Facts
- Newman Industries Ltd engaged in asset transfers with two companies controlled by its own directors.
- Prudential Assurance Co Ltd, as a minority shareholder, alleged these transactions harmed Newman Industries Ltd and constituted a fraud on the minority.
- The directors of Newman Industries Ltd were in a position of control and actively prevented the company from pursuing legal action against themselves.
- Prudential initiated proceedings on behalf of Newman Industries Ltd to address the alleged misconduct.
Issues
- Whether the "fraud on the minority" rule permitted a minority shareholder to bring a derivative claim when controllers blocked the company from suing over harm done to it.
- Whether the conduct by the directors constituted a "fraud" within the meaning of the rule, particularly if "fraud" required criminal conduct or encompassed breaches of duty and self-dealing.
- Whether the wrongful act complained of must constitute a harm to the company itself, as opposed to merely harming individual shareholders.
- What level or type of “control” by alleged wrongdoers is necessary for the rule to apply.
Decision
- The Court of Appeal confirmed the "fraud on the minority" rule applies when those in control of a company wrongfully prevent it from suing them for acts causing harm to the company.
- “Fraud” for the purposes of the rule does not require criminal conduct; it includes breaches of fiduciary duty, self-dealing, or misuse of company assets to benefit controllers at the company's expense.
- The wrongful act must harm the company directly. Only such “corporate wrongs” can ground a derivative claim, not mere personal losses to shareholders.
- Sufficient control by wrongdoers could arise from factors beyond ownership of a majority of shares, such as control over board decisions or voting power.
- Compensation in successful derivative claims is awarded to the company itself, not directly to the shareholder claimant.
Legal Principles
- The "fraud on the minority" rule is an exception to the general rule from Foss v Harbottle that a company alone is the proper plaintiff in actions concerning wrongs done to it.
- “Fraud” under this rule includes broader breaches of duty, not only criminal acts.
- Derivative claims are available only where wrongdoing causes harm to the company and those in control prevent the company from acting.
- Standing in such claims depends on the prevention of company action by those alleged to have committed the wrong, coupled with direct company harm.
- Any compensation awarded goes to the company; a shareholder’s personal loss matters only for standing.
Conclusion
Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 established the scope and requirements of the "fraud on the minority" rule, confirming that minority shareholders may pursue derivative actions where company controllers prevent redress for wrongs causing company harm. The case clarified that “fraud” includes breaches of fiduciary duty, and articulated the requirements for control and company harm in derivative claims. These principles remain fundamental safeguards in company law against abuse by those in power.
