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Derivative actions and exceptions to Foss v Harbottle
PRACTICE AREA GROUP: Commercial Litigation and Dispute Resolution
As a general rule, Irish law does not permit a shareholder to bring an action on behalf of the company in which it holds shares and treats the company itself as the proper plaintiff. This originates from Foss v Harbottle(1) and derives from the fact that a company has separate legal personality. However, through four recognised exceptions to that rule, a shareholder can bring proceedings on behalf of the company in a derivative action. In Connolly v Seskin Properties Limited(2) Judge Kelly examined the rule in Foss v Harbottle and whether a fifth exception existed – and, if so, on what terms.
Rule and its exceptions
The Foss v Harbottle rule reflects the principle that where damage is done to the company itself, it is the company that should bring any claim:
"the proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is, prima facie, the company or association of persons itself… the matter relied on as constituting the cause of action shall be a cause of action properly belonging to the general body of corporators or members of the company or association as opposed to a cause of action which some individual member can assert in his own right."(3)
As stated above, there are exceptions to the rule and, in order for a minority shareholder to bring a derivative action on behalf of the company, it must show "(i) that the company is entitled to the relief claimed and (ii) that the action falls within the proper boundaries of an exception to the rule in Foss v. Harbottle".(4) Under Irish law, the intended plaintiff must show "a realistic prospect of success"(5) in that regard in order to be given leave by the court to bring a derivative action.
In Fanning v Murtagh(6) Judge Irvine identified that, as a matter of Irish law, there are four recognised exceptions to the Foss v Harbottle rule, which she summarised as comprising the following categories of wrongdoing:
"(a) an act which is illegal or ultra vires (sic) to the company;
(b) an irregularity in the passing of a resolution which requires a qualified majority;
(c) an act purporting to abridge or abolish the individual rights of a member;
(d) an act which constitutes a fraud against the minority and the wrongdoers are themselves in control of the company."
In the case at hand, the judge recorded that the applicant had invited him to accept a fifth exception, relying on a Supreme Court of Western Australia decision(7) and an Irish High Court decision.(8) In the former case the court questioned whether a fifth exception to the rule in Foss v Harbottle existed. Judge Ipp quoted from Foss v Harbottle, where remarks made by Sir James Wigram VC were indicative that there should be a general power of interference by the courts where justice demands that such a power be exercised. Judge Ipp stated that:
"Equity is concerned with substance and not form, and it seems to me to be contrary to principle to require wronged minority shareholders to bring themselves within the boundaries of the well recognised exceptions and to deny jurisdiction to a court of equity even where an unjust or unconscionable result may otherwise ensue."
In Glynn v Owen Judge Finlay Geoghegan acknowledged that although the Supreme Court in Crindle Investments v Wymes(9) did not have to opine on the existence of the fifth exception for the purposes of that appeal, Judge Keane did refer to "the less solidly based fifth exception which suggests that the rule may be relaxed where the interests of justice so require", and also recorded his extra-judicial writings which were more positive as to its existence.(10) Ultimately, she stated the following, with which Judge Kelly agreed in the case at hand:
"I respectfully agree that the formulation of the rule in the earlier cases makes clear that it should not be applied in such a way as to lead to injustice. Nevertheless, the entitlement of a shareholder to pursue by way of derivative action a claim for and on behalf of a company is an exception to the elementary principle… As such, it should broadly or liberally applied. A very strong case would have to be made out. It would have to be consistent with the principles underlying the rule in Foss v. Harbottle and the exceptions to it. These include the reluctance of the courts to interfere in the internal management of a company."
In the case at hand the applicant contended that he fell within the fourth exception – namely, that the matters about which he complained constituted a fraud against the minority and the wrongdoers themselves were in control of the company. In the alternative, he relied on the fifth exception. In considering whether to give leave, Judge Kelly recorded that the applicant accepted that the onus was on him to demonstrate that he could pursue a derivative action – namely, that he must show that he had a realistic prospect of success in establishing that the company was entitled to the remedy involved and that he fell within one of the exceptions.
Judge Kelly felt that the prospects of succeeding in the underlying claim were poor and, in fact, the potential counterparty had a good prospect of succeeding in its counterclaim. Even if he were wrong in that, the judge felt that any judgment against the counterparty would be hollow, in that it would have insufficient assets. Notwithstanding that, he went on to consider whether the applicant fell within any of the exceptions to the Foss v Harbottle rule. On the fourth exception, he felt that the directors had a reasonable basis for believing that there was no claim against the counterparty and that they had not acted with a degree of fraudulent character or moral turpitude. With regard to the fifth exception, he noted that:
• one only falls within it if the interests of justice so require;
• the exception should not be broadly or liberally applied; and
• a very strong case must be made out.
Thus, Kelly ruled that there was no case to warrant the court's intervention, much less a very strong one.
The decision usefully confirms that the rule in Foss v Harbottle still limits shareholder claims on behalf of the company, except where recognised exceptions apply. Although the 'justice of the case' may permit a derivative action, it is only grudgingly acknowledged and an applicant would be better served to rely on one of the other exceptions than to hope that leave to commence a derivative action might be granted on that basis alone.
For further information please contact Gearoid Carey by telephone (+353 1 232 2000), fax (+353 1 232 3333) or email (email@example.com).
(1) (1843) 2 Hare 461.
(2)  IEHC 332.
(3) Jenkins LJ in Edwards v Halliwell  2 All ER 104, quoted with approval by the Irish Supreme Court in Balkanbank v Taher (Supreme Court, unreported, January 19 1995).
(4) Prudential Assurance Company Limited (No 2)  1 Ch 204.
(5) Fanning v Murtagh  1 IR 551, Judge Irvine.
(7) Biala Pty Limited v Mallina Holdings Ltd.  ASCR 785.
(8) Glynn v Owen  IEHC328.
(9)  4 IR 567.
(10) Keane, Company Law (Tottel Publishing 2007), para 26.20.