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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
CHAPTER FOUR
PROPER PLAINTIFF RULE AND ITS EXCEPTIONS
Contents of this chapter
- WHAT IS PROPER PLAINTIFF RULE
- RATIONALE FOR PROPER PLAINTIFF RULE
- DEFECTS IN PROPER PLAINTIFF RULE
- EXCEPTIONS TO PROPER PLAINTIFF RULE
- MAJORITY RULE
- INTERNAL MANAGEMENT RULE
- DERIVATIVE ACTIONS ON BEHALF OF THE COMPANY
WHAT IS PROPER PLAINTIFF RULE?
Proper plaintiff rule means if any wrong done to the company or the
company suffers any loss due to negligent or fraudulent acts of
directors or outsiders do not want to pay the debts due to the
company, only the company can sue the directors or the outsiders to
enforce the company rights. It is said that members of a company
cannot sue on behalf of the company to enforce the company rights,
because of the separate legal entity principle. The separate legal entity
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
principle states that the company is separate from all members in the
company. It is a legal person which can sue or be sued in its own name.1
If any wrong is done to the company or it suffers any loss due to the
fraud or negligent acts of the board of the directors or outsiders, only
the company can institute legal proceedings in the court to remedy the
loss suffered by it, the members are not allowed in company law to
bring a legal action on behalf of the company to remedy the loss
suffered by the company. An individual member of a company can bring
legal action against the wrong-doers on behalf of the company if only
he is authorized to do so by the board of directors or by an ordinary
resolution passed in the general meeting.2
The proper plaintiff rule originated from the decision of Foss v.
Harbottle3. In this case two shareholders of the company brought an
action on behalf of all shareholders except five directors and some
other shareholders. The plaintiff alleged that the directors sold their
1 Foss v. Harbottle (1843) 2 Hare 461; 67 ER 189; Prudential Assurance Co. Ltd. v. Newman Industries Ltd. (No. 2) [1982] Ch. 204, 224; [1982] All ER 354. In these cases the court held that the members cannot sue on behalf of the company to enforce its rights.2 Chan, Koh & Ling, Malaysian Company Law Principles and Practice, Malaysia: Sweet & Max-Well Asia, Second Edition 2006 at page 476; See also Fong Poh Yoke v. The Central Construction Co. (Malaysia) Sdn. Bhd. [1998] 4 CLJ Supp. 112, 127; AIC Dotcom Sdn. Bhd. v. MTEX Corp Sdn Bhd [2003] 4 MLJ 324. In this case AIC Dotcom Sdn Bhd. sued the dependents in a representative capacity for MTEX Corp. Sdn Bhd.
3 Foss v. Harbottle (1843) 2 Hare 461; 67 ER 189.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
own land to the company for a price which was higher than the market
price. As a result the company suffered loss. The plaintiff contended
that the directors must make good the loss incurred by the company
due to buying the land.
The issue was whether the shareholders could bring the legal action on
behalf of the company. The court held that because of the separate
legal entity principle, the shareholders were incompetent to bring such
an action on behalf of the company. In this situation only the company
could bring an action against the directors. Wigram V.C. in this case
observed that:
“It was not, nor could it successfully be argued that it was a
matter of course for any individual members of a corporation
thus to assume to themselves the right of suing in the name of
the corporation. In law the corporation and the aggregate
members of the corporation are not the same thing for purposes
like this; and the only question can be whether the facts alleged
in this case justify a departure from the rule which, prima facie,
would require that the corporation should sue in its own name
and in its corporate character, or in the name of someone whom
the law has appointed to be its representative.”
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
If a member of a company is affected by the decision of the board of
directors or by majority decision of the shareholders, that member
cannot bring an action against the board of directors or against the
majority shareholders4 unless he is so authorized by the board of
directors. Usually the board of directors are authorized to bring such an
action on behalf of the company.5 The articles of association of the
company provide provisions regarding who can bring an action on
behalf of the company. If the articles provide that the board of the
directors will initiate legal proceedings on behalf of the company for
any wrong done to it, the members cannot interfere with this power.6
The articles may also provide power to the members in a general
meeting to nominate a representative to bring legal action on behalf of
the company.7
RATIONALE FOR PROPER PLAINTIFF RULE
4 Stein v. Blake[1998] 1 All ER 724, 730, CA.5 Foss v. Harbottle [1843] 2 Hare 461; 67 ER 189.6 Fong Poh Yoke v. The Central Construction Co. (Malaysia) Sdn Bhd [1998] 4 CLJ Supp 112, at 126.7 See Automatic Self-cleaning Filter Syndicate Co. Ltd. v. Cuningham [1906] 2 Ch. 34, CA; Gramophone and Typewriters Ltd. v. Stanley [1908] 2 KB 89; Salmon v. Quin & Axtens Ltd. [1908] 100 LT 161; [1909] 1 Ch 311; John Shaw & Sons (Salford) Ltd v. Shaw [1935] 2 KB 113.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
The rationale for proper plaintiff rule is to avoid multiplicity of suits
against the company and its directors by its members.8 Such multiplicity
of suits by the members for frivolous and vexatious matters, may cause
a lot of legal fees which may affect the company’s financial strength
seriously. There may have some troublesome minority members in the
company who may like to harass or embarrass the board of directors.
They may institute frivolous and vexation litigations against the
directors with mala fide intention. Proper plaintiff rule may eliminate
such frequent frivolous and oppressive litigations against the directors
by the trouble making members in the company.
The proper plaintiff rule propagated in Foss v. Harbottle, has been
accepted and applied in Malaysia by the court. The rule forms an
important part of the company law in Malaysia.9 In Paidiah Genganaidu
v. The Lower Perak Syndicate Sdn Bhd & Others,10 the appellant on
behalf of the minority members of the company brought an action in
the court for a declaration that a resolution passed by the company in
an extraordinary general meeting was null and void because it was ultra
vires, illegal and a fraud on the minority shareholders. The Federal
Court of Malaysia referred to the proper plaintiff rule provided in Foss
8 Chan, Koh & Ling, Malaysian Company Law: Principles and Practice, Malaysia: Sweet & Max-Well Asia, Second Edition, 2006 at p. 478.9 Ibid, at p. 479.10 1974] 1 MLJ 220, FC.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
v. Harbottle and dismissed the appeal as the claim of the appellant did
not fall under any of the exceptions to the general rule in Foss v.
Harbottle. There are many other cases in Malaysia and Singapore which
considered and applied the proper plaintiff rule developed in Foss v.
Harbottle along with its exceptions.11
In Gray v. Lewis,12 a member of a company filed a bill against the
officers of the company for misapplication of assets. The court held that
the member had no authority to file the bill under proper plaintiff rule.
The company itself could file the bill to recover property from its
directors or officers or any other person.
In Pavlides v. Jensen,13 a minority shareholder brought an action
claiming damages on behalf of all shareholders of the company against
three directors who had been negligent in selling an asbestos mine
owned by the company for less than its market value. It was alleged by
the shareholder that the company had suffered loss by selling the mine
for lower price than the market price. The court held that the
shareholder was not eligible to bring such an action on behalf the 11 See Ting Chong Maa @ Tun Mun Seng v. Chor Sek Choon [1989] 1 MLJ 477; Ling Beng Hui & Others v. Ling Beng Sung [1990] 1 CLJ 512; Abdul Rahim bin Aki v. Krubong Industries Park (Melaka) Sdn. Bhd & others [1995] 3 AMR 3050; [1995] 3 MLJ 417, CA; Owen Sim Liang Khui v. Piasau Jaya Sdn Bhd & Anor [1996] 2 AMR 2477; [1996] 1 MLJ 113, FC.12 (1873) 8 Ch App 1035. [1956] Ch. 565; [1956] 2 All ER 518.13 [1956] Ch. 565; [1956] 2 All ER 518.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
company because the selling of the asbestos mine was intra vires and
the minority shareholder could not prove any fraud on minority
shareholders on the part of the directors. So, the plaintiff could not
maintain the action on the ground of proper plaintiff rule. In this case,
Danckwerts J. observed in his judgment that:
“It was open to the company, on the resolution of a majority of
the shareholders to sell the mine at a price decided by the
company in that manner, and it was open to the company by a
vote of the majority to decide that, if the directors by their
negligence or error of judgment had sold the company’s mine at
an undervalue, proceedings should not taken by the company
against the directors.”14
DEFECTS IN PROPER PLAINTIFF RULE
There are some defects and weaknesses of proper plaintiff rule. In
many occasions it has been found that the directors of the company
were negligent in doing business. As a result, the company suffered
loss. In some occasions the directors bought some goods or real
property belonged to them for the company with higher price than the
market price.15 As a result, the company suffered loss and the directors
gained personal profit. In some occasion it is found that the directors 14 [1956] Ch 565 – 567.15 Pavlides v. Jensen [1956] 2 All ER 518.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
sold company assets in lower price than market price and got some
commission from the buyer. In some occasions it is found that the
company made some resolution which went against the interest of
minority shareholders.16
In the above situations, the minority members in a company cannot
bring action against the directors because of the existence of infamous
proper plaintiff rule originated in the case of Foss v. Harbottle in 1843.
This rule caused a lot of dissatisfaction for the minority shareholders as
they were unable to bring legal action against dishonest and negligent
directors.
The rule requires that the company itself will bring legal action against
the negligent or dishonest directors of a company but the directors will
not allow the company to bring such action against them in the name of
the company. As the directors are wrong-dowers, they will not bring an
action in the court against them. It is normal.
In the hypothetical situations mentioned above, the directors are
ethically liable to the company as well as to the minority shareholders
for their negligent or fraudulent acts. Therefore, they will not bring any
action against them in the name of the company. As a result, other
shareholders are prejudiced and suffer loss, as they are not allowed to 16 Paidiah Genganaidu v. The Lower Perak Syndicate Sdn Bhd & Others [1974] 1 MLJ 220, FC.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
bring action against the directors due to the existence of proper
plaintiff rule. Hence, the efficiency of the rule is questionable and it
does not protect the interest of the minority shareholders.
As minority shareholders are affected by the proper plaintiff rule and it
cannot protect their rights, they were dissatisfied with this rule. As a
result, the court from time to time made some exceptions to the proper
plaintiff rule. Under those exceptions any member of a company can
bring legal action against the directors for damages for negligent or
intentional loss caused to the company.
EXCEPTIONS TO THE PROPER PLAINTIFF RULE.
Over the time, courts have invented certain exceptions to the Foss v.
Harbottle rule. Those exceptions are:
i) Ultra vires or prohibited acts;
ii) Fraud on minority shareholders;
iii) Not complying with special majority vote requirement;
iv) Invasion on personal rights;
v) Service of notice improperly;
vi) When wrongdoers are in control of the company;
vii) If justice of the case so requires.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
Note: Students are required to explain the above exceptions with the
help of relevant decided cases. Refer to chapter 12 of the textbook.
MAJORITY RULE
INTERNAL MANAGEMENT RULE
DERIVATIVE ACTION
Note: For explanation on the above three points, please refer to the
text book, Chapter 12.
SAMPLE QUESTIONS:
1. Explain the proper plaintiff rule provided in Foss v. Harbottle. Is there any exception to this rule? Explain the exceptions with examples.
2. Explain the following with examples and decided cases:
a) Majority rule; b) Internal management rule.
3. What is derivative action? In what circumstances a member is allowed to take derivative action? Write the procedure of derivative action.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013
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