Introduction
The "fraud on the minority" rule is a key principle in company law. It allows minority shareholders to bring legal actions on behalf of a company against directors or controlling shareholders whose conduct harms the company for personal gain. This rule modifies the general principle from Foss v Harbottle (1843) 2 Hare 461, which prevents individual shareholders from pursuing claims for the company. To apply the rule, claimants must identify a wrongful act harming the company, demonstrate that those responsible hold power over the company, and show this power prevents the company from acting. This article examines Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204, a key case that established the “fraud on the minority” rule.
The Facts of Prudential Assurance v Newman Industries
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) involved asset transfers between Newman Industries Ltd and two companies controlled by its directors. Prudential, a minority shareholder, argued these transactions harmed Newman Industries and amounted to a fraud on the minority. The directors, who held power over Newman Industries, prevented the company from taking legal action, leading Prudential to file a claim on its behalf.
Establishing the "Fraud on the Minority" Rule
The Court of Appeal in Prudential confirmed the rule applies when wrongdoers use their authority to prevent the company from suing them. The court clarified that “fraud” in this context does not require criminal fraud. It covers actions unfairly harming minority shareholders, such as breaches of fiduciary duties, self-dealing transactions, or misuse of company assets to benefit controllers at the company’s expense.
The Requirement of Wrongful Acts Harming the Company
Prudential ruled the wrongful act must directly harm the company, not just shareholders individually. The court distinguished “personal wrongs” (affecting shareholders directly) from “corporate wrongs” (damaging the company). Only corporate wrongs permit derivative claims, as the shareholder acts to advance claims the company cannot pursue.
Proving Control by the Wrongdoers
A key element of the rule is showing that wrongdoers hold sufficient power over the company to block action against them. The Prudential court stated control need not arise solely from majority ownership. It could result from influence over board decisions or shareholder voting.
Compensation in Derivative Claims
Prudential confirmed that compensation in these claims remedies the company’s losses, not the shareholder’s. This reinforces that the action benefits the company, with any award paid to it. The shareholder’s loss is relevant only for standing, not compensation.
Prudential’s Impact and Subsequent Cases
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) remains a foundational case in company law. It defined the “fraud on the minority” rule, including the scope of “fraud,” the need for company harm, and methods to establish control. Later decisions built on these principles, but Prudential continues to protect minority shareholders from abuse by controllers and ensure companies address misconduct. This framework supports fair governance.
Conclusion
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) established the “fraud on the minority” rule. It confirmed derivative claims are permissible when controllers prevent the company from suing over corporate wrongs. The case clarified that “fraud” includes breaches of duty harming the company, not solely criminal acts. By requiring proof of company harm and wrongdoer control, Prudential provided tools to safeguard minority shareholders and ensure corporate accountability. Its principles remain essential for fair governance, protecting minority interests against misuse of power.
