[Rakshit Agarwal is a 2nd Year Student at the National Law School of India University, Bangalore]
The judgment of the Delhi High Court in ICP Investments v Uppal Housing Pvt Ltd has spurred the debate as to whether section 241 of the Companies Act 2013 (“Act”) is the appropriate provision under which derivative actions can be instituted. The decision in ICP Investments to include derivative actions within section 241 of the Companies Act has been supported by the finding of the Madras High Court in Valluvar Kuzhumam v APC Drilling & Construction. This is a marked deviation from the presence of derivative actions within common law, as was the position earlier.
Although there has been scholarship criticizing these judgments as they deviate from common law, I argue that the finding of the Delhi High Court is sound in law. I first examine the language of sections 241 and 242 and then analyze the concurrent position in the United Kingdom (UK) as contained under the Companies Act 2006. I then argue that permitting section 241 to govern derivative actions is in the interests of minority shareholders.
Section 241 Encompasses Derivative Actions
Although section 241 is similar to its predecessor, namely section 397 of the Companies Act, 1956, there is a marked deviation in the language of section 241 in the 2013 Act. In the latter legislation, a suit for oppression or prejudice can be initiated when the company’s affairs are being conducted against its interests. This is different from the Companies Act, 1956, where oppression or unfair prejudice could be initiated only when the shareholders’ interests were adversely affected. An action under section 241 can be instituted when the company’s interests are affected, implying that redressing a personal wrong or the presence of personal injury is not the sine qua non to bring a suit. The change in the language led the Court in ICP Investments to infer that derivative actions can be included within section 241.
The fundamental purpose of derivative actions is to accord a remedy to the company when its management is being conducted against its interests. An observation and analysis of the remedies available under section 242 reveal that they are largely in the company’s favour. Setting aside company agreements or agreements entered into between a company and its directors under section 242(2)(e) contemplates situations that have arisen in common law derivative actions such as Daniels v Daniels [1978] Ch 406, where the controlling directors sold to themselves the company’s assets at an undervalued rate. In this case, the Court ultimately held that the minority shareholders had standing to bring about such a cause of action as the directors had breached their duties towards the company.
The removal of the directors and the recovery of undue gains made by the directors under section 242(2)(i) contemplates situations that have arisen in common law derivative actions, such as those in Cook v. Deeks, where the respondents obtained a contract in their name rather than the company’s. The Court held that since the benefit of the contract belonged to the company, the directors could not use their power to misappropriate funds. The tribunal has also been provided with the power to end matters complained of and make just and equitable orders under sections 242(1) and 242(2)(m), effectively covering situations not contemplated by other remedies. Thus, section 241 can encompass derivative actions. Thus, the statute contemplates situations that arose in common law derivative actions, ensuring that it forms an adequate replacement for the same in Indian law. I will now proceed to rebut arguments made against the inclusion of derivative actions within s 241.
Although the legislature did not intend to include derivative actions within the ambit of section 241, the courts are not bound to rely on the same. It can rely on the rule against surplusage, which holds that words of a provision or legislation should be read in a manner such that redundancy of any part can be avoided. Reading in derivative actions under section 241 gives effect to the words “interests of the company” and can thus be used to prevent redundancy. The same is also beneficial to minority shareholders and serves a dual purpose, which will be established in the next section.
While the judgments of Singapore such as that in Ng Kek Wee v Sim City Technology Ltd have been relied upon by scholars to argue that the words “interests of the company” can be used to initiate direct actions when the interests of shareholders as members of the company have been prejudiced, the same should not be relied on. This is because the relevant provision, namely section 216 of the Companies Act of Singapore, is in respect of “personal remedies in cases of oppression or injustice”. However, the explanatory note to section 241 of the Companies Act, 2013 does not specify or indicate that it is in the nature of a personal remedy. Thus, the interpretation accorded based on the holding of the Singapore Courts does not necessarily imply that section 241 is restricted to direct actions.
The UK has Interpreted Derivative Actions as a Part of Similar Remedies
Unlike its predecessor legislation, the Companies Act 2006 of the UK contains an explicit chapter that codifies and recognizes statutory derivative actions. Part 11 recognizes the right of shareholders to institute shareholder derivative actions in respect of any breach of negligence or trust by a director of the company. Under section 260(2), the Court recognizes the institution of a derivative claim under section 994 of the Act, which is the remedy against unfair prejudice. Section 994 authorizes a member of the company to apply to the court when the acts of the company are being carried out in a manner prejudicial to: (a) the interests of the members or; (b) the actions of the company are prejudicial in general. Despite the tendency to read the first part as meaning direct actions, I will demonstrate that derivative actions can be instituted under both parts of the section.
It is to be noted that the first part of the provision is in pari materia to section 459 of the Companies Act 1985. Under this provision, substantive corporate relief can be obtained through an unfair prejudice petition. In Clark v Cutland, the Court consolidated unfair prejudice and derivative actions under the said provision and granted the company £1.1 million in relief. In Re A Company [1986] BCLC 68, it rejected the contentions of the respondents that a suit in the nature of a derivative action cannot be brought about under section 459 of the Companies Act 1985. The same interpretation of law applies to its successor section 994.
The wording of the second part of the section expands the ambit of section 459 as a suit can be instituted for prejudice in general. Its wording is similar to that of section 241, which authorizes a suit for oppression and mismanagement when the acts are prejudicial to the “interests of the company.” I thus argue that bearing in mind the similarity and generality in the wording of the provisions, section 241 ought to be interpreted in a manner conducive to including derivative actions within its ambit. Further, section 242 of the Indian Companies Act is similarly worded to section 996 of the UK Act, which has been used in the UK to grant substantive corporate relief, in that it permits the court to give relief as it deems fit. This expansive provision can account for relief given in the form of derivative actions. Thus, derivative actions can be instituted under section 241
Although the UK has a specific chapter dedicated to derivative actions, the absence of the same in India should not be a hindrance to including derivative actions under section 241. This is for three reasons. First, a plain reading of section 241 explained above indicates that an action can be brought when the company’s interests are prejudiced or oppressed. There is no specific requirement for prejudice to the instituting shareholder for an action to be instituted. Second, the wide scope of remedies available under section 242 provides the National Company Law Tribunal (NCLT) an avenue to grant substantive corporate relief to the minority shareholders. Third, the same would ensure the adequate protection of minority shareholders, which is elaborated on in the next section. Thus, the absence of an exhaustive chapter for derivative action under the Indian legislation does not bar the inclusion of such actions under section 241. I will now elaborate why the same is desirable in the next section.
The Judgment is in the Interests of Minority Shareholders
Although I have used the wide scope of remedies as a reason to include derivative actions within section 241, the same acts in the favour of minority shareholders as well. The entire purpose of permitting derivative actions as an exception to the proper plaintiff rule laid down in Foss v Harbottle (1843) 2 Hare 461 was to ensure that the interests of the minority shareholders are safeguarded, in that they act as a manifestation of the company in protecting it against the tyranny of the majority. The judgment of ICP Investments is in the interests of minority shareholders for two reasons. Firstly, it is a welcome move away from common law. Secondly, it provides an avenue where direct and derivative actions can be consolidated and brought under a singular provision.
As observed by the Law Commission of the UK, derivative actions in common law are virtually inaccessible as it derives from a plethora of precedents over 150 years. It has also been described as “inflexible and outmoded” and “complex and obscure”. For instance, a derivative action can be instituted only when the wrongdoers have de jure control, which Pavlides v Jensen [1956] Ch 565 has interpreted to mean a simple majority of the total voting shares. However, the same cannot be instituted when the wrongdoers may not have a voting majority but de facto control. This is especially important for shareholders in companies that are not closely held. However, an action under section 241 can be brought in this situation, ensuring that the company’s interests remain at the forefront of things.
To prove fraud on the minority, which is one ground under which a derivative suit can be initiated in common law, it must also be shown that the wrongdoers’ actions benefited them Daniels v Daniels [1978] Ch 406). This becomes a hindrance in protecting the company’s interests. The very fact that a mere 10 derivative actions have succeeded or been granted leave in India goes to show the difficulties that have been put forth on petitioners before relief or leave is granted to them. Section 241 is far more flexible with fewer requirements for leave and a greater breadth of protection available to minority shareholders. A petitioner is merely required to approach the NCLT with a minimum shareholding requirement. Although this is docked at 10%, an application for a waiver can be made before the NCLT under section 244(1) of the Act and has been permitted by courts, such as in Cyrus Investments v Tata Sons. This ensures that common law does not hinder the company’s interests.
Although it may be argued that this inclusion would vitiate the proper plaintiff principle laid down in Foss, it is prudent to note that Indian courts have cast doubt on the watertight rule of Foss. In ICICI v Parasrampuria Synthetic Ltd, the Delhi High Court opined that the rule must not be mechanically applied to the Indian context. Unlike the UK, where the shareholding is largely disbursed among a vast number of small shareholders, ownership is rather closely held among a few individuals in India. Thus, a mechanical application of the Foss rule would severely jeopardize the interests of minority shareholders which, as demonstrated above, is key to the company’s interests.
My second argument is that the multiplicity of proceedings is automatically reduced as a result of section 241. The line between derivative and direct actions is blurred as the same cause of action may violate personal and corporate rights. As observed in Raj Kumar Sethi v Spark Dealers Pvt Ltd 2008 SCC OnLine Cal 587 [57], derivative actions are mistakenly brought to redress personal wrongs. This increases the suits filed as separate actions need to be brought under section 241 before the NCLT and derivative actions in common law before the civil courts. Considering that a cause of action may give rise to both kinds of actions, the multiplicity of litigation inconveniences petitioners.
Consolidation of proceedings under section 241 reduces the challenges associated with separating the two suits. The Court in Re A Company observed that the separation of actions would involve unnecessary duplication of proceedings. It thus awarded damages to the company and the plaintiff shareholders under the same remedy. Considering that section 241 permits an action to be brought in the company’s interests and there are a wide range of remedies available under section 242, such as those that give the NCLT the power to make an order to bring to an “end the matters complained of” under section 242(1), direct and derivative actions can be consolidated and remedies can be granted in respect of both.
Conclusion
The move towards section 241 is not only justified but also practical and sound for minority shareholders. In this post, I have listed three main arguments to prove that section 241 encompasses derivative actions. I have argued that the language of section 241 is wide enough to cover derivative actions. I then argued that the UK courts have interpreted their unfair prejudice remedy to cover derivative actions. I lastly argue for using section 241 to mean derivative actions are in the interests of minority shareholders as it deviates from common law and involves a consolidation of proceedings.
– Rakshit Agarwal
