Majority Rule and Minority Rights: Balance needed for Corporate Democracy
Author: Narendra Singh
Maharashtra National Law University, Nagpur
The Corporate world is witnessing the legal battle of shareholders for a long time. This problem lies not only in India but across the globe. Corporate democracy is a very essential pillar of good corporate governance as the word ‘governance’ is itself seems to be politically influenced word in public law. For better implementation of the model of corporate democracy, it is paramount that every member irrespective of whether he is in a minority or majority should get the opportunity to participate in decision-making process of that corporation. Companies Act has focused more on corporate governance but when coming to corporate democracy it has not focused that effectively as required for effective corporate democracy.
This paper will aim to provide a study of the power of majority and rights available to the minority for their protection and the recent trend in minority shareholder activism which is necessary for corporate democracy.
Every company is managed according to the rule of the majority, and the basic foundation is that directors are the representatives elected by members of the company and therefore they have the right to deal with all day to day conduct of the company. There are certain rights which are not given to directors and so they have to be performed by members of the company by deciding in general meeting. The final call in such meeting is taken by a majority of members. Hence the majority rule means rights to run and conduct the affairs of the company lies with majority shareholder. Thus the principle here is the will of the majority would prevail and will bind the minority group and it is called the principle of Majority Rule.
This rule is usually recognized by the company law of almost every country.All decisions related to the management and functioning of the corporate world are usually made as per this rule because it considers fair, reasonable and legitimized. It is beneficial to the company in many ways, also advantageous to the judicial system and economy of a country. As for companies, it provides for collective action.If we talk about the judiciary then it saves the court’s time and people money by preventing infructuous actions of minority group, and this rule encourages companies to thrive and more the companies prosper, it leads to the betterment of the economy of the country.
On the other hand, rights and privileges of minority shareholders are restricted and therefore numerous times it leads to violation of their rights in corporate history because their voice uses to be disregarded under the garb of no effective and sufficient say. Numbers of allegations are there in courtrooms throughout the world by minority groups on the majority. Indian law also protectsthe minority by giving them the right to claim relief for Oppression and Mismanagement, but the point of debate is the effectiveness of these rights.
The majority rule as the title itself suggests is rule by majority, means affairs of the company and day to day functioning of company would be governed by members who are in majority i.e. the majority shareholder.
This rule was for the first time came in Foss v. Harbottle, an English judgment where the court held that whatever the majority decision will be at the upper hand and the court will not interfere. In this case, two shareholders named Foss and Turton (minority group) allege in the general meeting of a company that directors of the company have misapplied the property of the company and have defrauded it. But majority shareholders in general meeting resolved not to bring any kind of action against directors by stating that they were not at all liable. So the plaintiff commenced a legal action in a court of law alleging that defendants had defrauded the company in numerous ways such as selling their property to the company at price much higher than its actual worth and also cheated on the company by mortgaging property improperly. They prayed that defendant must make good to the company all the losses.
But the court dismissed the suit on the basis of four grounds and one of them was Majority rule as court held that whatever directors did was already rectified by the majority group of the company in their general meeting, so the court will not interfere here. The court observed the reasoning that if anything complains that it is done in an illegal or irregular way and which if the majority is entitled to do in a legal or regular manner, there is no means of bringing it in litigation. Court held that majority rule is advantageous to prevent infructuous litigation. This reasoning was later on followed by a number of cases.Mellish LJ in MacDougall v Gardinerhas observed the real benefit of the majority rule in avoiding fruitless litigation when he said:
“If the thing complained of is a thing which in substance the majority of the company are entitled to do, or if something has been done irregularly which the majority of the company are entitled to do regularly … there can be no use in having litigation about it, the ultimate end of which is only that a meeting has to be called, and then ultimately the majority gets its wishes.”
And it was held by the court that majority decisions are binding on minority group and they have to oblige it as per “Majority Rule.”
Another important principle discussed in this case was proper plaintiff rule, which means that only the company is competent to bring legal action against any person who causes any harm to the company as it is a separate legal entity. So this idea that only a company can file a suit against the wrongdoer and no individual member can do it confer an important power to a majority as a company performs through it majority group’s will and so any member from minority will not be able to even complain of a wrong done by the majority group.
Indian case which follows the proper majority rule for the first time was Bhajekar v. Shinkar, where disputes arise on the appointment of certain persons as managing agents by BOD by passing a resolution by majority favor but some directors oppose it by filing a suit on the ground that appointment was irregular. But the court dismissed the suit by stating that even if it was irregular, it was ratified by the majority group in general meeting and so the suit is not maintainable. Though in Parshuram v. Tata Industrial Bank, Ltd., Bombay high court has already accepted the non-interference principle somehow and observed that “officious interference by the court in such matters would paralyze the working of all joint-stock companies”.
Some times with the help of majority rule, the majority shareholder use to adopt unethical practices which are prejudicial to minority rights. So the strict application of majority rule sometimes prove to be harsh and unfair for minority shareholders, therefore with the development of the corporate world, certain exceptions to this rule evolved for protection of rights of minorities.
Exceptions to Majority Rule
1) Ultra vires Act:
The majority rule applies only where the act is permissible as per the AOA or MOA, but if any action is not within the ambit of MOA and also it is wholly illegal as per the Companies Act, then even resolution of a majority cannot rectify such act. Therefore in such cases of ultra vires act, any individual shareholder can file a suit to prevent the company to perform such illegal activities and the majority rule here will be of no use.
2) The act needs special majority resolution
There are certain acts that need approval from a special majority i.e. 3/4 of total members of the company, so the majority rule as evolved from Foss v. Harbottle cannot be raised as a defense by simple majority where it requires a special majority. So if such an essential prerequisite of special resolution is not considered, any individual member of the company can prevent the company from proceeding further on the basis of such a simple resolution.
3) Fraud on Minority by those in control
The most important case dealing with such concept is evolved in Menier v. Hooper’s, where a defendant in order to protect himself from company’s claim himself while the process of winding up of company, an appointed liquidator of his acquaintance, so plaintiff (a minority shareholder) bring legal action against him and the court found that Hooper has committed fraud and so even single member can sue him.
4) Where personal rights are infringed
There are certain rights given to shareholders by virtue of their holding of shares, such as the right to attend general meetings, the right to receive dividends once issued, and other provisions of AOA and MOA. If such right to vote, vote recording, cast vote in an election of the director is infringed, even single shareholder can challenge it and no need of majority approval is required here.For example, if a chairman during a meeting does not take in the vote of some members which ought to be there in the total count, a suit can be filed by such shareholder.
5) Oppression and Mismanagement
This concept is one of the most renowned principles related to the rights of shareholders. With the passes of time, this concept got a place in a statute dealing with the company law. In India, the law where protection against this oppression and mismanagement is available is Chapter XVI of Companies Act, 2013 from section 241 to 246. In the earlier act of 1956, two different sections were there for Oppression and Mismanagement, which are now clubbed in single section 241 of the 2013 Act. Though the definition of these terms is not provided in any statute, its meaning should be derived from the interpretation of judgments. But in the leading case of Elder v. Elder & Watson Ltd., Lord Cooper has defined Oppression as: “The essence of the matter seems to be that the conduct complained of should at the lowest involve a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to the company is entitled to rely.”In Shanti Prasad Jain v. Kalinga Tubes Justice Wanchoo has cited it by approval and observed that member who is complaining must prove that oppression has been committed to him in his capacity as a member of company and not otherwise.
In Scottish Co-operative Wholesale Society Ltd v. Meyer, Court held that exercise of a power or given authority in harsh, wrong and burdensome manner would amount to oppression.
Mismanagement means “when a material change has been brought in management or control of a company which is in a manner prejudicial to its members or class of members.”
To file an application for oppression and mismanagement under section 241, the eligibility requirement is under section 244, which can be waived off by tribunal by virtue of proviso given under the same section.
In one of the recent decisions in the case of Cyrus Investments Pvt. Ltd. v Tata Sons Ltd., NCLAT has used its discretionary power under section 244 and allowed the petition for oppression and mismanagement under section 241 by waiving off criteria of 10% of shareholding which was earlier dismissed by the Mumbai bench of NCLT in case ofCyrus Investments Pvt. Ltd. v Tata Sons Ltd. NCLAT took in consideration exceptional instances such as fact that total investment of Tata Sons was 6 lakh crores, out of which Cyrus Investments had contributed 1 lakh crore, and also held that Cyrus Investments along with ShapoorjiPallonji group holds 18.37% shareholding in Tata Sons, therefore it was a fit case for a waiver under section 244. NCLAT by allowing petition under 241 held that there wasan act of oppression on minority shareholders as sudden removal of Cyrus Mistry as from the position of Executive Chairman, and also change of status of the company from public company to private company by registrar was not as per the proper procedure as permission of tribunal was not taken as it was against the section 14 of Companies Act, 2013. NCLAT order to reinstate Cyrus Mistry as Executive Chairman of company, and also held that from next time for the safeguarding of rights and interest of all shareholders and also for the protection of minority group, Tata group should make a consultation with Shapoorji group while appointing executive chairman, directors, and independent directors. But now it has been challenged and pending before Supreme Court which has stayed the order of NCLAT.
To file a suit for O & M, the presence of these conditions is prerequisite:
a) The act must be Oppressive: As per section 241, “the affairs of the company have been or are being conducted in a manner prejudicial to the public interest or in a manner prejudicial or oppressive to him or any other member or members or in a manner prejudicial to the interests of the company”
In Needle Industries (India) v. Needle Industries Newey (India) Holding Ltd, in this case as per the mandate of government, foreign share (majority) were to be sold to Indian shareholders, therefore majority alleged oppression by a minority (Indian shareholder) because minority buying out the majority. But the court held that is was not oppressive act as government mandate was there and ordered Indian minority shareholders to purchase majority shares as proper value.
But in the case of Deepak C. Shriram v. General Sales Ltd.where the same facts of the above-mentioned case were there, but because of the absence of any government mandate, the act was considered to be oppressive.
b) Just and Equitable cause for winding up
A petitioner claiming relief of winding up of a company under section 242 has to prove that there is no adequate alternative remedy available and only winding up of a company is just and equitable relief. This is because winding up of a company is such a step where the interest of almost every member is going to get affected in some or other ways, so till the time when adequate alternative remedy can be invoked, it should not be granted by the court. In the leading case of Rajahmundry Electric Supply Corpn Ltd. v. NageshwaraRao, certain members of the company allege the O & M act of vice chairman for financial exploitation. VC, therefore, says that there may be Oppressive act but that was not during his tenure, so he files an application for winding up of the company. But court order appointment of two administrators instead of winding up of the company as no just and equitable reasoning was there.
c) Continuity of Act: Act alleged must be of continuing nature or of such nature that once committed but still have continuing effects till the date of filing an application under section 241 of the act. “There must be continuous acts on the part of the majority shareholders, continuing till the date of the petition.” The act should not be in isolation but must be part of a consecutive story.
d) Qua Member:
The plaintiff must be a member of a company and has paid all calls and other dues on his share. Although the name of the member should be there in the register of the company as it is prima facie evidence of his being a member of the company, it is not conclusive.A share certificate is also not conclusive as if the member is issued a share certificate but he has not paid his call due, he could not file a petition under section 241.
In a very general term, corporate democracy is a bunch of legitimate rights associated with shareholders to participate in a concept known as corporate governance. It plays a vital role in corporate governance (a system that governs and controls the corporate world). It is the base of providing transparency in corporations. It presumes that shareholders must provide a platform through which they can actively participate in the public company’s affair. Shareholders should get an impartial and rational chance to be there in the administrative work of the corporation. They should be allowed and must be free to express their views in a corporation without any fear and favor.Corporate democracy is very essential as most of the public corporations stand on investment of people known as shareholders of that company so it is very necessary that they should be given equal significance in corporate governance. So few people such as managers, directors, etc. could not take advantage of their position and derive unnecessary benefits on the cost of these shareholders. Today in the name of Corporate democracy, most public companies are giving them power limited to vote to cast but whom they want to elect is not in their hand as the procedure of candidate nomination for director’s position is somewhere undemocratic and therefore they are quite powerless. In the proxy mechanism, shareholders who are absent can only have their vote counted but are not allowed to express their views. Though there are some committees such as audit committees, stakeholder relationship committees that are there to enhance corporate democracy, yet members in these committees are also nominated by the board and therefore is a representation of management. Representation of shareholders in such committees and in the nomination of directors is something that can be proved to be beneficial to them.
Role of Majority Power to maintain Corporate Democracy:
Majority shareholders play a vital role in corporate democracy as most of the important decisions of the company use to be taken only after approval of majority members, sometime by the ordinary majority, sometimes with approval from a special majority (3/4 voting).
The majority rule is now accepted and prevailing almost everywhere in the corporate world after its evolution in Foss v. Harbottle, from that time it continues to operate and this rule was accepted finally in India in the case of Bhajekar v Shinkar.As it is presumed that the majority will take a decision for the welfare of a company as most of the investment in the company comes from them and what constitutes company is the majority itself.
But there is a need for a proper balance of majority power and rights of minority shareholders for good corporate democracy as sometimes some decision of majority may be harsh or unfair to minority interests. It is very important that every action of the majority should be taken in such a way, by taking into consideration that it would not affect minority shareholders in any way which is not in their interest. So with the passage of time, some exceptions to majority rule arose such as ultra vires act, fraud on minority, wrongdoer in control, infringement of individual rights. In all such circumstances, minority shareholders (even single shareholders) have the right to challenge such action of the majority shareholder. But till the point that majority is taking decisions for the interest of the company which is allowed in the article, the memorandum of a company, even the court do not prefer to interfere in such internal management of the company on the basis of non-interference principle. Corporate democracy requires harmonizing relations between both these groups of shareholders.
Provisions of Companies (Amendment Act), 2019:
The central government has brought an amendment in the act and made several important changes in the act. One of the important provisions added is in Section 241 where new sub-section 3 has been added by virtue of which central government may proceed with filing case or refer to the tribunal for initiating inquiry if it is of view that person associated with management of company’s affairs is not carrying such business as per proper principles and rules, or is guilty of fraud, negligence or breach of trust, or he is conducting day to day affairs of a company in a manner causing injury to trade or interest of the company and also record the reason for taking a decision whether he is competent and proper authority to hold such position in the company.
This provision is a kind of preventive measure because till now Section 241 was dealing with scenarios where the act of oppression and mismanagement was already committed or was being committed but now this kind of acts may be prevented even at an earlier stage.
Section 243(1) has been amended and therefore the person who is not proper authority shall not be allowed to be on that position of director or any other post related to managing affairs of the company for 5 years, but proviso to this is there which enables the central government to allow such person to hold office before 5 years with the permission of tribunal. That person will not be able to seek any loss or compensation for termination from that position.
Majority rule which once used to be a representation of democracy even today it is prevailing, but now onwards it is not being blindly followed and many countries’ legislation is following it but not in that strict manner as it was followed in an earlier time when Foss v Harbottle case emerged.
Act of 1956 gave some rights to minority shareholders under section 397, 398, 399, 400,401, etc. It was the first step for considering the rights of minority groups. Later on position become stronger and clear by the act of 2013, when Section 397, 398, 401 were merged in only one section that is section 241 of Companies Act, 2013.
Day by day as the corporate world is growing, the government is taking effective measures to balance the rights of majority and minority so that minority groups could not be suppressed in any way. The recent amendment of 2019 in companies act make add some more effective provisions with regard to the power of central government as discussed above. But even today concept of corporate democracy needs some strong statutory support as amendments in company law are focusing on corporate governance and corporate democracy is somewhere sidelined.
One of the important suggestions is that shareholders should participate not only in the election of directors but also in the nomination of directors. Another suggestion is that shareholders must get a chance to participate in the formation of the Audit Committee, Remuneration Committee, etc. Also, proxy members should be allowed to express their views and not be limited to the right to vote.
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