This article is written by Sanskriti Sharma, an intern under Legal Vihdiya

Introduction

Profit is the undisputed purpose of any firm or corporate group in a free economic market. A company, however, cannot function efficiently with just its employees. It requires the assistance and patronage of a group of individuals called investors. These investors are the vital organs of this artificial organism known as the company, responsible for the sustenance and continuity of this entity. An investor may refer to any individual or firm that employs its capital intending to secure financial returns. This capital may be in the form of debt or equity investments.

The investors include two groups – shareholders and creditors. Shareholders, who may be persons, institutions, or even companies, provide the corporation with assistance in the form of owning stocks of the company and may be further divided into the category of minority shareholders and majority shareholders as per the proportion of investments in the shares. The shareholder with over 50% of the total shares is a majority shareholder. By his ownership, the majority shareholder has much more involvement and influence in the matters of the company. They may also be able to vote on the company’s decisions when the shares they own are voting shares. Hence, these shareholders have a considerable say in the company’s functioning. For example, electing people on the board of directors, thereby controlling the company’s direction.

Contrary to this are the minority shareholder, which, as the name suggests, only own or control less than 50% of the company’s shares. The extent of their powers is minimal. As a result, there is a constant threat of their powers being appropriated, which makes it essential to have specific guidelines and legislation to protect their interest. In this article, we shall be analysing such two provisions and remedies for protecting minority shareholders – derivative action and civil action suit in detail.

Remedies

The Companies Act of 2013 empowers the minority shareholders to approach the tribunals under its sections 241 and 242 on the grounds of matters of the company being prejudicial to any member of the company or the interests of the company. Similarly, it allows the Central government to apply to the tribunal if it believes the company’s acts are detrimental to the public interest. Section 125 of the same legislation provides for setting up an Education and Protection Fund by the Central Government to further investors’ interests and awareness regarding their rights.

In an instance of oppression and mismanagement by the majority shareholders and board of members, the Companies Act of 2013 permits the shareholders to take up three different actions – Personal actions, Derivative action, and Class action suits. 

Class Action Suits

Class action suits are remedial measures filed to redress the injuries, often similar or identical, suffered by a group of individuals from a common person. The action may be brought forward in the court by the people themselves or through representatives. Hence it is also called Representative Action as the set of individuals who have approached the court on behalf of a larger unit claiming redressal of their grievances. This form of suit aims to allow claims from a larger group of people while ensuring the procedure’s feasibility as it consolidates litigation that may have been filed individually.

Development

The historical development of class action dates back to the United States of America, where it was introduced in 1983. However, in India, such a provision before 2013 was absent and presented through the Company Acts, 2013. The JJ Irani Committee of 2012 proposed the requirement after the infamous ‘Satyam scandal.’ It was one of the biggest corporate frauds where Satyam Computers Services Limited scammed its investors by fraudulently misrepresenting the company’s accounts and sales to myriad stakeholders. However, since the concept of Class Action suits was yet to be introduced in India, around 3 lakh shareholders were left without any reparation for the injury worth millions of dollars they suffered. On the other hand, American investors were successful in their claims for damages in American courts.

In the JJ Irani Committee reports Class action suits were recommended to have the same locus standi as the derivative actions in the courts. The same was later crystallized by inserting section 245 in the act of 2013. This section provides that depositors or members can file a class action if they hold the notion that the company’s functioning is conducted in a manner that opposes the interests of the members. It allows proceedings against the company as well as the auditors of the company.

Furthermore, section 37 of the same act also has clauses where the action is permitted under sections 34, 35, and 36 for the inclusion or omission of any matter in the prospectus or misstatements that may have misled any person, groups of persons, or any association of persons. Class suits are not so much a provision of law as the procedure of law and can be instituted under myriad arenas of civil procedure. There are various types of class suits, like consumer class suits, product liability class suits, securities class suits, and employment class suits.

Entities who can file a class action

The company act of 2013, specifically under section 245(1) 245 provides following individuals to file a class suit –

• A company having share capital
  • A hundred or more members of the company holding not less than the prescribed number of share capital or,
  • At least 10 percent of the total members with the condition that they have paid all calls and sums due on their shares.

• A Company not having share capital
  • Not less than one-fifth of the total number of members or,
  • Any depositor that owns 5 percent of the total deposits of the company.
• Listed companies – members holding not less than 2 percent of the share capital

Against whom it can be filed

A class action can be filed against the following –

• The company
• Directors of the company
• Experts or advisors of the company for any wrongful conduct
• Auditor or auditing firm for fraudulently misleading statements relating to accounts and finance.

Reliefs at the disposal of the applicant

The applicant may file a suit before the National Company Law Tribunal (NCLT) under section 245(1) seeking the following orders –

• To prevent the company from executing acts in opposition to the memorandum or article of the company
• To deter breach of any provisions or clauses under the memorandum of association or article of association
• To pronounce any alteration or modification done in the memorandum of association (MOA) or the article of association (AOA) through active concealment of any fact material from members and depositors alike.
• To restrain the directors from incorporating such misleading and fraudulently enacted resolutions
• To deter the company from acting against any provision or law in practice at that time.
• To prevent the company from acting against any resolution passed by the members or depositors.
• To put forward a request for appeal seeking compensation or damage from or against-
  • The company or the director for their misconduct or negligent and fraudulent action or omission
  • Auditor or the auditing firm for misleading statements made in the reports and accounts or from each partner of such auditing firm as provided under section 245(2)
  • Any advisor or expert involved in such misconduct or unlawful act or omission.
  • To pursue any other remedy as provided by the tribunals.

Benefits of a class suit

• Greater accountability

Through class actions, the shareholders and depositors can hold big corporations accountable for any imprudent actions or omissions along with fraudulent misrepresentation or breach of any provision of the memorandum of association or article of association that may be ultra vires to the resolution of the members. It would also ensure the redressal of grievances of small shareholders, which may be dismissed due to jurisdictional limits.

• Greater efficiency

The class action mechanism makes it possible to entertain a single suit by large groups of individuals on similar matters of dispute against the same entity. This reduces the burden that courts may face on duplication of lawsuits when filed separately and prevents the creation of backlogs or a situation of pendency. With expeditious adjudication, the courts would be better equipped to deliver justice. Further, a bar on the entertainment of similar class actions on the same matters can also be achieved.

• Feasibility of litigation

The cost of litigation is considerably reduced due to the expenses being evenly distributed between the claimants. This would ensure the representation of all interests without bearing the brunt of expensive fees charged by legal representatives. Additionally, skilled attorneys can be hired when individuals pool their resources. The competency of legal representatives can benefit the claimants in acquiring favourable relief. Furthermore, there would be consistency in the damages accorded to the plaintiffs.

Derivative Action

Another type of action that the shareholders can bring forward to protect the corporation’s interests is Derivative action, also known as shareholders’ derivative action, wherein the shareholder can induce the corporation to sue any third party. This type of action ensures that shareholders with considerable interests associated with the company can safeguard such interests from nefarious acts of ‘insiders’ like directors, management, or even other shareholders.

It is called derivative as the cause of action is vested in the company and brought intending to protect the company itself. Resorting to such mechanisms becomes essential when the directors, officers, employees, or other people in authority refuse to act in accordance with the underlying principles of the company and against the interests of the company. A company as an entity has been given a distinct legal personality separate from its shareholders’ personal rights. The shareholders employ these legal rights of the company to bring an action for the company’s benefit as the company is constrained by the decisions of the wrong-doers, i.e., the insiders.

Two requirements need to be fulfilled to be classified as a derivative suit.

• It must be brought in the form of and to represent the company by the shareholders.
• The company and the wrong-doers would be considered defendants, and the shareholders seeking action against the misguided policies and activities of the people in authority. 

Development

It has been a long-held principle that courts will not proceed to intervene or interrupt the administration of the company and the management of its operation by the board of directors as long as they act within the ambit of the powers conferred to them by the policies of the company. This rule of the majority was held in the landmark case of Foss v. Harbottle^[1]and prevented claims from a minority shareholder. However, the courts in India, considering the need to protect the minority shareholders specified in the case of Kanika Mukherji v. Rameshwar Dayal Dubey,^[2] oppression and mismanagement as an exception to the rule in Foss v. Harbottle. It was ruled that sections 397 and 398 of the Companies Act, 1956, are an exception to the sanctity of this majority rule.

Apart from this, derivative action can also be undertaken in certain specified circumstances-

• Act ultra vires

This refers to acts or incidents where a violation of principles enshrined in MOA or AOA is involved in the management or functioning of the corporate. The nature of these acts must be such that they cannot be legitimized just because of the rule of the majority, as enshrined in Foss v Harbottle.

• Acts requiring a special majority

A derivative action may also be instituted when a company has decided on a subject through an ordinary majority when it requires a special majority. Suppose the majority does not pass a resolution in such a manner. In that case, the members may use this option to restrain the majority.

•  Fraud on minority

The directors of a corporation can be held responsible in situations where discriminatory provisions deliver excessive powers to majority shareholders. It was held in the case of Greenhalgh v Arderne Cinemas Ltd. to ensure that majority power doesn’t become a tyranny.

• Protection of interest of the company

Due to enormous powers being at the disposal of the directors, they may try to take up decisions that may be detrimental to the company and the investors. In such instances, shareholders must have the right to protect their interests.

Cases concerning Derivative Action

1. ICP Investments (Mauritius) v. Uppal Housing Ltd.^[3]

In this case, the Delhi High Court narrowed the jurisdiction of derivative action. It held it to be a part of section 241 of the Companies Act. Though the court attempted to distinguish the position of derivative actions from that under the common law, it instead believed that it couldn’t appreciate the need for an action on behalf of the company by shareholders rather than suits by individual shareholders.

2. Rajiv Saumitra v. Neetu Singh^[4]

Here, the suit was brought by the company Paramount Pvt. Ltd against its director. This was done through a derivative suit as the company Paramount could not bring the lawsuit due to the director owning more than 50% of the shares and being a majority shareholder. Hence the Delhi High Court allowed the derivative action and ruled, “In a derivative action, only the company can sue for redressal. It must act through its directors due to being an artificial person. However, when the directors do the mala fide, the company can protect its interest by suing through shareholders even if they are in the minority.”

3. Bharat Insurance Company Ltd. v. Kanhaiya Lal^[5]

The plaintiff was one of the shareholders in the company and filed a suit against the company’s directors for acting ultra vires to MoA and making investments contrary to the policies under the MoA. It was held that a single shareholder could bring an action in cases where the company’s directors act against the company’s interest.

4. Rajahmundry Electric Supply Corpn v. Nageshwara Rao ^[6]

A suit of action was brought by the plaintiff, a shareholder, against the company’s director for mismanagement. It was alleged that there was misappropriation of funds, the Vice chairman had grossly mismanaged the affairs, and debt to the government was being handled negligently. In this case, the court accepted mismanagement as grounds for a derivative action.

Conclusion

Shareholders are an integral part of a company. Although they may not be involved in a company’s day-to-day functioning and administration, their presence is of great importance and must be noticed. It is, therefore, essential to promote their interests and safeguard them

References

1.     Class Action Suits under the Companies Act 2013, Lakshmikumaran & Sridharan https://www.lakshmisri.com/insights/articles/class-actions-under-the-companies-act-2013/#

2. Anurag Tiwari, Shareholder Derivative Action Suits in India: Avoiding the Influence of Foss v. Harbottle and Taking Cue from the UK Law, SCC Blog https://www.scconline.com/blog/post/2022/08/10/shareholder-derivative-action-suits-in-india-avoiding-the-influence-of-foss-v-harbottle-and-taking-cue-from-the-uk-law/

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^[1]  Foss v. Harbottle, 67 ER 189, 461, (1843).

^[2]  Kanika Mukherji v. Rameshwar Dayal Dubey, 1 Comp LJ 65, (1966)

^[3]  ICP Investments (Mauritius) v. Uppal Housing Ltd. 2019 SCC 10604, para 36.

^[4] Rajeev Saumitra v. Neetu Singh, 2016 SCC 512, para 57

^[5] Bharat Insurance Company Ltd. v. Kanhaiya Lal (AIR 1935 Lah74)

^[6] Rajahmundry Electric Supply Corpn v. Nageshwara Rao [AIR 1956 SC 213]