A Comment on a Delhi High Court Ruling on Shareholder Derivative Actions

One of the age-old tenets of corporate law is the “proper plaintiff” rule laid down in the seminal case of Foss v Harbottle, (1843) 2 Hare 461. According to this rule, where a wrong has been done to a company, it is only the company and not an individual shareholder who may bring an action to seek redress. This represents a wholesome recognition of the separate legal personality of the company. However, over time, the restrictive nature of the proper plaintiff rule resulted in the evolution of several exceptions to it, by which shareholders are allowed to bring a legal action against a wrongdoer on behalf of the company for wrong suffered by it. One significant exception is “fraud on the minority”, whereby certain insiders such as directors appropriate benefits to themselves to the detriment of the company. This is a particularly knotty issue where the wrongdoers themselves are in control of the company and, as a result, are unlikely to cause the company to sue themselves.

The “fraud on the minority” exception to Foss sprouted the derivative action, by which a shareholder is entitled to sue a wrongdoer on behalf of the company when the wrongdoers are in control. Such a derivative action that emanated in common law formed the mainstay of shareholder remedies in corporate law, especially for minority shareholders. Indian courts too embraced such a common law derivative action. See eg, Dr. Satya Charan v Rameshwar Prasad Bajoria 1949 SCC OnLine FC 35; Nagappa Chettiar v The Madras Race Club AIR 1951 Mad 831. Over the last three decades, however, several jurisdictions in the Commonwealth began codifying the derivative action mechanism in their company law statutes. However, Indian law continued to embrace the common law derivative action, which did not receive legislative attention even under the Companies Act 2013. Hence, conventional jurisprudence and academic discourse have proceeded on the basis of the continuance of the common law derivative action under the present corporate law dispensation (Rajiv Saumitra v Neetu Singh 2016 SCC OnLine Del 512; Starlight Real Estate (Ascot) Mauritius Limited v Jagrati Trade Services Private Limited 2019 SCC OnLine Cal 7290).

Such a status quo has been upended by the decision of a single judge of the Delhi High Court in ICP Investments (Mauritius) Ltd v Uppal Housing Pvt Ltd (30 August 2019). The brief facts are that ICP Investments and Uppal Housing are shareholders (holding 52% and 45% shares respectively) of Umang Realtech Private Limited. ICP Investments alleged that Uppal Housing wrongfully obtained sums of money from Umang Realtech. As Umang Realtech is managed by a board of six directors with equal representation from ICP Investments and Uppal Housing, the board of Umang Realtech was unable to pursue legal action against Uppal Housing. Hence, ICP Investments initiated a derivative action on behalf of Umang Realtech against Uppal Housing as well as certain directors and another shareholder of Umang Realtech.

In the meanwhile, the National Company Law Tribunal (“NCLT”) admitted an application by a creditor of Umang Realtech under the Insolvency and Bankruptcy Code, 2016, thereby initiating a corporate insolvency resolution process in respect of the company. Hence, the Court found that upon commencement of the insolvency process and the assumption of the company’s affairs by the insolvency resolution professional, shareholders cannot maintain a derivative action. As a result, the Court decided that the derivative action to be “deadwood” and “liable to be dismissed on this ground alone” (para 26). This much is well understood, and merits no further discussion.

Despite such a finding, the Court went further to rule on the maintainability in general of derivative action against the company under Indian law. The Court engaged in a comparative survey of other common law jurisdictions to find that codification of derivative actions therein resulted in the abolition of the common law derivative action either expressly or by necessary implication (para 30). Struggling to discern any legislative intention for the absence of a statutory derivative action in India (para 31), the Court found that section 241(1) of the Act, which provides for a remedy for oppression, prejudice and mismanagement, gets attracted when the company’s affairs have been carried out ‘in a manner prejudicial to the interests of the company’ (para 40). This is unlike other common law jurisdictions where the oppression or unfair prejudice remedy is available only when the actions are prejudicial to the complaining shareholders, but not when they are merely prejudicial to the company itself.

Hence, the Court concluded that derivative actions are subsumed within section 241 of the Act, for which proceedings have to be brought before the NCLT (para 39). The Court also referred to section 430 of the Act, which states that a civil court shall not have jurisdiction in respect of matters which the NCLT is empowered to determine. It called attention to the fact that other courts which have accepted the common law derivative action in India as fait accompli have not considered this issue in detail. The Court therefore took the liberty of:

holding a derivative action to be per se not maintainable, specially claiming a relief of declaration, which … is a discretionary relief, and which discretion will not be exercised in favour of the plaintiff when a statutory remedy for a relief is available. (para 40)

This ruling is significant as it seeks to eviscerate in one fell swoop the common law derivative action in India. In a case note titled “ICP Investments v Uppal Housing: Pushing Shareholder Derivative Actions to the Brink”, I argue that this finding is unsustainable in law for a number of reasons. First, it represents an inchoate appreciation of the distinction between corporate wrongs (which are remedied through derivative actions) and personal wrongs of shareholders (which are remedied through oppression, prejudice and mismanagement actions). Second, it is not at all clear that the oppression, prejudice and mismanagement remedy under section 241 of the Act is wide enough to assimilate derivative actions. In this regard, a comparative analysis of the developments in the Commonwealth unveils a picture that does not comport with the finding of the Court in ICP Investments. Third, the Court’s ruling fails to square up with procedural and remedial considerations. Its eagerness to sequester the powers of the civil court in hearing a derivative action on the ground that they are vested in the NCLT is misplaced. Also, the existing statutory remedies under the Act are tuned towards redressing wrongs caused to the shareholders rather than to the company. If the finding in ICP Investments stands, it would not only roil the murky waters encircling derivative actions in India, but also emasculate the power of shareholders to seek remedies for wrongs caused to the company, and diminish the strength of corporate governance in Indian companies.

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.

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