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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

DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

cannot sue on behalf of the company to enforce the company rights, because of the separate legal entity principle. The separate legal entity 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 wrongdoers 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
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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.

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
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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 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
for MTEX Corp. Sdn Bhd.
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Foss v. Harbottle (1843) 2 Hare 461; 67 ER 189.

DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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. 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
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Stein v. Blake[1998] 1 All ER 724, 730, CA. Foss v. Harbottle [1843] 2 Hare 461; 67 ER 189.

DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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 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 companys 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
Fong Poh Yoke v. The Central Construction Co. (Malaysia) Sdn Bhd [1998] 4 CLJ Supp 112, at 126.
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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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Chan, Koh & Ling, Malaysian Company Law: Principles and Practice, Malaysia: Sweet & Max-Well Asia, Second Edition, 2006 at p. 478.
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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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 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
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Ibid, at p. 479. 1974] 1 MLJ 220, FC.

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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

DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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 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

Liang Khui v. Piasau Jaya Sdn Bhd & Anor [1996] 2 AMR 2477; [1996] 1 MLJ 113, FC.
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(1873) 8 Ch App 1035. [1956] Ch. 565; [1956] 2 All ER 518. [1956] Ch. 565; [1956] 2 All ER 518.

DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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 companys 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 sold company assets in lower price than market price and got some
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[1956] Ch 565 567. Pavlides v. Jensen [1956] 2 All ER 518.

DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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
Paidiah Genganaidu v. The Lower Perak Syndicate Sdn Bhd & Others [1974] 1 MLJ 220, FC.
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shareholders are prejudiced and suffer loss, as they are not allowed to 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) ii) iii) Ultra vires or prohibited acts; Fraud on minority shareholders; Not complying with special majority vote

requirement; iv) Invasion on personal rights;

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v) vi)

Service of notice improperly; When wrongdoers are in control of the

company; vii) If justice of the case so requires.

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:

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DR. MD. ABDUL JALIL, COMPANY LAW, Chapter 4, 2013

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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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