980), at p. 169. where they say that. "in some

contexts, more particularly where parties have a continuing relationship, all-or-nothingdetermination, far from effectively resolving a dispute, may serve to exacerbate it. To achieve atrue 'settlement,' or at least an acceptable compromise, techniques of conciliation and mediationcan sometimes be more suitable."

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article that it is comprehensible as a contract only if one views it in thecontext of the rules that company law has evolved for adjustingdifferences and solving disputes. The rights given to a member by thiscontract are not necessarily absolute ones. They cannot be seen inisolation but only in relation to the rights enjoyed by the othermembers.

It is suggested that a conscious presentation of the issues involvedin a given dispute, in terms of the relative rights of the participants inthe company contract, leads to a better appreciation of the mosteffective route to a solution. Existing techniques concentrate on aparticular right enjoyed by a member, and seek to determine from itsnature alone whether it can or should be enforced. Hence it becomesclassified as an insider right, outsider right, personal right, proprietaryright and so on. These techniques have not produced a universallyaccepted approach.

For example, in trying to lay down one general rule governing theenforcement of a member's rights under the company contract, LordWedderburn has stated that, 19 "[Tihe proposition is that a member cancompel the company not to depart from the contract with him underthe articles," and that, "each member has a primafacie right to enforceby injunction and declaration, 'in aid of his legal right,' every provisionof the contract found in the articles." This has proved to be a verycontroversial proposition and has run into difficulties in two areas inparticular. These areas relate to the problem of "outsider rights" andto the effect of the Rule in Foss v. Harbottle on internal proceduralirregularities. There has been little agreement on the best way ofdealing with these difficult areas or on fitting them into a generaltheory governing the company contract.

If one adopts what could be described as a relational approach, onecould propose that the right of any one shareholder to enforce aparticular term of the company contract should be considered in thelight of the rights of the other shareholders in that company. Thesewould be rights to enforce any alternative or conflicting terms of thatcontract, to alter its terms and also, where it is appropriate for a simplemajority to do so, to condone or regularise any breaches of thatcontract. If in a given fact-situation there are no alternative orconflicting terms, and there is not a three-quarters majority who wishto change the articles, and either there is no majority who wish tocondone the breach or the matter is one which it is inappropriate tosubmit to the majority, then our shareholder should have no barrier tohis right to enforce that particular term. However, if one or more of

K. W. Wcddcrburn, 'Shareholders' Rights and lie Rule in Iossv. Harbottle" 119571C.L.J. 194 atpp. 212 and 214 respectively. The article is concluded at 119581 C.L.J. 93.

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these factors are encountered then it is suggested that the matter is bestreferred initially to the company's internal dispute-resolutionmachinery. This machinery is provided by the company contract itselfand by the framework of law which supports it, and is thus acomponent part of the rights of the participants in that contract. Anysubsequent court decision which, in the circumstances envisaged, failsto take account of any actual or presumed finding of that machineryruns an increased risk of prejudicing the long-term relationship uponwhich the company concerned is founded, and failing to do full justiceto the respective rights of the members of the company.

A number of examples can be given of the court's desire to takesuch findings into account, to the extent that where no satisfactoryreference has been made to the internal dispute-resolution machinery,the court will endeavour to ensure that one is made. These examplesrange from the dicta of James L.J. in MacDougall v. Gardiner2"through Danish Mercantile Co. Ltd. v. Beaumont2 l to Hogg v.Cramphorn,22 which is perhaps the best known. In the last caseBuckley J. stood the action over to allow the directors to call a generalmeeting and stated, "I will consider what order I should make in thelight of the proceedings at any such meeting."

In order to explain the relational approach more fully, and todemonstrate its application, it is proposed to look at the two problemareas where conventional techniques, which concentrate on the natureof the individual shareholder's right, have been applied. Thus theissues of outsider rights and internal procedural irregularities will beinvestigated in turn.

2. Outsider Rights

(a) The Problem

The outsider rights problem briefly stated is this. There exists oneline of cases, perhaps best represented by Salmon v. Quin & AxtensLtd 23 which supports the proposition that a member can bring anaction in certain circumstances to require the company to adhere to itsmemorandum and articles, i.e. to perform its part of the section 14contract. But there is a second line of cases typified by Eley v. Positive

25 (1875) 1 Ch. D. 13 at p. 22, where he said, "Any one of the shareholders might have filed his bill in

the name of the company, and then if the directors had said, 'You arc not the company: themajority do not act with you, but with us'-the court would, as it has done in other cases, havetaken the means of ascertaining which party it is, the Plaintiff's or Defendant's, which reallyrepresents the majority of the company."

2 1 11951] Ch. 680, where on a similar point Jenkins L.J. said, at p. 687, "It is common practice in suchcases to adjourn any motion brought to strike out the company's name, with a view to a meetingbeing called to see whether the company desires the action to be brought or not."

22 [1967] Ch. 254, esp. at p. 272.23 [1909] 1 Ch. 311, affd. sub nom. Quin & Axtens Ltd. v. Salmon 119091 A.C. 442, H.L.

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Government Security Life Assurance Co. 24 (Eley's Case) which appearsto say that if the articles purport to give a right to an individual in acapacity other than as a member, e.g. as solicitor or director, thatindividual cannot bring an action to enforce his right by claiming thatthe articles constitute a contract with him in his capacity as a member.Thus it has been argued that a member cannot enforce all the terms ofthe section 14 contract, but only those which relate to him in hiscapacity as a member.

These two lines of authority vere reviewed by Astbury J. in thecase of Hickman v. Kent or Romney Marsh Sheep-Breeders'Association25 (Hickman's Case). Of the latter line of authorities hesaid, 26 "An outsider to whom rights purport to be given by the articlesin his capacity as such outsider, whether he is or subsequently becomesa member, cannot sue on those articles treating them as contractsbetween himself and the company to enforce those rights." While ofthe former line of authority he said, 27 "It is also clear from manyauthorities that shareholders as against their company can enforce andrestrain breaches of its regulations."

He found it difficult to reconcile these two lines of decisions andultimately contented himself with making one uncontestable point,"that no article can constitute a contract between the company and athird person" and then restating the two conflicting propositions. Hisview was28 that articles regulating the rights and obligations of themembers generally as such do create rights and obligations betweenthem and the company respectively, but that if the right is given to aperson in another capacity it cannot be enforced-it is an "outsiderright."

(b) Some Proposed SolutionsSeveral efforts have been made to find a solution to this problem.

The one proposed by Lord Wedderburn concentrates upon thecapacity in which the plaintiff brings his action. He argues, 29 "that amember can compel the company not to depart from the contract withhim under the articles, even if that means indirectly the enforcement of'outsider' rights vested either in third parties or himself, so long as, butonly so long as, he sues qua member and not qua 'outsider.'"Appealing though this proposition is, it conflicts with the views

24 (1875) 1 Ex.D. 20, affd. (1876) 1 Ex.D. 88.25 [19151 1 Ch. 881.26 Ibid., at p. 897.7 Ibid.. at p. 898.

2X Ibid., at p. 900.29 [1957] C.L.J. 194 at p. 212, and subsequently in a number of case notes [1958] C.L.J. 148, [1959]

C.L.J. 137 and (1965) 28 M.L.R. 347.

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expressed in Hickman's Case and it appears contrary to the decision inEley's Case.30

A subsequent effort was made by Gordon Goldberg31 to reconcilethe conflicting lines of authority. He sought reconciliation by asomewhat idiosyncratic, if well argued, interpretation of thepredecessor of section 14 in terms that the contract in thememorandum and articles does not extend to all the provisions ofthose documents, but only confers on a member3 2 "a contractual rightto have any of the affairs of the company conducted by the particularorgan of the company specified in the Act or the company'smemorandum or articles." "Outsider rights" would under thisargument only be enforced where these are incidental to the member'sright to have the company's affairs conducted by the appropriateorgan. Unfortunately, no convincing explanation was given of why ashareholder's right to enforce the contract should be qualified in thisway nor why the clear wording of section 14 should be so limited. Hislater article3 3 supplies the missing link in his reasoning, for he statesthat as a shareholder can never obtain damages from his owncompany, only equitable remedies for breach of the contract arerelevant. Then he cites Middleton v. Greenwood34 as authority for theproposition thus expressed in Spry's Principles of EquitableRemedies,3 5 "the fact that obligations are mere incidents of theagreement, not affecting its substance, may induce a court of equity toprovide for them otherwise than by requiring them to be specificallyperformed. . ." Goldberg takes this statement of tentative preferenceagainst specific performance, and turns it into an inflexible tenet ofdogma, that equity will give no remedy for breach of warranty, butonly for breach of the conditions (substance) of a contract. From thistapping of a slender stream of equity he derives succour for hiswide-reaching proposal that only the major allocation of powerprovisions of the company contract can be enforced by members, theother terms counting apparently for naught. It is submitted that in anyevent authorities drawn from classical contract law are not alwaysreliable precedents for application to the company contract for thereasons given above.

Now it may or may not be true that the rationes decidendi of theconflicting cases can be reconciled by the adoption of Goldberg's

30 However, see the explanation of Eley's Case given by Roger Gregory, "The Section 20 Contract"

(1981) 44 M.L.R. 526 at pp. 528-531.31 G. D. Goldberg, "The Enforcement of Outsider-Rights under Section 20(l) of the Companies Act

1948," (1972) 35 M.L.R. 362.32 Ibid., at p. 363.33 G. D. Goldberg, "The Controversy on the Section 20 Contract Revisited," (1985) 48 M.L. R. 158,

esp. at p. 161.34 (1864) 2 De G.J. & S. 142." 2nd ed., (London, 1980) at p. 100.

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elegant reasoning, but it certainly is true that such a technicalformulation was not present in the minds of the judges, and neverformed part of the basis on which they made their decisions. In fact theproposition is unsound for general application because it does notexplain cases like Wood v. Odessa Waterworks36 where the organspecified in the articles (the directors with the sanction of the companyat the ordinary general meeting) actually was conducting thecompany's affairs, but conducting them improperly. In such a situationGoldberg's thesis would lead us to believe that a member could go nofurther than to ensure that the matter was dealt with by the appropriateorgan. However, the case shows that a member can go much furtherand ensure that the appropriate organ acts in conformity with thearticles concerned. Goldberg's thesis, therefore, while it seemssuperficially to reconcile the results, if not the reasoning, of the casesinvolving outsider rights, cannot serve as a basis for understanding thenature of the contract in the memorandum and articles, and the extentof a shareholder's right to enforce it.

Graham Prentice37 has also made an attempt to investigate theenforceability of outsider rights and he proposes a theory which, inmany ways like Goldberg's, allows only a selective effect to thecontract created by section 14. He argues that

the terms of the memorandum and articles of the company whichbind the company contractually to the members are only thoseterms which of necessity must affect and can only affect each andevery member regardless of his individual capacity . . . [The]terms of the contract being those provisions which form the basicconstitution of the company and define the circumstances andlimits of the company's permissible actions, together with anyterms implied by reason of the general law relating to thefunctioning of the company.

He grants that the company is contractually bound to each member toact in accordance with the powers granted by its constitution, butinexplicably follows this by a statement that once these powers havearisen there is no contractual obligation relating to how they are to be.exercised. 38 He says that a member only has rights granted by thememorandum and articles so far as their provisions restrict or relate tothe power of the company to function, but he does not see an articlepermitting the company only to employ a specified solicitor asconstituting a limit on the company's power to function. Apart from a

36 (1889) 42 Ch.D. 636.

3 Graham N. Prentice, "The Enforcement of 'Outsider' Rights," (1980) 1 Co. Lawyer 179.3 This appears to be a land law analogy, presumably to the powers of a mortgagee. This point again

seems contrary to the effect of Wood v. Odessa Waterworks Co. (supra), where the companyundoubtedly had power to function, but was restrained from exercising that power in an impropermanner.

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general point that this, too, appears to be ex post facto reasoning notpresent in the minds of the judges who decided the leading cases towhich he refers, the theory is not helpful in explaining why the wordingof section 14 should be given this very selective interpretation,unsubstantiated by any indication in the section itself.

(c) The Relational Approach to Outsider Rights

It can be argued that these efforts to reconcile the conflicting casesall examine the question of shareholders' rights under the section 14contract from too close a standpoint. They deal with outsider rights inabsolute terms, and then only from the position of the outsiderhimself. They do not relate these rights to the function of the companycontract as a regulator of long-term relationships. Company law, ashas been said above, includes within its scope a number of processesfor resolving or mitigating disputes, thus recognising the polarising anddisruptive effect of litigation. In these processes the rights and interestsof the member who considers himself in some way wronged are placedalongside the rights and interests of the other members. In this fashionthe dispute itself may be resolved, or a majority of shareholders maysupport the wronged party in feeling that litigation is the only possiblesolution. Company law is also wide enough to allow a way around thismachinery where it feels that some essential interest of the wrongedshareholder is at stake, and has provided exceptions to the Rule in Fossv. Harbottle to cater for this.

If one approaches the problem of outsider rights from this angle, itbecomes possible to suggest that a member does have a contractualright to have a particular provision in the company's memorandum orarticles observed, but that this right is equal to the rights of every othermember to have alternative or inconsistent articles observed, orultimately to seek a change in the articles. One may then arrive at asituation where a resolution of the conflict between these rights issought. With an ordinary contract a court would no doubt decide bynormal canons of interpretation alone which right was superior. Indealing with a discrete transaction such an approach is perfectlyproper. However, as has been suggested, the company contract is notan ordinary contract and still less is it a discrete transaction. It is acontract which is the foundation of a long-term dynamic relationship,and it contains its own dispute-resolution machinery. In thesecircumstances, therefore, it is both inevitable and proper that anycourt seized of such a conflict should take full account of any actual orpresumed bona fide decision of that dispute resolution machinery. Anapproach which involves consideration of the wishes of the generalmeeting, or even a consultation of that body is, it is suggested, in line

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with current thinking in company law which, in both statute andcommon law, increasingly seeks to augment or consult shareholders'rights or opinions, often in counterbalance to the usually dominantpower of the board. It must be stressed that this recognition ofcompeting rights is quite consistent with the wording of section 14 anddoes not require any selective effect to be given to its language, assome other theories do.

If there are no competing rights in the articles then a shareholder atthe substantive phase of his dispute39 should be able to enforce hisrights to see that all the terms of the section 14 contract, includingthose governing outsider rights, are complied with. In such a situation,the only relevant machinery provided by company law is that whichenables the articles to be amended by a special resolution involving thevotes of a three-quarters majority. It can be argued that such can beconstrued as dispute-resolution machinery, as the actual or threateneduse of the special majority's power to alter the contracting parties'rights for the future may settle their immediate differences. Also, theretrospective effect of an alteration to the articles was not ruled out byLindley M.R. in Allen v. Gold Reefs of West Africa Ltd.4"

In short, it is suggested that where an outsider-rights dispute turnsupon what are in fact competing rights, the decision of the majority hasa strong claim to being the determining factor in any case which goes asfar as the court room. In such a situation, the judge must also take intoaccount whether it is an appropriate case for the majority vote to beconsidered decisive, thus, as explained below, dealing with theprocedural Foss v. Harbottle issue. Where there are no competingrights under the articles then a judge, subject again to the proceduralissue, should find for the plaintiff unless there is a three-quartersmajority in the company who are able and willing to solve the disputeby altering the articles.

(d) The Relational Approach and the Cases

With this approach in mind one could look first at the paradigmdecision against outsider rights-Eley's Case.4' In this case the courtconcluded that the 118th article did not constitute a contract betweenEley and the company which he could enforce. The court was preparedto accept (albeit at times reluctantly) that article 118 formed part of theconstitution of the company. Why then could Eley, a shareholder, notenforce it? One argument is to say, as Lord Wedderburn might argue,

3 I.e., if he gets through the procedural stage and can show either that he enjoys the support of thcmajority ' or that the matter is one which is inappropriate to refer to an ordinary majority. Thisaspect is dealt with more fully in the next section of this work.11900 I Ch. 656 at pp. 671-673.

4 Note 24, supra.

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that the court considered the Eley was bringing the action in hiscapacity as solicitor, and therefore naturally held that the articles didnot constitute a contract with him in that capacity. Such an argumentderives substance from the fact that the court mentioned once thatEley was a shareholder, but thereafter consistently denied that he wasa party to the contract. Alternatively, one could explain the case asGregory42 has very ably done, on the basis that when it was decidedthere was still considerable uncertainty about the parties to thecompany contract. The court held that the articles of the companywere just an agreement between the shareholders inter se, and thuscould not give rights against the company. Because Eley brought hisaction against the company, the court, on this perception of the law,could not possibly find in his favour. Such a perception, it must be said,has long been dropped in favour of the current view that the companycontract binds the members and the company equally. However, giventhe view prevailing in Eley's Case, is it possible to divine how the courtmight have reacted to an action by Eley against his fellow members fortheir apparent disregard of his rights under the contract?

An answer could be found by building upon Goldberg'sobservation that,43 "the court held that, on the proper construction ofthe articles when read as a whole, the power to appoint the company'ssolicitors still resided in the board of directors." If that was the case,then there was an inherent conflict within the articles. How should aresolution be found to the conflict between Eley's right to enforcearticle 118 and the right of the other shareholders, if they wished, toenforce the conflicting article empowering the directors to appointwhoever they chose as the company's solicitor? Unless the case fallsinto one of the exceptional categories mentioned below, it could surelyhave been settled by the majority rule processes upon which much ofcompany law is based. The majority could have decided to supportEley, or to support the directors in appointing another solicitor. Theycould have agreed a compromise or even solved the matter for thefuture by altering the articles, a procedure expressly permitted underthe section 14 contract. The opinion of the majority of shareholderswas presumably against Eley, otherwise the case would not have beenbrought. This factor is one which was capable of determining the issuein the subsequent litigation. Some support for this approach can befound in the judgment of Amphlett B.44 where he says,

The act of the directors in employing another solicitor was, nodoubt, as between themselves and the company, a violation of the

42 Roger Gregory, (1981) 44 M.L. R. 526 at pp. 528-531.43 (1972)35 M.L.R. 362 at p. 366. See the judgment of Amphlctt B. in Eley's Case (1875) 1 Ex. D. 2(1

at p. 25.*' Ibid., at p. 28.

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118th clause; but that might have been condoned by the company,and if the plaintiff, as a member of the company, had called thatact into question at a general meeting, I do not think it difficult toguess what the result would have been.

He earlier 45 described the provision preventing Eley's removal exceptfor misconduct as

a stipulation which might be disobeyed if found inconvenient,without exposing the company to any action, and which,moreover, might at any time be revoked by a statutable majorityof the shareholders.

Eley's problem therefore should have been dealt with by referringit to the dispute-resolution machinery provided for this type of case bycompany law. If he had referred it to the general meeting and found abona fide majority of shareholders to support him, the case wouldnever have come to court. Equally, if he had found himself in aminority he should have acceded to the will of the majority (againassuming that they were acting bona fide) and either consideredhimself bound by their verdict, or perhaps cowed by their threat toalter the articles if he persisted. It is only if his case had fallen withinthose exceptions to the Rule in Foss v. Harbottle which are provided asa safety valve in the interests of justice that Mr. Eley could haveflouted the wishes of the majority and enforced his right, despite theirviews.

The next question to consider is whether the theory here proposedis of any use in understanding the leading case on the other side,namely Salmon v. Quin & Axtens Limited.46 In this case a generalpower of management of the company was given to the board ofdirectors by clauses 75 and 76 of the company's articles of association.However, in certain specified matters, including the ones in dispute,clause 80 provided that no resolution of the board should be valid orbinding unless notice had been given to each of the managingdirectors, and neither had dissented. This effective right of veto wasemployed by Salmon, one of the managing directors. Nevertheless anextraordinary general meeting of the shareholders was called, whichby an ordinary resolution, i.e. by a simple majority, purported toconfirm the board resolutions passed in contravention of clause 80.This resolution was successfully contested by Salmon. One cantherefore say that Salmon, as holder of 22,085 out of the total of 50,007issued shares in the company, had a contractual right to see that clause80 was enforced. The court considered whether clause 75 constituted aconflicting article which an ordinary resolution of the general meeting

Ibid., at p. 27.4 Note 23, supra.

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could have enforced in preference to clause 80. It found that therelevant part of clause 7547 did not constitute a conflicting articlebecause it was itself subject to clause 80. There was thus no challengeto the contractual right of veto which Salmon enforced pursuant to thearticles. The relevant machinery provided by company law toresolve this particular dispute was alteration of the articles (thecompany contract) by means of a three-quarters majority. Thoseproposing to disregard the existing rights under the contract lacked themajority laid down by company law to achieve their objective. If thecamp opposed to Salmon could have mustered a three-quartersmajority then undoubtedly they would have changed the companycontract to make it accord with their wishes. Their failure to complywith the proper machinery here constituted an invasion of the rightsthat Salmon was entitled to enforce under the terms of the contract,and forced him to seek a remedy in the only way remaining, namely bylitigation. Whether the company continued to function after theobviously disruptive effect of this litigation is not recorded.

As Eley's Case has to a certain extent been discounted on the basisadopted by Gregory, the relational approach ought to be applied toother leading cases which pronounce against outsider rights.

In Browne v. La Trinidad48 -the plaintiff made an agreement withindividuals acting for a company to be incorporated, that he should sellcertain mining property to the company and receive in exchange fullypaid shares. One clause in this agreement provided that he shouldbecome a director of the company and should not be removed untilafter the year 1888. The articles of association of the companyinstructed the directors to adopt this agreement (a copy beingincorporated in the schedule to the articles), but also contained aclause permitting the company by special resolution, "save asaforesaid" to remove any director before the expiration of his periodof office. A dispute arose about the plaintiff's performance of thecontract of sale, and subsequently an extraordinary general meeting ofthe company was called at which a resolution for the removal of theplaintiff from his directorship was passed unanimously. The courtdealt with the problem in two ways. Firstly it held that the words "saveas aforesaid," in the clause permitting the removal of directors,referred not to the protected position of the plaintiff under thepre-incorporation contract, but to another article which in certainevents required the removal of directors from office. This done, wehave at best two inconsistent articles, and the court took account of the

" "The board may exercise all the powers of the company, subject, nevertheless, to the provisions ofany Acts of Parliament or of these articles, and to such regulations (being not inconsistent with anysuch provisions of these articles) as may be prescribed by the company in general meeting."

48 (1887) 37 Ch.D. I.

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wishes of the majority of shareholders in deciding which of thosearticles they preferred to enforce (possibly in the belief that this choicewould be the best in the long-term interest of the company as acontinuing entity). The second approach taken by the court was tostate that no evidence had been produced which showed that thecompany had "adopted" the pre-incorporation contract andincorporated it into its articles. Thus Mr. Browne failed even toestablish that his right to a protected position had become part of thecontract between the company and himself as shareholder. 49 The caseis thus not an authority against outsider rights50 but illustrates theproposition that conflicting rights of shareholders under the companycontract should be adjusted in the manner provided either by thearticles or by company law generally.

In Hickman's Case51 the plaintiff claimed to enforce his rights as amember given to him by the articles of association. However thearticles contained a provision that disputes over such matters should bereferred to arbitration. The articles of association here constituted thecontractual framework behind a long-term relationship subsistingbetween members of a sheep breeders' association. The function ofthe arbitration clause was discussed by Astbury J., who said,52

This is a common form of article in private companies, and theobjects of this association being what they are, it and its membersmight be seriously prejudiced by a public trial of their disputes.

Because the articles of association provided the machinery throughwhich disputes were to be resolved in the interests of the continuingrelationship between the members, 53 Astbury J. held 54

it would seem reasonable that the plaintiff ought not to be allowedin the absence of any evidence filed by him to proceed with anaction to enforce his rights under the articles, seeing that theaction is a breach of his obligation under article 49 to submit hisdisputes with the association to arbitration.

, That he was a shareholder is clear from the judgment of Lindley L.J. where he said at p. 14, "ithappens that this gentleman has had shares allotted to him, and is therefore a member of thecompany." This point appears to have been missed by Pennington, who in the fifth edition of hisCompany Law (1985), at p. 65 cites the case as relating to a director who was not a member beingunable to prevent the company from dismissing him during his term of office.

SI Notwithstanding several dicla in support of Eley's Case..' 119151 1 Ch. 881.52 Ibid., at p. 889.5 See Robert L. Bonn, "Arbitration: An Alternative System for Handling Contract Related

Disputes" (1972) Administrative Sciences Quarterly 254 at p. 262, where he argues that arbitrationis more conducive to future business relationships than litigalion. I lowcvcr, his survey of 78 casesin textile arbitration in 1967 showed that in only 14 (or 18%) of the cases were businessrelationships renewed. This is hardly an eloquent argument in favour of arbitration on thisground, and only works at all if one assumes, as may indeed be the case, that the percentage wouldbe much lower if the cases had gone to litigation proper.1191511 Ch. 881 at p. 90)2.

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Hence Hickman's claim to enforce his rights under the section 14company contract was determined in the light of the presumed wishesof all the other members to refer his claim to arbitration. The relationalapproach would require that in similar circumstances the actual wishesof the general meeting should be ascertained.

A third case usually cited 55 as authority for the proposition thatoutsider rights cannot be enforced by a member suing under thesection 14 contract is Beattie v. E. & F. Beattie Ltd.5 6 This case alsoconcerned an attempt to refer a dispute to arbitration, and the failureof the defendant to get the issue so referred might be seen as contraryto the theory proposed in this article. However, the case was in factdecided upon two rather different grounds. The facts were that thecompany was effectively bringing an action against one of its directorsin respect of certain payments that he had made, in breach of thecompany's regulations. Although the defendant director was ashareholder, the dispute related entirely to his actions, and hence hiscapacity, as a director. The defendant claimed that the dispute must bereferred to arbitration under clause 133 of the company's articles. TheCourt of Appeal first examined the decision of the judge at firstinstance that the arbitration clause which referred to disputes betweenthe company and any member should be construed as meaning"member in his capacity as member." This was an interpretation whichwould have excluded the dispute in question, and given no member theright to have it referred to arbitration under the clause. However, theCourt of Appeal preferred to base its judgment on another point. Inorder to have the issue referred to arbitration, the defendant had tobring himself with section 4 of the Arbitration Act 1889 and show thatthere was a written agreement between the parties to the dispute tosubmit it to arbitration. The defendant relied upon the equivalent ofthe section 14 contract as his written agreement. The court held that asthe dispute with the company was a dispute relating to the defendant'scapacity as a director, he needed to produce a written contract with thecompany in that capacity, i.e. the capacity in which he was a disputant,to submit the issue to arbitration. No written service contractincorporating the articles existed, and as the section 14 contract wasmade with the defendant in his capacity as a member, he could produceno agreement between himself as director and the company to refersuch disputes to arbitration as the Act demanded. In this case thedichotomy is not between the defendant, in his capacity as member,trying to force the company to adhere to its articles, in relation to adispute with him as a director. It is rather the defendant, in his capacityas a disputant, trying to prove that the company was contractually" See, e.g. Gower, op. cit.. note I supra, at p. 317.

[ 193813 All E.R. 214.

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bound to him as a director to refer the dispute to arbitration. The courtwas prepared to concede that as a shareholder the defendant mighthave succeeded, but that as disputant he could not take advantage of acontract made with him in another capacity.

Although the case turned on the narrow technical point raised bysection 4 of the Arbitration Act 1889 it is very interesting because thecourt in its scrutiny of the section 14 contract did in fact assert thegeneral right of a shareholder, suing as such, to enforce the articles,and also illustrated the court's approach to such rights on the linesadvocated in this work. It is necessary therefore to quote at length partof the judgment of Sir Wilfrid Greene M.R. where he said,5 7

Let me assume that this article on its true construction entitles anymember of the company to say to the company, when it is indispute with a director: "You, the company, are bound by yourcontract with me in the articles to refer this dispute to arbitration,and I call upon you so to do." That is the right, and the only rightin this respect, which is common to all the members under thisarticle. If that were the right which the appellant were seeking toexercise there might be something to be said for that argument• . . That right is one which a member might find very greatdifficulty in enforcing in the courts, because it concerns a matterrelating to the internal management of the company, with whichthe courts will not, in general, interfere.

(e) Conclusion

One can argue, therefore, that where a matter arises concerningoutsider rights, the outsider cannot sue directly to enforce that rightmerely because he happens to be a member; but as a member he has aright to call upon the company to adhere to the terms of its contractwith him. Then his claim upon the company to enforce that contractmust be decided, like any other matter of internal management, inrelation to the rights of the other members. This approach, it can beclaimed, looks at the outsider-right cases from a different perspective,and enables them to stand alongside the many cases which assert therights of shareholders to have the company's affairs conductedaccording to the articles. 58 Thus it is by an adjudication between the" Ibid., at pp. 218-219.5 These cases would include Pulbrook v. Richmond Consolidated Mining Co. (1878) 9 Ch.D. 610,

upholding the right of a shareholder director not to he wrongfully excluded from acting as adirector, per lessel M.R.: "lHe has a right by the constitution of the company to take a part in itsmanagement ... It may affect his individual interest as a shareholder as well as his liability as adirector," Cf. Hayes v. Bristol Plant Hire 119571 I All E.R. 685, on a similar point, where Wynn.Parry J. said that Jesscl M.R.'s reasoning on the right of a director to participate in management"must equally apply where the articles do not require that a director should hold a [sharequalification, but as a matterof fact he is, ts well as being a director, a shareholder, because if he isa shareholder then he must assuch be entitled to the degree of protection which is mentioned bythe Master of the Rolls" (author's emphasis); Catesby v. Barnett 119161 2 Ch. 325, whereshareholders were enabled to enforce election of new directors and the retirement of the old inaccordance with the articles; and Wood v. Odessa Waterworks Co. (note 36, supra). where ashareholder was able to enlfrce the payment of dividends in accordance with the articles.

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competing rights of the members of the company that a conclusion canbe found, rather than by asserting the absolute nature of any oneindividual's rights to have the articles enforced.

3. Internal Procedural Irregularities

(a) The Problem

The second problem area in which the relational approach can bedemonstrated covers the effect of the Rule in Foss v. Harbottle59 oninternal procedural irregularities. If a shareholder did have anunrestricted right to sue to force the company to adhere to everyprovision of the company contract, then he could always bring anaction to set aside any resolution of the general meeting obtainedwhere there had been some breach, however trifling, of the provisionsof the articles relating to notice, the appointment of the chairman orthe like. His unrestricted right to litigate could thus jeopardise thelong-term relationship between the members because of the polarisingeffect of litigation referred to above. However, company law does notgrant to a member an unrestricted right to sue. The doctrine ofmajority rule enshrined in the decision of Foss v. Harbottle andsubsequent cases6

0 appears to provide that, where the irregularitycomplained of relates to the internal management of the company, anindividual shareholder cannot bring an action in his own name becausethe company itself is the only proper plaintiff. If the company is tobring the action then there needs to be a majority among theshareholders in favour of it. The rights of the individual are thussubordinated to the wishes of the majority.

However, another line of cases exists which shows that in certaincircumstances, in connection with matters which could also loosely bedubbed procedural, an individual shareholder is allowed to bring anaction to protect his rights under the company contract, without havingto defer to the wishes of the majority. Hence actions have beenbrought by shareholders to enforce their right to vote on their shares, 6'their right to have a dividend paid in the manner laid down by thearticles, 62 their right to have decisions taken in the way the articlesprescribe, 63 their right to proper notice of meetings ' and so on.

5 (1843) 2 lare 461, 67 E.R. 189.6 See Mozley v. Alston (1847) 1 Ph. 790; MacDougall v. Gardiner (1875) 1 Ch.D. 13; Burland v.

Earle 119021 A.C. 83; Cotter v. National Union of Seamen 1192912 Ch. 58.61 Pender v. Lushington (1877) 6 Ch.D. 70.61 Wood v. Odessa Waterworks Co. (notc 36, supra).6' Edwards v. Halliwel 1119501 2 All E.R. 1164 and Sahnon v. Quin & Axtens Ltd. (note 23, supra).' Kaye v. Croydon Tramways 1189811 Ch. 358.

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(b) The Traditional ApproachDifferentiation between these two lines'of authority is a matter of

some dispute. It is usually65 accomplished by asserting that ratifiableinternal irregularities are subject to the Rule in Foss v. Harbottle, butpersonal rights (usually of a proprietary nature) can always be madethe subject of an individual action. The criteria for distinguishingbetween personal rights and those which are within the province ofinternal management have proved difficult to define. Pennington 66 hassuggested that "the court will incline to treat a provision in thememorandum or articles as conferring a personal right on a memberonly if he has a special interest in its observance distinct from thegeneral interest which every member has in the company adhering tothe terms of its constitution." Personal rights therefore involvesomething more than just a shareholder's general right to enforce thecompany contract, and certainly the existence of some proprietaryinterest weighed heavily with Jessel M.R. in Pender v. Lushington.67

(c) The Relational Approach

The traditional analysis, though, does not always give a totallysatisfying solution 68 and most writers admit that the borderlinebetween internal procedural irregularities and personal proprietaryrights is a difficult one to draw. In view of this it may be useful to see ifthe approach suggested in this work is of any assistance in putting theproblem into perspective. It is necessary to bear in mind the long-termcontractual relationship between the participants in a company, andthe probable inimical effect of litigation upon this. It then becomespossible to suggest that every shareholder has the right to have thecompany run in accordance with the contract in the memorandum andarticles of association, but that this right is subject to the rights of everyother shareholder to condone or ratify. breaches of internalmanagement procedure. Adjudication between these conflictingrights is then best accomplished by reference to the machinery

6 Usually but not always: R. J. Smith in his article "Minority Shareholders and CorporateIri'egularitics" (1978)41 M.L.R. 147 asserts, at p. 160, that "Foss v. Harbottle has no applicationto the personal shareholder action, although the courts will not lcan in favour of a minority whereto do so would unreasonably embarrass the majority. The cases to the contrary can be explained asbeing based upon misconceptions as to the nature of the personal action and of ratifiability."

'' Pennington. op. cit.. (note 49, supra) at p. 727.61 (1877) 6 Ch.D. 70 at p. 81 where he said that a member has "a right to say, 'whether I vote in the

majority or minority, you shall record my vote. as that is a right of property belonging to myinterest in this company, and if you refuse to record my vote I will institute legal proceedingsagainst you to compel you."'

6 See Gower, op. cit., (note I, supra) at p. 642 where, after describing the extension of the rule inFoss v. Harbottle to internal irregularities, he says. "Though the courts often describe theseactions as wrongs done to the company, it is far from clear why they should not instead be regardedas breaches of the rights of each shareholder under the contract established by the memorandumand articles."

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provided by company law, namely by taking into account the wishes ofthe majority69 to see which they support. Such an approach wouldfacilitate (but not guarantee) the resolution of the dispute withoutrecourse to harmful litigation. However, this position is displaced, andimmediate access to the courts by an individual shareholder ispermitted, in those situations where reference to a majority decision isinappropriate. Those situations arise where company law eitherprotects a particular class of rights (such as personal proprietaryrights), or provides safeguards to protect an individual shareholderagainst abuse of his rights by the other shareholders.7 t

In order to support this thesis it is necessary first to determinewhether the Rule in Foss v. Harbottle can be seen in this context as amanifestation of shareholders' rights to participate in regularisingbreaches of internal procedure under the company contract. If it can,the next step is to seek to elucidate those types of situation in whichdetermination of a dispute in this way will be inappropriate.

(d) The Function of the Rule in Foss v. Harbottle in InternalProcedural Disputes

The courts have a well documented reluctance to interfere in theinternal affairs of companies. 7' Its purpose is to cut down resort tolitigation where a majority can put the matter right.72 The Rule can beseen as an automatic procedural barrier erected to encourage or forceshareholders to evolve their own solutions to their problems. Such aninternal solution will probably do the least damage to their continuingrelationship because it does not involve the polarising effect oflitigation. By enforcing the containment of certain disputes overinternal procedure within the confines of the general meeting, thecourt is effectively giving to each shareholder the right to participate inthe process of determining whether a majority will exists to solve thedispute by ratifying, condoning or otherwise regularising the breach.73

6 If the wishes of the majority are not known then the court may take steps to ascertain them. Seethe quotations from the judgment of James L.J. in MacDougall v. Gardiner in note 20. supra, andDanish Mercantile Co. Ltd. v. Beaumont 119511 Ch. 680: and, in another context, Hogg v.Cramphorn Ltd. 119671 Ch. 254.Certain acknowledged exceptions to the rule in Foss v. Harbottle, such as fraud on the minorityand ultra vires or illegal actions, would fall within this category, as would attempts to achieve byordinary resolutions objectives which would propcrly require a special resolution.

7' Witness Lord Eldon's famous dictum in Carlen v. Drury (1812) 1 V. & B. 154 at p. 158, where hcprotested that "This Court is not to be required on every Occasion to take the Management ofevery Playhouse and Brewhouse in the Kingdom". See too Foss v. Harbotle (note 59, supra),Burland v. Earle (note 60,supra) and not least the dicta of Mclish L.J. in MacDougall v. Gardiner(note 20, supra).

72 See again the judgments of Mellish L.J. in MacDougall v. Gardiner (ibid.). Lindley L.J. inBrowne v. La Trinidad (1887) 37 Ch.D. I at p. 17 and Plowman J. in Bentley-Stevens v. Jones1197412 All E.R. 653 at p. 655, where he said that "the irregularities can all be cured by goingthrough the proper processes and the ultimate result would inevitably be the same.'

73 This viewpoint seems to be shared by Baxter, "The Role of the Judge in Enforcing ShareholderRights" 119831 C.L.J. 96: sec n.75 on p. 112.

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If no such will does exist then the majority can take steps to redress thebreach, for example by dismissing an errant chairman, taking a poll orcommencing an action in the company's name.

If this aspect of the Rule in Foss v. Harbottle is capable of beingexpressed as a manifestation of the rights of shareholders to regularisecertain breaches of the company contract, does this help us torecognise those cases where the rights of an individual shareholdershould not be subjected to the Rule? Surely it does, because theautomatic barrier to suit has been set at the level of an ordinarymajority of the general meeting. It will thus have no application wherethe rules of company law require some higher majority, or where thematter is such that it is inappropriate to refer it to an ordinary majority.

Many attempts have been made to chart this borderline betweencases where the Rule applies, and those where it does not prevent anindividual shareholder from bringing an action. Some writers such asBastin, 74 and some judges, including Megarry V.-C., 75 have said thatthe test may be whether an ordinary resolution of shareholders cancarry out or ratify the acts in question. However, they provide noworking guide to ascertaining which matters are able to be so dealt with.Smith 76 on the other hand prefers to concentrate on the issue ofwhether policy factors require limitations on the personal action.Although Lord Wedderburn's thesis required him to confine thecategory of internal management to "matters already covered byjudicial pronouncement, ' 77 his subsequent comment is much moreenlightening. He states that, "The question which the court should askitself is: 'Was this an irregularity such that we will allow an ordinarymajority to put it right?"'-78 This could be rephrased as asking whethera particular dispute is appropriate for determination by an ordinarymajority.

If one concentrates on this question, it is possible to view many ofthe cases where the courts have given a negative answer as onesinvolving a situation where one group of shareholders hasendeavoured to get its way without going through the correctdispute-resolution machinery. There are many instances where thismachinery involves obtaining something other than an ordinary

7 Nigel A. Bastin. "The Enforcement of a Member's Rights" 119771 J.B.L. 17 at pp. 23-24.However, he is forced to add an exception to his analysis to cover cases where there has been aratifiable breach of procedure, but nevertheless the plaintiff can establish that the application ofthe Rule would result in injustice because it would deprive the majority of an opportunity ofcarrying out their will.

7 In Estnanco (Kilner House) Ltd. v. G. L. C. 1198211 All E.R. 437at p. 444. Other judges usuallycited in this context include Mellish L.J. in MacDougallv. Gardiner, Lindley L.J. in Bro'ne v. LaTrinidad and Plowman J. in Bentley-Sevens v. Jones (all cited in note 72. supra).

7, R. J. Smith, (1978) 41 M.L.R, 147 at p. 154.77 119571 C.L.J. 194 at p. 214.78 Ibid. at p. 215.

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resolution. It may be that, in order to produce a settlement of aparticular dispute, what is required is a special resolution, or even aspecial resolution which is held to be for the benefit of the company asa whole. If an attempt is made to impose a solution without goingthrough the correct process, then an individual shareholder ispermitted to come to court to seek a remedy. The automatic ordinarymajority barrier of Foss v. Harbottle is not appropriate in thesecircumstances to confine the dispute.

There are several other types of situation which can be recognisedas inappropriate for reference to an ordinary majority. Colin Baxter 79

has made a very perceptive contribution to analysing the cases from asimilar standpoint. He argues that there is no difficulty in recognising acase for judicial action. He says that, "[Sluch a case arises if, and onlyif, (1) a dispute situation has arisen in which it is impossible orimpracticable for the members of the body to sort things out forthemselves, and (2) there is something that the court can do aboutit."' 80 He argues that the law will not bother about irregularities atmeetings unless there is a chance that they have influenced the result ofa vote, and that in addition intervention must be appropriate. Baxtersuggests that an individual shareholder may seek judicial interventionin three types of situation which, transposed into the terminology ofthis article, are those where it is inappropriate to refer the matter foradjudication by an ordinary majority.

His first situation, which has in part been mentioned above,involves acts which are beyond the power of an ordinary majority.Hence we have the category used by Jenkins L.J. in Edwards v.Halliwell,8 1 embracing matters which can only be done or sanctionedby a special majority, for example cases of irregular specialresolutions. In addition we have the type of case referred to in theprevious paragraph, i.e. that involving non-compliance with specialmachinery. Of these Baxter says, "until the constitution is altered by avalid special resolution, what has been done cannot be done de jure."

The second type of situation is one where there is no prospect of themembers of the body resolving a disputed issue in time. Hence becausesome irreversible transaction could be carried out before a simplemajority was able to deal with the matter it would not be appropriate torefer the matter to them. Baxter's third type of situation is less clear,and arguably parts of it can be subsumed under the headings. He refersto situations where there is a dispute about which side is a majority,and gives a sub-heading of "major constitutional crises." The cases hecites relate to disputes over claims to exercise voting rights at a general

N [19831 C.L.J. 96.FA Ibid., at p. 98.8 [195012 All E.R. 1064.

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meeting. In the context of this article it could be said of such a categorythat it is not appropriate to refer a dispute to the general meetingwhere the dispute itself is over who is entitled to attend and vote at thatmeeting. It is in these circumstances "impossible and impracticable"for the members of the body to sort things out for themselves becausethe dispute relates to the very constitution of the dispute-resolutionmachinery.

It is submitted that Baxter's work demonstrates a clearer approachto the problem of defining the scope of the application of the Rule inFoss v. Harbottle because it concentrates on the factors which renderadjudication of a dispute by a simple majority impossible orimpracticable. It is not the intention of this article to purport toprescribe any finite boundaries in relation to cases where an individualshareholder can sue, because it is recognised that flexibility greatlyassists the court to do justice between the parties. Nevertheless it ispossible to suggest that many of the cases in which an individual's rightto bring an action was upheld have in common the fact that in themvarious circumstances existed which rendered it inappropriate orirrelevant to refer that individual's claim to a decision of an ordinarymajority in general meeting. Such an explanation of the scope of theRule in Foss v. Harbottle in this context would fit in with the limitationson its scope in other situations which do not necessarily involveindividual shareholder rights under the company contract. Thus it canbe regarded as equally inappropriate to refer disputes connected withultra vires activities, illegality or fraud on the minority to arbitration bya simple majority.

(e) Application of the Relational Approach to Internal ProceduralIrregularities

The relational approach is seen as applying to a dispute over aprocedural irregularity in the following way. Let us say that a disputearises over an individual shareholder's procedural right given by thecompany contract. The relational approach would suggest that thisright should be viewed in the context of the rights' of the othershareholders in the company. These would include their rights(created by the Foss v. Harbottle procedural barrier) to participate indetermining whether there is a majority wish to condone or ratify thebreach of the individual's right, provided that it is appropriate to refersuch a dispute to an ordinary majority. If it is inappropriate (and it maybe so for a number of reasons, e.g. that some special majority isrequired for the effective resolution of the dispute), then the automaticprocedural barrier would not prevent the individual shareholder fromcoming to court. However, the court should decide on the

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enforcement of the disputed right in the light of any evidence of thewishes of the other shareholders to resolve the dispute in the relevantmanner, e.g. by altering the articles, etc. Thus the rights of the othershareholders to exercise any appropriate dispute-resolutionmachinery are also taken into account.

If the matter is one which is appropriate to be dealt with by theordinary majority dispute-resolution machinery, any judge whoignored the wishes of the majority would do so on pain of imperillingthe existence of the long-term shareholder relationship. However, theself-policing effect of the Rule in Foss v. Harbottle would be to ensurethat such a dispute did not get to court unless there was a majority wishfor it to do so. A shareholder would thus need a prima facie case thatthe dispute was inappropriate for reference to an ordinary majoritybefore he could commence suit.

This theme can be illustrated by reference to some of the leadingcases in this area. For example in Pender v. Lushington82 what was atstake was the plaintiff's right to vote, a right which was inseparablefrom his shares. Subjection of the right to exercise this essentialingredient of Mr. Pender's shares to the will of a simple majority wouldhave been tantamount to a de facto variation of class rights, or todepriving him of the shares themselves. Variation of class rights, orexpropriation of shares, are not matters to be decided by an ordinarymajority, usually requiring respectively either a three-quartersmajority of the class concerned, or an alteration of the articles by aspecial resolution passed for the benefit of the company as a whole.8 3

The same sort of argument holds true, it is suggested, for other casesinvolving what are described as proprietary rights. To take these awaywould need some form of expropriation, requiring more than just theactions of a simple majority of the company. Reference to an ordinarymajority would thus be inappropriate, and the plaintiff would be ableto refer the dispute to a court. There, in the absence of any effectivevariation of his rights by the proper machinery, he would be entitled tosucceed.

Equally, in Wood v. Odessa Waterworks84 the plaintiff was seekingto enforce his right to a dividend, payable in the manner provided inthe articles. No pronouncement by an ordinary majority could takeaway that right. Any attempt to amend the situation for the futurewould need to be made by a special resolution altering the articles, andas Stirling J. said, "no such resolution has in this case been passed or

'2 (1877) 6 Ch.D. 70.8, See, e.g. Clause 4 of Table A. Companies Act 1948 and s. 125 Companies Act 1985: Brown v.

British Abrasive Wheel Co. 1191911 Ch. 290. Dafi'n inplate Co. Ltd. v. Lihmelly Steel Co. 1192012Ch. 124 and Sidehottotn v. Kershaw Leesve & Co. Ltd. 11921)1 I Ch. 154 CA.

84 (1889) 42 Ch.D. 636.

C.L.J.


attempted to be passed." The majority's right to produce a specialresolution was unquestioned, but as they had not done so theindividual shareholder's right was unchallengeable.

The impropriety of referring the adjudication of a shareholder'sclaim to an ordinary majority in general meeting can also be seen as amajor factor in cases like Edwards v. Halliwell.85 In this case anindividual member of a union was able to challenge an increase in theunion's dues made in contravention of the provision in the union'srules which required a two-thirds majority obtained on a ballot vote toeffect it. If the plaintiff's claim to enforce the rules was to beadjudicated by an ordinary majority, then under the Rule in Foss v.Harbottle the effect would be (translated into a company context), asJenkins L.J. said, 85 "to allow a company acting in breach of its articlesto do de facto by ordinary resolution that which according to its ownregulations could only be done by special resolution." Equally, onecould say that similar factors were present in Salmon v. Quin & AxtensLtd87 where Farwell L.J. castigated the general meeting's approval ofthe directors' disregard of the articles by saying that, 88 "in truth this isan attempt to alter the terms of the contract between the parties by asimple resolution instead of by a special resolution."

Other types of situation may render reference of a dispute to anordinary majority inappropriate, and one of these was demonstratedin Hodgson v. NALGO.8 9 In that case the court upheld the plaintiffs'individual claim for a declaration that the actions of the union'sNational Executive Council were in breach of the union's rules. Thiswas despite invocation of the Rule in Foss v. Harbottle to the effect thatit was a matter for the members in general meeting to decide whetherthey approved of what their officers were doing in their name. Oneground for upholding the claim was that it was impossible to consultthe wishes of the majority in time for those wishes to be effective."Therefore," as Goulding J. said, 9" "the practical reasoning that thecourt should leave matters of internal decision to the properconstitutional machinery of the association really does not apply."Hence, because there was nothing that the majority could do in time, itwas inappropriate to refer the matter to their adjudication.

8' 1195012 All E.R. 1064.86 Ibid., at p. 1067, citing thc obscrvations of Romer J. in Cotter v. National Union of Seamen 119291

2 Ch. 58.87 1190911 Ch. 311." Ibid., at p. 319.

[19721 I All E.R. 15." Ibid., at p. 24.

[1986]

C.L.J. A Shareholder's Right 245

(f) Conclusion

It can be seen from the preceding discussion that a member'scontractual right to have his company run strictly in accordance with itsmemorandum and articles is subject to the rights of the other membersto propose the regularisation of breaches and to have certain disputesreferred to adjudication by the majority in accordance with establishedprinciples of company law. It may well be that the provision of suchmachinery to resolve disputes, in relation to internal proceduralirregularities which can be regularised by the majority, is indeedcalculated to safeguard the long-term contractual relationshipbetween the members. From such a viewpoint one can see more clearlythe justification for the existence of a class of cases where the rights of ashareholder to enforce the company contract are not subjected todetermination by the majority. In cases like the ones above, and in theother exceptions to the Rule in Foss v. Harbottle of ultra vires or illegalactions and fraud on the minority, the rights of the individualshareholder are considered paramount because there is nothing thatan ordinary majority can properly do to resolve the dispute. It may bethat the matter is beyond their competence, as it is in the case of ultravires actions or illegality, or that its solution would require the passingof a resolution by special majority, or that the interests of justice orpracticality preclude the delivery of the matter into the hands of themajority.

Now it can certainly be argued that the present position isunsatisfactory, and that the policy of English company law towardssuch things as reference of internal procedural disputes to the majoritywill should be changed. There could perhaps be some other morecentral course charted, between the Scylla of unrestricted individualshareholder enforcement of all the terms of the company contract, andthe Charybdis of the restrictive Rule in Foss v. Harbottle eroding therights of minorities. One might suggest something along the lines ofGerman or French law, both of which, in certain circumstances, allowa specified minority to bring an action on behalf of the company. 9'

9' The German Aktiengesetz of 1965, in paragraph 147, permits a minority holding not less thanone-tenth of the stated capital to assert the claims of the company to damages against the membersof its managing board or the supervisory board. Under paragraphs 241-245, even an individualdissenting shareholder may petition to set aside a shareholders' resolution for breach of the law orof the company's articles of association (para. 243), although this may in appropriate cases bebarred by a subsequent resolution of the company properly ratifying an earlier voidable resolution(para. 244). French law is even more sweeping, and gives to an affected shareholder, or to anyshareholder, (according to the circumstances) the right to challenge internal irregularities in theprocedure of the general meeting. See Droil Commercial, by G. Ripert and R. Roblot, 8th ed.,(1974) pp. 720-721. The right to bring an action against the directors of a public company allegingbreaches of the laws or of the articles of association, or mismanagement, is vested by articles 244and 245 of the loiof 24 July 1966, either in a shareholder individually, or in a group of shareholderstogether representing at least one-twentieth of the company's capital, who may then appoint oneor some of their number to represent them. See Ddcret No. 67-236 of 23 March 1967, arts 200 and201.


However that is not what this article sets out to do. All that is intendedis to put the existing right of the majority to arbitrate upon particulartypes of claims in its context, as part of the dispute resolving machineryprovided by company law in relation to enforcement of the companycontract by an individual shareholder.

C. SUMMARY

It has been suggested in this article that every shareholder does have aright to have all the provisions of the company contract enforced, butthat this right is not an absolute one, and cannot be considered inisolation. For a more complete appreciation of the picture this rightmust be viewed in a context where the company contract constitutesthe framework of a long-term relationship between the contractingparties. Thus we need to take into account the equally valid rights ofthe other shareholders to enforce conflicting provisions of thiscontract, to change those provisions, and to condone or regularisebreaches of those provisions relating, inter alia, to the rules of internalprocedure. We need also to consider the machinery provided bycompany law for the resolution of disputes concerning theseconflicting rights, machinery which includes reference of the dispute tothe decision of the majority, where it is appropriate to do so. Finally, itmust be borne in mind that one of the aims of providing suchmachinery is the preservation of the long-term relationship betweenthe participants in the company. It is only be considering such factorsas these that the relative, rather than absolute, nature of any oneshareholder's right to enforce the company contract can be trulyunderstood.

[1986]

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