This is an important rule concerning the Foss v Harbottle Rule and the separation of a company as a legal entity apart from its shareholders.

Gihwala and Others v Grancy Property Ltd and Others (20760/14) [2016] ZASCA 35 (24 March 2016) per Wallis JA (Lewis, Leach and Seriti JJA and Tsoka AJA concurring).

The rule has two components:

  • A company is a separate legal entity from its shareholders.  In general any loss caused to the company must be recovered by the company and not by its shareholders, based on the diminution in the value of their shares or the loss of anticipated dividends.
  • The need for exceptions to this principle to avoid oppression.  Shareholders are permitted to recover loss caused to the company by way of what is termed a derivative action.  In certain circumstances it also permits recovery of the shareholder’s own loss.

See also Derivative action: Delictual claim for pure economic loss

Selected quotations from judgment (without footnotes)

“[108]     A helpful summary of the rule and its different elements is to be found in the following passage from the leading case of Prudential Assurance Co Ltd v Newman Industries Ltd and Others (No 2) (Prudential Assurance):

‘The classic definition of the rule in Foss v Harbottle is stated in the judgment of Jenkins LJ in Edwards v Halliwell [1950] 2 All ER 1064 at 1066 – 7 as follows.

(1) The proper plaintiff in an action in respect of a wrong alleged to be done to a corporation is, prima facie, the corporation.

(2) Where the alleged wrong is a transaction which might be made binding on the corporation and on all its members by a simple majority of the members, no individual member of the corporation is allowed to maintain an action in respect of that matter because, if the majority confirms the transaction, cadit quaestio; or, if the majority challenges the transaction, there is no valid reason why the company should not sue.

(3) There is no room for the operation of the rule if the alleged wrong is ultra vires the corporation, because the majority of members cannot confirm the transaction.

(4) There is also no room for the operation of the rule if the transaction complained of could be validly done or sanctioned only by a special resolution or the like, because a simple majority cannot confirm a transaction which requires the concurrence of a greater majority.

(5) There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company.  In this case the rule is relaxed in favour of the aggrieved minority, who are allowed to bring a minority shareholders’ action on behalf of themselves and all others.  The reason for this is that, if they were denied that right, their grievance could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue.’

[109]     The parameters of the rule are apparent from this passage.  It precludes shareholders from suing in their own right where the claim is one in respect of a wrong done to the company causing it to suffer loss.  That is so even where the result is to diminish the value of the shareholder’s shares or deprive them of a dividend and the company has declined or failed to take steps to recover the loss.  On the other hand, where there is no wrong to the company, but only one to the shareholder, there is no reason to bar the shareholder from suing.  That is so even if the measure of the shareholder’s loss is the diminution in value of their shareholding.  Those two propositions appear clearly from the speeches of Lord Bingham of Cornhill and Lord Millett in Gore Wood.

[110]     There is a third case described by Lord Bingham in Gore Wood in the following terms:

‘Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers loss separate and distinct from that suffered by the company caused by a breach of duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other.’

[111]     It was unclear under which leg of the rule it was contended that Grancy’s claims were precluded.  Grancy’s claims were undoubtedly claims arising from breaches of obligation separate and distinct from any claim that SMI may have had.  They arose from obligations owed to Grancy by Mr Gihwala, the Trust and Mr Manala under the investment agreement.  As such they appeared to fall in the third category referred to in para 110.

It is true that in respect of all of them, save that for loss of interest on the late payment of dividends, the measure of Grancy’s loss was the pecuniary loss arising from SMI’s failure either to repay its loan account or distribute surplus funds to its shareholders by way of dividends.  But the fact that SMI did not have the funds available for this purpose because they had been diverted elsewhere does not mean that SMI had a claim to recover those amounts.  A brief examination of the different claims is called for.

[112]     The claim for the repaid amount cannot, as I have held, be separated from the decision to invest in Scarlet Ibis.  The funds that should have been used for the former purpose were used for the latter.  That is why Fourie J said that this was a ‘wilful misappropriation of Grancy’s funds’.  But the investment in Scarlet Ibis was an investment that SMI was entitled to make.  The impropriety arose not because it exceeded the permissible limits of SMI’s investment powers, but because the investment agreement imposed an obligation not to engage in such an investment without Grancy’s consent and an obligation to use these funds to repay Grancy’s loan.  No basis was suggested for saying that SMI could recover the money invested in Scarlet Ibis from anyone.  Nor could it recover from the Trust and Mr Manala the money used to refund their initial loans to SMI.  It follows that this claim is not affected by the Foss v Harbottle rule.”