Delhi High Court on Directors’ Duties and Derivative Actions

It
is not very often that we witness cases in India relating to intrinsic company
law issues such as breaches of directors’ duties and shareholder remedies
through derivative actions. However, questions of directors’ duties have been
brought to the fore following the Companies Act, 2013 as they have been codified
in the legislation. Derivative action, however, still remains within the realm
of common law and has not been the subject matter of codification. Some of
these issues were brought to light in a case before the Delhi High Court in Rajeev
Saumitra v. Neetu Singh
, which was decided on 27 January 2016.
This
is one of several cases where matrimonial disputes often morph into significant
company law issues.[1]
Here, the plaintiff Rajeev Saumitra brought a shareholder derivative suit
against his wife Neetu Singh and a private limited company Paramount Coaching
Centre Pvt. Ltd. (“Paramount”), of which they were shareholders holding 50%
shares each. Another defendant is K.D. Campus Pvt. Ltd. (“K.D. Campus”), a company
set up by Neetu Singh. The primary dispute relates to the claim by Rajeev
Saumitra that while Neetu Singh was a director and shareholder of Paramount,
she began engaging in competing activity with that of the company, and set up
K.D. Campus in parallel and began luring the students (customers) of Paramount
away. It was alleged that she therefore breached her duties as a director of
Paramount. There was also a dispute relating to the use of the PARAMOUNT name
and mark, which is not germane to the issues at hand.
Without
delving into the details of the facts, this post discusses two company law
issues that arose in the case. The first relates to the breach of directors’
duties, particularly the duty to avoid conflict of interest. This might very
well be one of the first few cases that deal with the issue under the new
Companies Act of 2013. The second is the question of whether and shareholder
derivative suits can be permitted to be brought by a shareholder on behalf of
the company against a director for a breach of duties.
Breach of Directors’ Duties
The
Court examined section 166 of the Companies Act, 2013 that codifies directors’
duties. Apart from requiring the director not to be involved in a situation
where he or she has a direct or indirect conflict of interest with the company,
the statutory provision states that if a director obtains any undue gain or
advantage, the same must be paid over to the company.[2] On the facts, the Court found
that Neetu Singh had sought to enter into a competing business by establishing
K.D. Campus, thereby suggesting a breach of her duty as a director of Paramount
under section 166 of the Companies Act. One issue that came up during the
arguments of the parties, but did not receive significant attention in the
judgment, is whether there could be common law duties of directors in addition
to what has been expressly set out in section 166. In other words, is section
166 an exhaustive codification of directors’ duties in India? This has
previously exercised our minds as well, as we have noted here
and here.
While the Court discussed this in passing and implies the continuance of common
law duties, it appears that there was no need to rule definitively on the
issue, as it found a breach of section 166.
In
addition to breaches of directors’ duties, the plaintiff also alleged
violations of section 88 of the Indian Trusts Act, which provides that a
director who obtains a gain or advantage in any dealing that is adverse to the
interest of the company must hold that for the benefit of the company. Under
law, directors are strictly not trustees, although their roles may be similar
as they are both fiduciaries. Section 88 of the Trusts Act specifies various
relationships that are similar to trusts, and includes directorship of a
company as one of them. While this is understandable, the plaintiff also
alleged a violation of section 16 of the Partnership Act, which deals with
account for profits arising out of a partner’s engaging in a competing business
from that of the firm. This is somewhat confounding given that a private
limited company was involved in this case, which is legally a different vehicle
from that of a partnership. Even though a private limited company (especially
one that is owned by a husband and a wife) may carry some practical features of
the partnership, it is not clear if partnership law can therefore be applied to
deal with disputes, especially when it comes to breaches of directors’ duties. The
Court did not conclusively rule on these issues.
Derivative Actions
Shareholder
derivative actions in India are few and far between. A number of
reasons
have been proffered for this. However, lately there have been some
actions that have come up before the courts.[3] As often happens in the few
cases that come up before the Indian courts, the judge is required to decide
whether the action is a personal action brought by a shareholder or one that is
a derivative action brought on behalf of the company. In case of a derivative
action, the benefit of the action and the remedy flow to the company and not
the shareholders.
In
the present case, the defendants put forward the argument that the action was a
personal action and that it was more appropriate to be brought before the
Company Law Board as one for oppression and mismanagement under sections 397
and 398 of the Companies Act, 1956.[4] However, the Court rightly
found that the breach of directors’ duties would give the plaintiff shareholder
the right to initiate a derivative suit against the errant director on behalf
of the company. Moreover, the Court found that the provisions relating to
actions for oppression and mismanagement do not oust the jurisdiction of the
civil court, which is very much entitled to hear cases such as civil suits
brought in the form of shareholder derivative actions.
Based
on the conclusion arrived at on the question of breach of directors’ duties as
earlier and also the admissibility of a derivative law suit, the Court issued
appropriate orders on injunctions relating to the defendant’s ability to carry
on competing business.
Although
the Court’s decision was largely dependent upon the facts of the case, and was
not as such called upon to lay down any significant principle of law, it
highlights some of the issues that are likely to arise under the Companies Act,
2013, and also under common law to the extent that certain aspects (such as
shareholder derivative actions) are not codified under that legislation.



[1] One such significant case is the UK Supreme
Court decision in Prest
v. Petrodel Resources
, [2013] UKSC 34, which dealt with piercing the
corporate veil.

[2] Sub-section (4) and (5) of section 166.

[3] For example, see Starlite Real Estate v. Jagrati
Trade Services
(Calcutta High Court, 14 May 2015); Darius Rutton
Kavasmaneck vs Gharda Chemicals Ltd.
(Bombay High Court, 7 April 2015).
There may be others as well that we are not immediately aware of.

[4]
The parallel provision of section 241 of the Companies Act, 2013 is yet to come
into force.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • IMPROMPTU
    WRT the observation, selected:
    “…..it highlights some of the issues that are likely to arise under the Companies Act, 2013, and also under common law to the extent that CERTAIN ASPECTS (SUCH AS SHAREHOLDER DERIVATIVE ACTIONS) ARE NOT CODIFIED UNDER THAT LEGISLATION.”
    Going by common sense reasoning, and having regard to the wisdom open to be gathered in hindsight from past experience, there is, in one’s conviction, no substance , much less remedy hopefully lies, in ‘codifying’ such aspects, whatever that means or is meant to say. For, howsoever sincere an attempt is made, no such or similar issue could be expected to be resolved, ‘objectively’, and even through resort to either civil court or CLB as chosen by the disputants, mostly under expert advice of a lawyer. And, to be noted, court has not ruled whether or not the two lines of action are alternative, or either, could be emphatically said to be mutually exclusive. In this view of the matter, perhaps, the only way to minimise scope for litigation, -lawyer stimulated or otherwise, -would be to, without scope left for a choice, specially provide that recourse should be had ONLY to CLB or CIVIL COURT, as is considered to be idealistic in any situation; keeping in mind that, in today’s context, for obvious reasons, the uppermost must be the saving of cost and time. CLB being the designated authority for company law matters that, as viewed, could be the preferred recourse to be mandated. As , otherwise, such disputes as to which one is more appropriate course of action, by selves, apart from merits of each case, would involve an inconclusive litigation, and vexing prolongation to eternity.

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