"An interesting area of law, relatively unexplored, is the law governing derivative action mechanism, which enables the shareholders of a company to bring an action on behalf of the company against a third party before the regular civil courts. The jurisprudence on derivative action in India is still developing and any measure enhancing the enforcement mechanism is always welcome"...
"An interesting area of law, relatively unexplored, is the law governing derivative action mechanism, which enables the shareholders of a company to bring an action on behalf of the company against a third party before the regular civil courts. The jurisprudence on derivative action in India is still developing and any measure enhancing the enforcement mechanism is always welcome"
There have been several instances where two groups of shareholders of a company wrestle for the control of that company. These battles are either fought in the confines of a board room or escalated before the courts, tribunals and other bodies exercising quasi judicial functions. Proceedings requiring interference of the Company Law Board for oppression and mismanagement by those in control are often resorted to. In the case of listed companies, complaints regarding irregularities in the conduct of affairs of a company or malpractices in the securities market are made to regulators like the Securities and Exchange Board of India, the country’s securities market regulator. The Securities and Exchange Board of India has wide investigative powers and is duty bound to take steps to ensure that the interest of public shareholders who invest in the securities market and who are inevitably affected in cases of shareholder dispute is protected.
"It is imperative that such an action is brought in good faith and supported by bonafide intentions. It is pertinent to note that the personal rights of the plaintiffs cannot be the subject matter of a derivative action as a derivative action is for the benefit of the company."
The Companies Act, 1956 provides for the protection of the interests of minority shareholders of a company by making specific statutory provisions enabling minority shareholders to approach the Company Law Board against acts of oppression and mismanagement by those in control of the company. The regulatory regime dealing with corporate commercial litigation is now sought to be expanded by making specific provisions for bringing class action suits by shareholders in case of instances like corporate frauds. Though the Civil Procedure Code, 1908 always provided for representative actions, the specific inclusion of the class action mechanism in the Companies Bill, 2011 itself is a welcome development. The Companies Bill, 2011 provides that the prescribed number of shareholders may file an application inter alia claiming damages or compensation from the company or its directors for any fraudulent, unlawful or wrongful act or omission. A similar claim may be brought against the auditors or any expert advisor or consultant.
An interesting area of law, relatively unexplored, is the law governing derivative action mechanism which enables the shareholders of a company to bring an action on behalf of the company against a third party before the regular civil courts. There are no specific statutory provisions for a derivative action in India. However, the doctrine of derivative action is recognised by Indian courts. Normally, the management of a company is responsible for bringing and defending proceedings on behalf of the company.
However, there are occasions where the majority shareholders or shareholders in control of the company may be reluctant to bring an action on behalf of the company. In such an eventuality, the minority shareholders may take it upon themselves to bring an action for the benefit of the company. The welfare and interest of the company is the primary objective of such a derivative action.
It is imperative that such an action is brought in good faith and supported by bonafide intentions. It is pertinent to note that the personal rights of the plaintiffs cannot be the subject matter of a derivative action as a derivative action is for the benefit of the company. The distinction between personal action on the one hand and derivative action on the other appears to be that for a derivative action to be brought or to succeed, the wrongdoing complained of and ultimately to be established has to be a wrong done to the company. In the purest form of derivative action, no personal benefit would accrue to the plaintiff shareholder upon a decree being passed. It is the company, notwithstanding it being shown as a defendant, that gets a voice through the plaintiff shareholder in derivative suit. Hence, it is essential that such a power is not misused to foster ulterior objects or oblique motives of individual shareholders and that necessary checks and balances in the system are in place.
Keeping this in mind, the courts have observed that where there is an unfair action, inefficient management, self dealing by the majority stakeholders and if such a charge is supported by material evidence, the courts may be inclined to grant interim reliefs on an application made by the minority shareholders on behalf of the company and for the benefit of the company. It is important that the merits of a claim are substantiated by relevant documents, material and evidence as a safeguard against frivolous proceedings. The Bombay High Court, while recording that there were no specific statutory provisions for such derivative action in India, has recently observed that it is a permissible mode for the minority shareholders to check and control unfair, influential, malafide action for personal gain by others which is not in the interest of company.
If a shareholder alleges that a wrong has been done to the company by persons in control thereof, he may bring a derivative action where he derives the authority from his corporate right to sue on behalf of the company. The premise on which the court entertains this extraordinary form of action is upon the complaining shareholder’s assertion that the company cannot sue as the persons in control would not bring an action on its behalf or for its benefit. The time is perhaps right to introduce the derivative action mechanism by way of specific enabling statutory provisions. The jurisprudence on derivative action in India is still developing and any measure enhancing the enforcement mechanism is always welcome.
Disclaimer–The views expressed in this article are the personal views of the author and are purely informative in nature.