1998/38A - Gamlestaden Fastigheter v Boleat and ors [1998] UR 38A (23 February 1998)

THE GREFFIER SUBSTITUTE:On 29 January 1998, I heard the abovementioned application of the defendants to strike out the Order of Justice in this action and reserved judgment therein.

Although the defendants summons dated 18 September 1997, to strike out was based upon various grounds, the defendants were only proceeding with their application upon the basis of the Order of Justice disclosing no reasonable cause of action.

The plaintiff owns 22% of the shareholding of the fifth defendant with the remaining 78% of the shareholding being owned by Hengoed Limited, a company which is allegedly owned by a Mr Karlsten or by a Panamanian company called IKK Inc. which is allegedly controlled by Mr Karlsten. From April 1989, onwards the fifth defendant owned 22% of a limited partnership which I will refer to as SPK. SPK had interests in two properties known as Chilehaus and Sprinkenhof. During 1993 SPK sold the interest in Chilehaus but the fifth defendant did not receive any money from that sale. Over a period of time the interest of the fifth defendant in SPK was converted into a 98.4% shareholding in a German limited liability company, which I will refer to as SPG, which owned Sprinkenhof. In May 1994, allegedly, Baltic gave an option to a third party, whose identity is not set out in the Order of Justice, to purchase its interest in SPG for just over 200 million Deutschmarks plus interest.

The fourth defendant is a member of the Coopers & Lybrand group which carries on business as specialist company and trust administrators and the first, second and third defendants are the directors of the fifth defendant who have been provided by the fourth defendant.

The action which is being brought is a minority shareholders action brought by the plaintiff as a minority shareholder in the fifth defendant against the first to fourth defendants. The allegations against the first to fourth defendants are mainly that they were negligent in allowing the different transactions referred to above to take place. However in paragraph 21 of the Order of Justice there is an allegation that the first, second and third defendants acted at the behest and/or in the sole interest of Hengoed and/or Mr Karlsten to the exclusion of and damage to the interests of any other shareholders in Baltic, including the plaintiff.

It is the case of the defendants that the rule in Foss v Harbottle (1843) 2 Hare 461 applies and that any right of action in this matter is vested solely in the fifth defendant.

In the recent case of Floor Khan and another v Leisure Enterprises (Jersey) Limited and others (18 December 1997) Jersey Unreported, there was a very helpful résumé of cases in relation to minority shareholders actions commencing on page 5 of that judgment and I am now quoting the relevant section as follows:-

"It is well established that I should exercise the power to strike out only if it is plain and obvious that the action will not succeed. The mere fact that the case is weak and not likely to succeed is not sufficient. It must be on its face obviously unsustainable. On the other hand a striking out may "often be required by the very essence of justice to be done" (per Lord Blackburn in Metropolitan Bank v Pooley (1885) 10 App Cas. 210, p221).

Mr O’Connell submits that the rule in Foss v Harbottle (1843) 2 Hare 461 makes it plain and obvious that the plaintiffs will not succeed. The classic exposition of the rule upon which Mr O’Connell relies is to be found in the Privy Council case of Burland v Earle [1902] AC 83 where Lord Davey stated at page 93:

"It is an elementary principle of the law relating to joint stock companies that the court will not interfere with the internal management of companies acting within their powers, and in fact has no jurisdiction to do so. Again, it is clear law that in order to redress a wrong done to the company or to recover moneys or damages alleged to be due to the company, the action should prima facie be brought by the company itself. These cardinal principles are laid down in the well-known cases of Foss v Harbottle and Mozley v Alston ((1847), I Ph790), and in numerous later cases which it is unnecessary to cite. But an exception is made to the second rule, where the persons against whom the relief is sought themselves hold and control the majority of the shares in the company, and will not permit an action to be brought in the name of the company. In that case the courts allow the shareholders complaining to bring an action in their own names. This, however, is mere matter of procedure in order to give a remedy for a wrong which would otherwise escape redress, and it is obvious that in such an action the plaintiffs cannot have a larger right to relief than the company itself would have if it were plaintiff, and cannot complain of acts which are valid if done with the approval of the majority of the shareholders, or are capable of being confirmed by the majority. The cases in which the minority can maintain such an action are, therefore, confined to those in which the acts complained of are of a fraudulent character or beyond the powers of the company. A familiar example is where the majority are endeavouring directly or indirectly to appropriate to themselves money, property, or advantages which belong to the company, or in which the other shareholders are entitled to participate, as was alleged in the case of Menier v Hoopers Telegraph Works ((1874), 9 Ch. App.350)."

Both counsel agree that this principle forms part of the law of Jersey and indeed it has been applied on several occasions.

The so-called "fraud upon a minority" exception has been described as "doubly misleading". The learned editors of Palmers Company Law state at paragraph 8.813:

"First, "fraud" in this context is not confined to common law fraud, ie deceit, but embraces a wider equitable meaning. Secondly the fraud is not so much committed on the minority as on the company. Hence, where the exception operates, the plaintiff shareholder brings a derivative action for the benefit of his company."

Mr Thompson for the plaintiffs argued that the applicants’ conduct fell within this wider equitable meaning of "fraud". He relied upon the judgement of Templeman J in Daniels and others v Daniels and others [1977] Ch. 89. The headnote of that case reads:

"The plaintiffs were minority shareholders in the third defendant ("the company"). The first and second defendants were majority shareholders and directors of the company. In October 1970 the company sold certain land to the second defendant for £4,250 on the instructions of the first and second defendants as directors, In 1974 the land was sold by the second defendant for £120,000. The plaintiffs brought an action against the defendants alleging that the price at which the land had been sold to the second defendant was well below its market value and that the first and second defendants knew that that was so, but had purported to adopt the probate value of the land although a probate value was usually much less than the open market value. The defendants applied to strike out the statement of claim as disclosing no reasonable cause of action since it did not allege fraud or any other ground that would justify an action by minority shareholders against the majority for damage caused to the company.

Held - The application would be dismissed. The confines of the rule that minority shareholders could not maintain an action on behalf of the company should not be drawn so narrowly that directors were able to make a profit out of their own negligence. Accordingly, minority shareholders were entitled to bring an action where the majority of the directors negligently, though without fraud, had benefited themselves at the expense of the company."

"The authorities which deal with simple fraud on the one hand and gross negligence on the other do not cover the situation which arises where, without fraud, the directors and majority shareholders are guilty of a breach of duty which they owe to the company, and that breach of duty not only harms the company but benefits the directors. In that case it seems to me that different considerations apply. If minority shareholders can sue if there is fraud, I see no reason why they cannot sue where the action of the majority and the directors, though without fraud, confers some benefit on those directors and majority shareholders themselves. It would seem to me quite monstrous particularly as fraud is so hard to plead and difficult to prove, if the confines of the exception to Foss v Harbottle were drawn so narrowly that directors could make a profit out of their negligence. Lord Hatherley LC in Turquand v Marshall opined that shareholders must put up with foolish or unwise directors. Danckwerts J in Pavlides v Jensen accepted that the forbearance of shareholders extends to directors who are ‘an amiable set of lunatics. Examples, ancient and modern, abound. But to put up with foolish directors is one thing; to put up with directors who are so foolish that they make a profit of £115,000 odd at the expense of the company is something entirely different. The principle which may be gleaned from Alexander v Automatic Telephone Co (directors benefiting themselves) from Cook v Deeks (directors diverting business in their own favour) and from dicta in Palvides v Jensen (directors appropriating assets of the company) is that a minority shareholder who has no other remedy may sue where directors use their powers intentionally or unintentionally, fraudulently or negligently in a manner which benefits themselves at the expense of the company".

It is arguable on the pleadings that the applicants were negligent or acted in breach of duty. But that is not in my judgment sufficient by itself to bring their conduct within the scope of the exception.

Mr O’Connell relied upon Palvides (sic) v Jensen and others [1956] 2 All ER 518. In that case a minority shareholder brought an action against the defendant directors following the sale of an asbestos mine for £182,000. The sale was not submitted for the approval of the company in general meeting. It was alleged that the defendant directors had been grossly negligent because the true value was about £1 million. Fraud was not alleged. The plaintiff claimed on behalf of himself and all other shareholders except the defendant directors a declaration that the directors were guilty of a breach of duty and the payment of damages by them to the company. It was held that the action was not maintainable by the plaintiff because, the sale of the mine not being ultra vires and no acts of a fraudulent character being alleged by the plaintiff, the sale could be approved or confirmed by a majority of the directors. Danckwerts J stated, at page 253:

"On the facts of the present case, the sale of the companys mine was not beyond the powers of the company, and it is not alleged to be ultra vires. There is no allegation of fraud on the part of the directors or appropriation of assets of the company by the majority shareholders in fraud of the minority. 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 be taken by the company against the directors. Applying, therefore, the principles as stated by Lord Davey, it is impossible to see how the present action can be maintained ."

This extract was referred to with approval by Templeman J in Daniels v Daniels. The learned judge stated, after citing the above extract:

"Counsel for the defendants relies very strongly on this decision as showing that, whatever the exceptions to Foss v Harbottle may be, mere gross negligence is not actionable, and he says all that is pleaded in the present case is gross negligence at the most. But in Pavlides v Jensen no benefits accrued to the directors. Counsel for the plaintiffs asks me to dissent from Pavlides v Jensen but the decision seems to me at the moment to be in line with the authorities, in what is a restricted exception to the rule in Foss v Harbottle.""

I am, of course, in the same position in relation to this striking out application as the Bailiff was in in Khan and so his comments in the first paragraph of the quotation above apply equally here.

The first issue which I must look at is the issue as to the circumstances in which a minority shareholders action may be brought. According to the Burland v Earle (1902) AC 83 quotation the relevant exception to Foss v Harbottle exists:-

The first to fourth defendants in this case clearly neither hold nor control the majority of the shares in the fifth defendant. If the section set out immediately above accurately sets out the current state of the law in relation to a minority shareholders action then there can be no doubt that this action, as presently pleaded, must fail. Any minority shareholders’ action would have to be brought against Hengoed and/or Mr Karlsten.

The Khan case itself was not decided upon this basis but was rather decided upon the basis that the cause of action would fail for different reasons. However, there is nothing in the judgment to suggest that the law is any different to that set out in the quotation above. In the case of Pavlides v Jensen and others [1956] 2 All E R 518 there was an allegation that a mine had been sold at an undervalue to another company. In that case the directors of the company which had sold the mine (of which the plaintiff was a minority shareholder) also formed a majority of the directors of the company to which the mine was sold, allegedly at an undervalue. Although the decision was not made upon this ground, there is the following interesting and helpful section beginning at letter F on page 523 of the judgment:-

"That really disposes of the matter, and it is not really necessary to consider whether, on the allegations contained in the re-amended statement of claim, the defendant directors can be said to have such control of the company as to require (in any appropriate case) the allowance of an action by a minority shareholder. The defendant directors are not in fact the holders of the shares, the voting power of which would settle the company’s decision. I think that it must be admissible in certain cases to go behind the apparent ownership of shares in order to discover whether a company is in fact controlled by wrongdoers - as, for instance, in the case were the shares were held by mere nominees, bound to vote as the owners required them to vote. In the present case, the shares are held by a company of which the defendant directors were, for the greater part of the material period, not only directors, but sufficient in number to out-vote the other directors, of the shareholding company. In this manner, it is said that they could prevent the shareholding company passing any resolution which might result in proceedings being taken in the name of the company which is alleged to have been injured against them. I suppose the shareholders of the shareholding company could in general meeting decide differently and disagree with the decision of the directors of that company. I am not satisfied that the defendant directors are in such control of the company as is necessary to justify an action by a minority shareholder, but I need not decide this question."

I have carefully considered the question as to whether any of the cases which have arisen since Pavlides v Jensen in 1956 have changed the position.

Daniels v Daniels (1977) Ch. 89 involved the case which was brought against the directors of the relevant company but they were also the majority shareholders of the company.

In the case of Eastmanco (Kilner House) v Greater London Council, (1982) 1 WLR 2 the defendant controlled all the shares in the relevant company which had voting rights.

In the case of Barrett v Duckett (1995) 1 BCLC. 243 and others, there was a 50:50 deadlock in relation to the company. At the bottom of page 249 of the judgment in that case there are a number of general principles set out one of which reads as follows:-

The court did not then state precisely what it meant by "where the wrongdoer has control" but there is nothing in that judgment to indicate that there was any intention to alter the previous state of the law. That action, in fact failed because there was another remedy available to the plaintiff, namely an application for a just and equitable winding up of the company.

Accordingly, I have come to the conclusion that this action, as presently worded, must fail for the simple reason that the defendants are not sufficiently in control of the company to prevent the company from bring the action against them.

The second point which I have to consider is the point as to whether any other remedy is available in this case. On page 250 of the Barrett v Duckett case one of the six principles set out therein reads as follows:-

In that particular case the Court of Appeal came to the conclusion that there was another available remedy namely an application for a just and equitable winding up in order to end the deadlock between the shareholders and directors.

In this case, Advocate Le Cocq submitted that there was another remedy under article 141 of the Companies (Jersey) Law 1991, the relevant part of which article reads as follows:

Article 143 confers a number of powers on the Court if it is satisfied that an application under Article 141 is well founded.

If there is a factual basis upon which a minority shareholders action can be brought in this case then it appears to me that it would be extremely likely if not certain that the Court would make an order under Article 141 of the said law. Accordingly, it seems to me that any proceedings which could be brought ought to have been brought under that Article and that there is a further ground for striking out the action by reason of this.

Much of the argument before me related to the question as to whether the allegations against the first to fourth defendants involved complaints against them which were of a fraudulent character. The relevant section from the Burland v Earle judgment reads as follows:-

This concept of fraud upon a minority was widened by virtue of the case of Daniels and others and the relevant part which is quoted in the Khan judgment reads as follows:-

There was no allegation here that the directors had benefited themselves at the expense of the company and, accordingly, the argument came down to whether or not the allegations against the first to fourth defendant were of a fraudulent character.

However, as I have already decided against the plaintiff in relation to two other points, and as the arguments in relation to this, are quite complex, I have not needed to decide as to whether or not the action should be struck out as failing to fall within this category.

Finally, I shall need to be addressed by both parties in relation to the costs of and incidental to the whole action including the costs of and incidental to the application to strike out.

Khan -v- Leisure Enterprises (Jersey) Limited (18 December 1997) Jersey Unreported

Spokes -v- The Grosvenor and West End Railway Terminus Hotel Company Limited (1987) 2 QBD 124

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You are here: BAILII >> Databases >> Jersey Unreported Judgments >> 1998/38A - Gamlestaden Fastigheter v Boleat and ors [1998] UR 38A (23 February 1998) URL: http://www.bailii.org/je/cases/UR/1998/38A.html Cite as: [1998] UR 38A

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