Class Action Suits & Corporate Governance In India

Class action suits against Indian companies on grounds of corporate governance violations are on the rise. It’s time to revisit the rules and laws around it to be better prepared.

News of class action litigation seems to have got a new lease of life with Indian companies being sued in the United States, primarily under securities laws there. Class action suits against Indian companies in the context of corporate governance first made headlines back in 2009 at the time of the Satyam scam. While investors in India were not in a position to take legal action against the company and were constrained to wait for SEBI to act, their counterparts in the United States filed class action suits and demanded compensation from Satyam.

It may surprise many to know that the Code of Civil Procedure, 1908, recognises class action in Order 1 Rule 8 and lays out a clear and simple procedure. Civil lawyers cynically remind us that in addition to Order 1 Rule 8 of the Code of Civil Procedure, 1908, the common law right of “derivative action” by shareholders to protect the company has been well recognised and civil courts in India have been actively dealing with this for many decades now, despite this right not being specifically recognised in company law.

The idea behind class action is fairly simple and one that can prove to be beneficial for many reasons – avoid multiplicity of proceedings by a large number of interested people. Class action allows everyone interested in the issue to benefit from the resolution of the issue in one forum thereby avoiding conflicting decisions that may arise from different courts hearing different stakeholders on the same issue.

Who can file Class Action suits?
The number of members or depositors who may file class action suits under section 245 of the Companies Act differs, depending on whether or not the company has share capital. For a company with share capital, 100 members of the company or 10 per cent of the total number of members of a company may file a class action suit, only if the members filing a class action suit have paid all calls and dues on their shares. On the other hand, for a company without share capital, this number increases to one fifth of the total number of members of the company. In addition to shareholders, other stakeholders like depositors have also been granted this right.

Who can be sued?
In addition to the company itself, the directors of the company, its auditors, or even the advisors of the company will now be targets before the National Company Law Tribunal (NCLT), in case the management or affairs of the company are not being conducted with transparency or are being conducted in a prejudicial manner.

With a class action lawsuit, applicants (which may include a member or a depositor) are able to seek compensation for any unlawful or fraudulent behaviour from directors as well as third party experts or obtain an injunction against the company...

It is expected that suits can be filed for acts of breaching, or activities beyond the scope of charter documents, misrepresentation or suppression of material facts, fraudulent conduct and making incorrect statements.    

Why is there a need for a separate provision for Class Action suits?
While the provisions for class action suits are contained in the chapter related to the prevention of oppression and management in the Companies Act of 2013, one may wonder why there is the need for a separate provision for class action suits and how this is different from similar provisions in the Companies Act, 1956.

The outcomes sought from explicit class action suits and those from the general provisions of oppression and management are very different from each other. With a class action lawsuit, applicants (which may include a member or a depositor) are able to seek compensation for any unlawful or fraudulent behaviour from directors as well as third party experts or obtain an injunction against the company and directors from doing certain acts.
Another important aspect would be what happens to the companies that are subject to proceedings under the Insolvency and Bankruptcy Code? Should class action suits be suspended under the provisions of the Insolvency and Bankruptcy Code?

Banking companies are exempted from these kinds of lawsuits; however, any company which fails to comply withan NCLT order is punishable with fine between `5,00,000 and `25,00,000. The lawsuits might also result in officers or directors being imprisoned up to three years and/or fined between `25,000 and `1,00,000.

Directors and Officers beware
While the Indian company law is now recognising class actions, judicial precedent demonstrating the practical application of this are awaited.  Directors and those in managerial positions in companies throughout the country now need to be vigilant and should have updated information about the process of class action lawsuits and what must be done to prevent a lawsuit being filed against them. They must also understand that providing misleading information and engaging in fraudulent activities can end up in legal action being taken not only against the company, but the directors themselves. It will not be prudent to be complacent and rely on lack of enforcement action by regulatory agencies. Activist stakeholders in India will now be able to hold companies and management to account.

About the Author:
Kalpana Unadkat is a Partner at Khaitan & Co and focuses on corporate and M&A practice areas. The views are personal and do not necessarily reflect the views of Khaitan & Co.

Add new comment