A New Approach To Claims By Shareholders For Loss Caused To A Company – by Don Mahon

 

Shareholder activism is not a privilege – it is a right and a responsibility. – Mark Mobius

 

The principle which has come to be known as the “Foss v Harbottle” rule (made famous in the English case of Foss v Harbottle (1843) 2 HARE 461: (1843) 67 ER 189) is not as entrenched as everyone may think. Simply put, the rule dictates that in any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself and a claim does not lie with the company’s shareholders, regardless of whether such wrong has caused a diminution in shareholder value.

An exception to this rule is the case of a derivative action enjoyed by shareholders and, save for this exception, it is commonly considered that the rule is Foss v Harbottle is immutable.

However, a closer consideration of the authorities demonstrate that this is not so.

In Mccrae v ABSA Bank, an exception was taken to a claim advanced by a shareholder who was alleged to have suffered a diminution in the value of his shareholding of a company as a result of the bank’s conduct. It was alleged that the bank had breach a duty of care owed to claimant which had caused his shareholding to diminish in value.

It is well-established that, for the purposes of determining whether a pleading is excipiable, all the factual allegations relied upon by the party claimaing are accepted as true – unless manifestly false.

See             TWK Agriculture Ltd v NCT Forestry Cooperative Ltd and Others 2006 (6) SA 20 (N) at 23B

Amongst the issues to be decided in the trial in due course was whether or not the Bank owed a duty of care to the claimant, would have foreseen the possibility of harm occurring to the claimant and ought to have taken steps to guard against its occurrence. These are ultimately policy questions.

See             McLelland v Hulett and Others 1992 (1) SA 456 (D) at 464

Her Ladyship stated that a Court faced with an exception to a claim should be careful not to make a premature decision as to whether a legal duty could be said to exist.

See             McCrae v ABSA Bank Ltd, unreported, case number 08/42229 at para 15

Where an exception had been taken solely on the grounds that the facts alleged by the plaintiff did not give rise to a legal duty of care by a collecting banker to the true owner of a lost or stolen cheque, the Supreme Court of Appeal held in Indac Electronics (Pty) Ltd v Volkskas Bank Ltd 1992 (1) SA 783 (A) that, at the stage of deciding an exception, a final evaluation and balancing of the relevant policy considerations which have been mentioned should not be undertaken.

Only rarely will the Court be in a position to determine the question or otherwise of a duty of care owed by professional advisors on a strike-out application and it is necessary to establish the full factual matrix before a final pronouncement is made.

See             Axiam Holdings Ltd v Deloitte & Touch 2006 (1) SA 237 (SCA); Andrews and Others v Kounnis Freeman (Affirm) [2000] Loyds Rep PN 263

It is well-established that the foundation of policy as to the existence of a legal duty of care is the “criterion of reasonableness” to which considerations of “moral indignation” and “the legal convictions of the community” contribute.

See             McLelland supra at p464

In the circumstances, in order to undertake a fair examination of the policy considerations involved, one must firstly, “proceed upon the assumption that the rule in Foss v Harbottle is not necessarily an absolute bar to the present action”, secondly, that the “defendant’s conduct should be regarded as unlawful”, thirdly, that “the true relationship between a shareholder and the commerce of the company … ought to be seen against a broader backdrop”.

See also     Stellenbosch Farmers Winery Ltd v Distillers Corporation SA Ltd and Another 1962 (1) SA 458 (A)

What is, in effect, required, is that, not merely the interests of the parties inter se, but also the conflicting interests of the community, be carefully weighed and that a balance be struck in accordance with what the Court conceives to be society’s notions of what justice demands. It is impossible to arrive at a conclusion except upon a consideration of all the circumstances of the case and of every other relevant factor which indicates that the matter should be considered by means of a trial and not be disposed of on exception.

See             Minister of Law & Order v Kadir 1995 (1) SA 303

The bank argued, in essence, that the claimant was not entitled to endeavour to construe a duty of care by the bank to him in circumstances where the law did not recognise his claim and that the claim lies with the company and not the shareholder. In advancing this contention, the plaintiff relied upon the rule against “double jeopardy”/”double recovery”, usually referred to as the rule in Foss v Harbottle.

The rationale for the rule and the basis upon which the claimant’s exception was advanced, relied upon the risk of placing a third party in jeopardy of double litigation and double payment; the mischief of allowing a shareholder to recover twice – personally and through the company must be prevented.

In excepting to the claim, the bank did not advert to any risk to which it would be subject. Instead, it approached the exception on the basis that the claimant was non-suited because no claim vests or can vest in the shareholder.

The risk of double jeopardy or double recovery is something which can only be considered once evidence is heard.

Furthermore, the liquidation of a company may affect assessment of the risk of double recovery: the mischief of double recovery ought not to be decided at the exception stage because “at this stage I am not aware whether or not the liquidator has elected to pursue any claim which the company may have against the defendants arising out of their alleged wrongful conduct. At the trial it may transpire that the liquidator, upon the instructions of the general body of creditors, has been precluded from pursuing any litigation on behalf of the company. In that event the potential mischief of “double recovery” alluded to in the authorities cited above will not occur. In such event it would be open to the plaintiff to pursue his remedy. On the other hand it is equally open to the defendant to plead in defence to plaintiff’s claims, that the liquidator has decided to pursue its remedies against the defendants in which case plaintiff may very well be non-suited in regard to his derivative action”.

See             Kalinko v Nisbet and Others 2002 (5) SA 766 at 778

There are a number of imponderables and permutations which at the exception stage cannot be properly assessed or contemplated.

See             Kalinko supra at 779

The bank contended that a finding of liability, even on the pleaded facts, would be untenable as the loss would have been suffered by the company and not the shareholder.

The rule in Foss v Harbottle is not immutable nor is it unchanging or inflexible. When the decision in Foss v Harbottle supra was originally pronounced, the derivative action was recognised to allow relief for oppressed minority shareholders.

In Foss v Harbottle, the Court conceded that the rule might have been too broadly stated and that “there are cases in which a suit might properly be so framed”. Such a case was found where a society of private persons would:

“be deprived of their civil rights”, [where] “no adequate remedy remained except that of a suit by individual corporatives in their private characters” [and where the] “claims of justice would be found superior to any difficulties arising out of technical rules …” (202/203)

In Berland v Earl [1902] AC 83, it was held that it was a “mere matter of procedure to give a remedy for a wrong which would otherwise escape redress”.

See also     TWK Agriculture Ltd v NCT Forestry Cooperative Ltd and Others 2006 (6) SA 20 (N) at para 16

In McLelland supra, the learned Judge acknowledged that “the more pressing demand of justice and of the law is that wrong should be redressed and that structural or technical impediments should not likely be permitted to stand in the way of redress of a wrong”.

See            page 464

It was also held that in a certain context, too narrow a view of the definition of a shareholder’s rights was not justified:

“A reliance on this “technical” status of a shareholder ought not to be allowed as a matter of policy”.

See            McLelland supra at p487

Where the risk is non-existent and a shareholder is left with a diminished patrimony, the continued application of the rule would amount to an unwarranted and technical obstruction to the course of justice.

See             McLelland supra at p467

In Letseng Diamonds Ltd v JCI Ltd and Others; Trinity Asset Management (Pty) Ltd and Others v Investec Bank and Others 2007 (5) SA 564 , it was recognised that there could be very exceptional circumstances where “there was no remedy available to a plaintiff” where such relief might be granted.

See             para 61

In short, therefore, the rationale for the exceptions to the rule against double recovery/double jeopardy arise from an acknowledgment that considerations of equity and the interests of justice require a recognition of a shareholder’s rights and protection of same and that technical niceties should not obstruct such recognition and protection.

See             McCrae v ABSA supra at p49

From this, it becomes clear that the Rule in Foss v Harbottle is not immutable. Although a defendant to a claim by a shareholder will be able to plead and rely on policy considerations which would dictate that the rule cannot, in the circumstances of a particular case, be departed from. This would not be a basis for an exception to the claim.