Protecting minority shareholders

By: Laiba Tariq 

One important factor in attracting investment is the protection of the rights of shareholders. While shareholders have a direct interest in the affairs of the company, directors are not accountable to them, instead, they are accountable to the company. This is because the company has a separate personality and the directors are contractually bound to the company and not the shareholders. Directors may act in a manner that is detrimental to the interest of the shareholders. Hence, an effective mechanism is needed to enforce director duties.  “Intra Corporate Dispute (ICD) arbitration” is one such mechanism. “ICD arbitration” is based on an arbitration clause incorporated in the constitution of a company. This paper will discuss the arbitrability of the derivative claim brought by minority shareholders by looking into the contractual nature of the company’s constitution and the impact of national laws. Then it will highlight the approach taken by the UK on the ICD arbitration concerning minority shareholder protection. Finally, it will anlayse the arbitrability of intra-company disputes in Pakistan.

Before adding the arbitration clause to the constitution of any company it is necessary to ascertain whether the laws of a country allow the incorporation of ICD arbitration clauses. The “ICD arbitration” idea is based on the “nexus of contract theory of corporation”. This theory treats a company’s constitution, which contains an ICD arbitration clause, as a binding contract between the company and shareholders and “amongst shareholders inter se”. Thus the company and its members are the parties to this contract and oy they can “invoke the ICD arbitration clause”. Interestingly, only shareholders can invoke the arbitration clause and directors cannot. However, this does not prevent the shareholders bringing a derivative claim (on behalf of the company) in arbitration against directors collectively as directors are agents of the company who get their authority from the constitution. The idea of the constitution being a contract is significant because it assumes that the company and members have autonomously agreed to the constitution, and this party autonomy, in turn, is central to the concept of arbitrability. The significance of any such “party autonomy-based intra- corporate dispute resolution” is that the arbitration clause can be enforced by any person/ party privy to the contract. The arbitrability of any dispute is also based on whether the subject matter is arbitrable in a particular state. This is determined by the statutes such as the laws governing companies and arbitration in general. Furthermore, arbitrability, especially in the case of “ICD arbitration” is determined by the type of relief which is sought and the power of the arbitrator to grant such a relief; the dispute may not be arbitrable if it impacts the rights of any third party such as creditors. Hence the arbitrability of the disputes brought by minority shareholders in derivative claims is determined through the laws of the jurisdiction where the company is incorporated and the type of relief sought by the party. Thus the shareholders, especially minority shareholders can enforce director duties through arbitration by bringing the action on behalf of the company in disputes covered by the arbitration clause.

Protection of the rights of minority shareholders is a part of the UK’s “delegalised corporate governance” courts in the UK have held that the disputes arising from the constitution of the company are contractual and are arbitrable as long as they do not engage the rights of creditors or infringe any statutory protection imposed for the benefit of third parties. The question of whether the arbitration tribunal can adjudicate the shareholder derivative action was answered by the English Court of Appeal in the case Fulham Football Club Ltd v Richards. The court looked at the power of the arbitration tribunal to adjudicate upon a derivative claim brought by a minority shareholder invoking the unfairly prejudicial remedy available under “section 994-5 of the Companies Act 2006 (2006 Act)”. The primary question before the court was “whether the statute or public policy prohibits the reference to arbitration of an unfair prejudice petition”. The court’s decision highlighted the significance of domestic law in determining the arbitrability of the claim. The court looked into the provisions of the “2006 Act and the Arbitration Act 1996” and concluded that neither the 2006 Act nor the 1996 Act contains an “express bar on submitting the unfair prejudice petition to arbitration based on public polic. The court held that the only restriction placed on the arbitrator was concerning the relief claimed by the parties; relief such as winding up, which impacts the rights of the third parties cannot be granted by the tribunal. However, the court held that just because a relief impacts third-party rights does not mean the subject matter of the dispute is not arbitrable at all, it may be arbitrable to the extent of the reliefs that do not impact third-party rights. This explains the contractual approach reinforced by the courts of the UK. Third parties, that are not privy to the contract are not involved in the process of “ICD arbitration”. Hence, in the UK courts have recognised the role of the “ICD arbitration” in protecting the rights of minority shareholders.

While the “Companies Act, 2017 (2017 Act)” and the “Arbitration Act, 1940 (1940 Act)” do not contain any express bar against the arbitrability of the claim brought by a minority shareholder, no right of derivative claim is available for the minority shareholders under the section 286 of the 1940 Act. Section 286 provides an equitable remedy to the minority members against the “oppression” of the majority. Under oppression remedy, claims can only be brought in cases where the conduct of the majority shareholders constitutes “oppression”. This narrows the scope of this provision because of the definition of oppression. The protection of the rights of minority shareholders can be better guaranteed by encouraging “ICD arbitration”. However, it is essential to amend section 286 and widen its scope by replacing the oppression remedy with a broader unfairly prejudicial remedy so that tribunal has more expansive remedies available to enforce the rights of minorities. It might be argued that unlike in the UK since no right to bring ring a derivative claim is available under the 2017 Act, it cannot be brought before an arbitration tribunal. Hence, the 2017 Act should allow derivative claims to prevent the arbitration clause allowing the “ICD arbitration” in this regard to be declared null and ineffective. The 2017 Act should also be amended to clarify whether directors will be bound by the” ICD arbitration” clause.

ICD arbitration and the above-mentioned legislative reforms can provide an alternative to minority shareholders to protect their rights. The “ICD arbitration” will provide an effective and expeditious dispute resolution mechanism that will help attract investors. This is because, unlike the court proceedings, confidentiality is maintained in the “ICD arbitration.” This confidentiality ensures there is no drop in the share price. Also, “ICD arbitration: will take away the burden from courts. Hence the promotion of “ICD arbitration” is important in Pakistan.

The writer is a law student. 

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