[Pratyush Singh is a third-year student at the National Law School of India University, Bangalore]
Does the National Company Law Tribunal (NCLT) have exclusive jurisdiction over matters pertaining to derivative action? In November 2022, the Madras High Court in Valluvar Kuzhumam Pvt. Ltd. v. APC Drilling & Construction Pvt. Ltd. ruled in the affirmative. The argument to bar a civil court’s jurisdiction in a derivative action suit has been brought up several times before but the courts never reached a verdict owing to the plaint getting rejected for other reasons. Thus, Valluvar Kuzhumam is a significant development in corporate law jurisprudence.
It is in this broad context that this post argues that the NCLT should not have jurisdiction over derivative suits. To that end, the post will, first, present the requirements of barring a civil remedy and how the court in Valluvar Kuzhumam reached that conclusion, second, argue why shareholder derivative action should not lie under the Companies Act, and third, elaborate on the ramifications of the findings.
Establishing Exclusive Jurisdiction of the NCLT
How does the civil court lose its jurisdiction over a category of cases? This is a question that gained immense relevance ever since the rise in tribunalisation in India. Dhulabhai v. State of Madhya Pradesh is a seminal case that established seven principles through which one can assess if the jurisdiction of the civil courts is barred. In essence, it had to be proved that, first, a statute provided finality to the orders of the said tribunal and, second, that there was an express bar on the civil court’s jurisdiction under the statute which would also be supplemented by adequate remedies that a tribunal could grant.
Section 430 of the Companies Act, 2013 prohibits civil courts from having jurisdiction over any matters that the Act confers to the NCLT or the National Company Law Appellate Tribunal (NCLAT). In Sas Hospitality v. Surya Constructions, the Delhi High Court was called upon to comment on the exclusivity of the NCLT’s jurisdiction under section 430. The Court observed that under sections 241 and 242 the NCLT has broad powers which allow it to pass any “such order as it thinks fit.” This means that even if a civil court had jurisdiction over such company matters, it would not have the authority to pass orders to the extent the NCLT can. The Court thus concluded that the instant case would come within the domain of the NCLT. The issue that arises here is that the ratio of Sas Hospitality severely limited its scope by restricting its application to only cases dealing with the need to restrict the allotment of shares. What this entails is a case-by-case analysis for every matter to determine if the remedy sought by the plaintiff is provided under the Companies Act. Thus, there are instances where the court may conclude that since the Companies Act is inadequate to provide relief to the plaintiff, they can file a civil suit instead of approaching the NCLT. For example, in Bakshi Faiz Ahmad v. Bakshi Farooq Ahmad, the Jammu and Kashmir High Court held that since NCLT does not have the power to decide on serious issues of fraud and collusion, a civil court can be duly approached.
This brings us to Valluvar Kuzhumam. The Court in this case stated that section 241 empowers ‘any member’ to complain against an action in the ‘the interest of the company’, while section 242 provides the NCLT the authority to deal with section 241 applications. In the Court’s opinion, these provisions encompassed everything there was to a shareholder derivative action suit. Hence, as the Companies Act provided remedies for the said contention, the Court concluded that the jurisdiction of a civil court would be barred. The next section briefly discusses the jurisprudence of derivative action in India to understand its requirements.
Evolution of Shareholder Derivative Action in India
Since the derivative action in India not codified and is, instead, rooted in common law, it is important to briefly discuss its origins. Foss v. Harbottle (1843) 2 Hare 461 set the foundation for one of the earliest corporate law principles, i.e., the proper plaintiff rule. This rule states that if a particular wrong has been committed against a company, then only the company has the locus to bring an action and not a shareholder. Almost a century later, Edwards v. Halliwell 1950 (1) All ER 1064 carved out three exceptions to Foss v. Harbottle. Jenkins LJ stated that the majority in a company cannot ratify acts that are either ultra vires, or which require a qualified majority or acts that constitute a fraud against the minority. This act of a shareholder suing on behalf of the company is called derivative action. It arises in cases where the wrongdoers are in positions of power (or are the majority shareholders), and are thus unlikely to bring a suit on behalf of the company against their own interests.
Indian courts in various decisions had accepted this common law derivative action under the existing corporate law jurisprudence. However, the Delhi High Court in ICP Investments (Mauritius) Ltd v Uppal Housing Pvt Ltd (previously discussed here) completely changed this settled law. The Court ruled that section 241(1) of the Companies Act would encompass derivative action. The rationale of the court is that section 241 allows a member of the company to file a petition when the affairs of the company are conducted in a way that is prejudicial to the company’s interest. The Court further went ahead to state that since section 241 now subsumes derivative action, its common law remedy (at least to the extent that the oppression and mismanagement provision is equipped to handle) will cease to exist. It is the same understanding that the Court in Valluvar Kuzhumam seems to rely upon. Now since both the major requirements mentioned in Dhulabhai were fulfilled, i.e., an explicit bar under section 430 and adequate remedies under section 242, the Court concluded that the civil court’s jurisdiction for derivative actions would be barred.
Futility of Locating Derivative Action under the Companies Act
This section attempts to establish that no provisions under the Companies Act contain the concept of derivative action as formulated by the earlier common law jurisprudence.
The earlier section of this post would suggest that the Indian courts see merit in the idea of reading derivative action within section 241 of the Companies Act. This post argues to the contrary. The Court failed to acknowledge the differences between a corporate wrong and a personal wrong. Under a derivative action, since it is the company that has suffered a wrong (corporate wrong), the remedies are directed toward the company. However, a claim under section 241 can also be brought to enforce a personal right for a claim of oppression and mismanagement. What this entails is an argument that states that the interests of the company and shareholders are the same. This argument breaks one of the corporate law’s core tenets of treating a company as a separate legal personability.
It must further be noted that there is also a lack of legislative intent when arguing that derivative action comes under section 241. The erstwhile Companies Act had two different sections for oppression and mismanagement. Section 398 of the erstwhile Act had almost the same phrasing (“[affairs conducted] prejudicial to the interests of the company”) as section 241 of the 2013 Act. However, previous jurisprudence would suggest that sections 397 and 398 were expressly interpreted to mean that they do not contain any cause for a derivative action suit. The 2013 Act consolidated the two sections but made the prejudice remedy available for wrongs caused to the shareholders as well as the company. It is interesting to note that the original Companies Bill only provided this remedy in the context of harms caused to the shareholder. It was the Bombay Chamber of Commerce and Industry, who in their memorandum, recommended adding the phrase “in a manner prejudicial to the interests of the company.” This proposal was later accepted by the Ministry of Corporate Affairs. There is no other deliberation linked to the addition of this phrase. In such a situation, how does one interpret a provision that in a way provides for corporate as well as private wrongs? One author argues that the addition of the phrase may be the Parliament borrowing from Singapore jurisprudence. The Singapore Courts have noticed that there may be instances where a case for oppression/mismanagement where during the course of inquiry, it is revealed that the company has also suffered an incidental harm. Thus, it would still not amount to a suit for derivative action owing to a direct action being the primary reason for its existence. The remedies for corporate and personal wrongs are completely different and hence cannot be presumed to be conflated by the legislature.
Although never used by courts, various academics have considered that section 245 of the Companies Act may be a more suitable provision to fit a shareholder derivative action suit. Regardless of its resemblance, it is argued that section 245 does not encompass derivate action suits for three reasons. First, section 245 is provision providing for class action suits. However, it must be noted that even section 245 is filed by either members or depositors on behalf of other members or depositors, and not on behalf of the company. Second, a single shareholder is allowed to bring a derivative action; however, under section 245, the members or depositors need to form a numerical ‘class’ before being able to file a suit. And third, almost all of the remedies are directed toward the company instead of being available to the company for relief. Thus, the overall structure of section 245 is starkly different from a derivative action provision. Even the Calcutta High Court in The Punjab Produce & Trading Co Pvt Ltd v Pilani Investment & Industries Corp Ltd accepted that derivative action does not fall within the scope of section 245.
Lastly, it is pertinent to note that the legislature expressly rejected the inclusion of a provision for derivative action. The only rationale provided was that it is a new concept that should not be inserted in a hurried manner. By rejecting the concept of derivative actions during deliberations, the legislature clearly never intended to include it in section 241 or section 245. Thus, any attempt by the judiciary to read derivative action into any of the provisions of the Companies Act would amount to an erroneous interpretation of the statute.
Impact of Civil Court Jurisdiction
Having established that a claim for derivative action is not present under the Companies Act, the logical conclusion one would reach is that the bar on the jurisdiction of civil courts thus does not exist. The obvious question now relates to what consequence this will carry. In order to be eligible to file a case under section 241, a member has to satisfy the conditions mentioned under section 244. Similarly, there are certain conditions that a member or a depositor has to fulfil under section 245 before they are eligible to file a class action suit. Since NCLT does not have exclusive jurisdiction over derivative suits, a person can approach a civil court without complying with any of the abovementioned conditions. In Cyrus Investments v. Tata Sons, the respondent counsel had argued that they would not have to fulfil the requirements under section 244 if they had filed their suit before a civil court. Although their argument was rejected owing to NCLAT holding that the allegation against them fit squarely within section 241, an important point can be derived from this. In a derivative action suit, which does not fall under the Companies Act, one can directly approach the civil courts for remedies by merely adhering to the earlier common law jurisprudence.
Thus, if the legislature wishes to introduce certain requirements to avoid frivolous litigation under derivative actions, it should explicitly introduce a provision for it under the current Companies Act.
This post argued that the Court in Valluvar Kuzhumam erred in its judgment by locating derivative action under section 241. Derivative action has been intentionally and by design left out of the Companies Act. Until the time the legislature deems fit, it should not be read into any of the provisions, thus giving the NCLT exclusive jurisdiction over such matters. This would entail allowing a plaintiff to approach civil courts for seeking remedy under a derivative action suit without imposing additional requirements on them.
– Pratyush Singh