Awakening of Shareholder Activism

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Date added: 17-06-26

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Awakening of Shareholder Activism: Reflection on Indian Framework
Introduction “Shareholder activism is not a privilege- it is a right and a responsibility. When we invest in a company, we own part of that company and we are partly responsible. If there is something wrong, we must become active and vocal.” --Mark Mobius Recognizing the significance and need for bringing about a transformation towards protection of minority shareholders’ interest, Indian legislature introduced the concept of Class Action Suit (“CAS”), or what is popularly known as ‘representative suit’, within range of safeguards provided statutorily. This radical development has evidently found a strong foothold within the growing arena of corporate governance in India.[1] A civil law remedy in United States[2] and a crucial weapon for safeguarding investors’ interest within a company, class action recognizes shareholder activism as just another component that is devised procedurally to entitle investors the right to take collective action against the prejudicial actions done by or on behalf of the company.[3] The new Companies Act, which was long-anticipated and welcomed in India recently, lays down a strict regime for those accepting deposits from the public and also gives protection for whistle blowers.[4] Class Action Suits: Concept and Scheme in other Jurisdictions In common parlance, the term ‘class action’ suggests a legal recourse collectively initiated by a group of investors, having common interest and cause of action, on behalf of the company to seek remedy on behalf of all the other aggrieved investors. In other words, it gives right to one member on behalf of a group to initiate an action against the defending company on the premise that they have the same locus standi.​[5] Governed by Federal Rules of Civil Procedure, 1938[6] and State laws within the framework of United States, class action has, over time, culminated into a broad spectrum of jurisprudence and procedural underpinnings. CAS was gradually broadened to cover monetary remedy.[7] On the other hand, European Union has restricted the scope of this remedy only to aggrieved consumers.[8] Another jurisdiction where the concept finds emphasis is Australia wherein this crucial component of discipline for shareholder activism has been generally discerned in light of principles of common law.[9] Significance and Lessons from Satyam Class action will afford protection to small and dissenting investors and make directors and promoters more accountable. Even though CAS has been well-established within Indian frame, the concept was not accorded much importance until it was statutorily recognized through introduction of its scheme within Companies Act of 2013 (the “2013 Act”). In the advent episodes of corporate farces like Enron in United States and Satyam in India, shareholder protection has evolved as a novel discourse that reinforces responsibility of insiders to bolster their role as patrons for legal compliance of internal affairs. In addition to providing effective and economically viable recourse against the company than on an individual basis, representative suits aim to promote efficient settlement of claims while also minimizing resources. It is aimed at deterring company officials from giving effect to scrupulous maneuvers against the interests of a class of investors and averting legal compliance. The well-known Satyam debacle highlighted the need for regulation towards investor protection when small Indian shareholders were left with no effective remedy while investors who were based in United States were assured range of possible remedies.[10] This enormous set back culminated into efforts directed at protecting interests of persons like these investors who are devoid of any bargaining power. In Satyam fiasco, fraudulent schemes were floated while inflated balance sheets. Deceiving the shareholders regarding its profits, the company officials had flouted almost all the fiduciary duties. A New Beginning: Statutory Framework in India “Representative suits”[11] and Public Interest Litigation (PIL)[12] were the only recourses available to the shareholders to enforce their rights against the company prior to the enactment of 2013 Act. Section 245[13] as enshrined under Chapter XVI (“Prevention of Oppression and Mismanagement”) of 2013 Act introduces the concept of CAS. Accordingly, it can be initiated under two situations, as namely: If the management of the company is being conducted in a manner prejudicial to the interest of the company, as provided under Section 245(1) or; in case of misleading statements in the prospectus, as stipulated under Section 34 to 36 of 2013 Act. These provisions deal with mis-statement in prospectus and the criminal as well as civil liability associated with it. Section 245(1) enumerates the grounds for initiating CAS. These include restraining company from going beyond Memorandum, Articles or provisions of law, passing and acting on a resolution on the basis of suppression of material facts. The scheme of CAS, being a representative suit, stipulates a threshold required to be met for filing an application under Section 245(3) of 2013 Act. An application can be filed by hundred or more members of a company having share capital or a percentage of shares cumulatively held by aggrieved members as may be prescribed, whichever is less.[14] Any shareholder holding shares above this prescribed limit can file an application, provided these shares are fully paid up.[15] In cases involving a company having no share capital, an application is required to be filed by one-fifth of its total members.[16] An application can further be filed by hundred or more depositors of a company or group of depositors constituting the prescribed percentage, whichever is less. Furthermore, depositor(s) who has invested certain percentage of the total deposit as prescribed is eligible to file an application.[17] The procedure after admitting the application is provided under Section 245(5). It is initiated by service of a public notice to all the members or depositors of the company. Subsequently, all admitted applications are combined into a single application and all members or depositors are conferred freedom to collectively decide the lead applicant. If the members or depositors of the class are unable to come to a consensus, the National Company Law Tribunal (NCLT) is empowered to appoint an applicant who shall be in-charge of the proceedings on behalf of applicants.[18] No parallel application for the same cause of action is allowed under Section 245(5) (c). Moreover, the cost of proceedings is required to be compensated by company, and in case of successful claim, by the fraudulent person. Company and all persons associated with it are bound by the order passed by NCLT.[19] In the event of failure to comply with the order, the company shall be punished with fine which shall not be less than rupees five lakh but may extend to rupees twenty-five lakh.[20] In respect of ‘every officer of the company who is in default’[21], the punishment covers imprisonment for a term which may extend to three years and with fine which shall not be less than rupees twenty-five thousand and more than rupees one lakh.[22] Additionally, the concept of CAS does not apply to Banking Company.[23] The provisions of Sections 337 to 341 of 2013 Act, which deal with liability of certain company officials for committing fraud during winding up mechanism, are to apply mutatis mutandis[24] in relation to an application made to NCLT. The legal expenses incurred while pursuing class action by members under Sections 37 and 245 can be reimbursed from Investor Education and Protection Fund, provided it is authorized by NCLT.[25] As per SEBI (Investor Protection and Education Fund) Guidelines of 2009, Investor Protection and Education Funds are required to be maintained by Securities Exchange Board of India (SEBI) for aiding legal proceedings taken by the investor associations that are registration. Clause 5(2)(d) of the Guidelines provides for ‘aid’ to investors’ associations, that are recognized by SEBI. Accordingly, investors are provided financial assistance to undertake legal proceedings for safeguarding their interest in securities that are listed or proposed to be listed on any of the recognized Stock Exchanges.[26] Notably, the ambit of the term ‘aid’ is broad enough and hence can be interpreted to cover litigation cost under CAS. Due to similar wordings of the provisions under Sections 245 and 241, class action is misread with provisions governing oppression and mis-management. An application under Section 241against oppression and mis-management can only be filed by members of the company whereas, under Section 245, both members and depositors can file applications.[27] Even though both provisions provide certain thresholds, it is worthy to note that the NCLT has discretion to waive threshold in cases dealing with oppression and mis-management.[28] While applications under Section 241 can be filed against the company and its statutory appointees, Section 245 applications can be filed against the company, any of its directors, auditor, including audit firm, expert or advisor or consultant or ‘any other person’.[29] Application under Section 241 is restricted to past, present or recurring activity. However, the scope of remedy for CAS is wide enough to cover future actions of the company. Essentially, the rationale for having distinct provisions for class action and recourse against oppression and mis-management was that, although majority of cases for oppression and management were entertained by Company Law Board (CLB), the scope of these cases failed to cover all forms of fraudulent conduct by defaulter or any person who may be associated with the company. Offshoot of Corporate Governance: Revolutionary or Hollow? Clearly, the new provision under Section 245 lacks clarity which, in turn, erodes its effectiveness. The scope of the term ‘depositor’ has been restricted to circumstances that involve acceptance of ‘deposit’[30]. The rationale for explicitly excluding the depositors who are in consultation with Reserve Bank of India cannot be logically comprehended as there may only be negligible considerations distressing the component of deposit. Moreover, the provisions for CAS clearly allow piercing the corporate veil by allowing members to take action against auditors, expert or any other person who have a contract with company. This breaches the privity of contracts executed by the company and such persons. Section 245 fails to provide opt-out mechanism for the investor who may choose to move NCLT individually. In United States, if an investor is not satisfied with settlement made on his behalf, he/she is conferred the option to opt-out of the proceedings.[31] Further, contingency fee is allowed for in United States. This incentivizes investors to combine their claim and initiate collective proceeding.[32] On the contrary, as per Bar Council of India Rules and Advocates Act of 1961, contingency fee not permitted in India. Furthermore, Courts have been following the practice of awarding cost in favor of winning party. Consequently, the losing party is required to incur all costs which is undoubtedly an additional burden sanctioned by Court. Therefore, if plaintiff-investors lose CAS, they are required to sustain huge losses comprising of the litigation fees, investment in the company and defendant’s litigation cost. Section 245 fails to provide limitation period. Moreover, the compensation awarded as a group may be argued to be less as compared to the individual case. VI. Conclusion CAS will strengthen investors’ protection and will retain investor confidence. The power given to the members will deter auditors, experts, directors and advisors from being flouting the accuracy of financial data and promote quality of its reporting. The major advantage of CAS is out-of-court proceedings before a specialized forum like NCLT. The adjudication of disputes before NCLT promises efficiency and less consumption of time. This consideration, however, will be diminished by the lack of certainty within relevant CAS provisions. Consequently, the numerous discrepancies will make recurrent Court proceedings a commonplace. While considering the cost of coordinating and filing suit, the scheme of CAS is necessary to be inculcated within the practice of investor associations. However, there are very few investors association that are registered with SEBI.[33] It is, undoubtedly, important that investors are made aware of the newly incorporated provisions in order to be able to fully address their concerns against those of companies. 1 | Page
[1] Khushboo Narayan, Model India Files Class Action Suit in NSEL case, LiveMint, January 15, 2014. Available at: <>. [2] Fed. R. Civ. P. 23. [3] PR. Raamaanathan, Class Action Law Suits vis-à-vis Companies Act, 2013, 42 Taxman 513 (2014). [4] Public Trust of India, Now, Whistleblowing Mechanism for Public Deposit Taking Companies, The Financial Express, October 02, 2013. Available at: <>.

[5] Alipak Banerjee, M.S. Ananth and Vyapak Desai, U.S. Court Dismisses Class Action Suit Against Mahindra and Mahindra, Dispute Resolution Hotline, (Mar 26, 2014). Available at: <>; J.J. Iraniet. al.,Report of The Expert Committee on Company Law. Available at:<>.

[6] Fed. R. Civ. P. 23. [7] Barabin v. Aramark Corp., No. 02-8057, 2003 WL 355417, at *1 (3d Cir. Jan. 24, 2003)(citing James v. City of Dallas, 254 F.3d 551, 571 (5th Cir. 2001)); Jefferson v. Ingersoll Int’l, Inc.,195 F.3d 894, 898 (7th Cir. 1999); Murray v. Auslander, 244F.3d 807, 812 (11th Cir. 2001). [8] John Davies and Andrew Austin, Consumer Class Actions in the EU, Freshfields Bruckhaus Deringer, (April, 2009). Available at: < class actions in the EU.pdf>. [9] Federal Court of Australia Amendment Act (Cth), Part IV A (1991); See. Stuart Clark and Colin Loveday, Class Actions in Australia: An Overview, Clayton Utz, (2004). Available at: < Actions_Aug04.pdf>. [10] John Samuel Raja, Corporate Governance: How New Rules Will Change Indian Companies, The Economic Times, Jan. 8, 20 13.Available at: 08/news/362166631 corporate-governance-companies-bjp-president-nitin-gadkari/2>; Also See. Ruchir Sinha and Nishchal Jodhpuria, The Great Deception, Asia Law, February 2009. Available at:< Lab/AsiaLaw-Satyam.pdf> . [11] Civil Procedure Code, Order I, R. 8 (1908). [12] Paul Karlsgodt (Ed.), World Class Actions: A Guide to Group and Representative Actions Around the Globe, 525 (Oxford University Press 2013); Supreme Court of India has upheld S.P Gupta v. Union of India, AIR 1982 SC 149 and Upendra Baxi v.State of U.P., (1981) 3 Scale 1136, uphold the validity of PublicInterest Litigations. [13] The Companies Act, 245 (2013). [14] Id. 245(3) (i) (a). [15] Id. 245(3) (i) (a). [16] Id. 245(3) (i) (b). [17] Id. 245(3) (ii); See. The Companies Act, 75 (2013). [18] Id. 245(5) (b). [19] Id. 245(6). [20] Id. 245(7). [21] Id. 2(60). [22] Id. 245(7). [23] Id. 245(9). [24] Cases [25] The Companies Act, 125(3)(d) (2013). [26] SEBI (Investor Protection and Education Fund) Guidelines, R. 5(2) (d) (2009). [27] The Companies Act, 245(3) (ii) (2013). [28] Id. 244(1) Proviso. [29] Id. 245(1) (g). [30] Id. 2(31). [31] Fed. R. Civ. P. 23(e)(3); See. Muhammad v. County Bank of Rehoboth Beach, Del., 189 N.J. 1, 912 A.2d 88 (2006). [32] Model Rules of Professional Conduct, Rule 1.5 (c) (1983). [33] Bharati V. Pathak, Indian Financial Systems: Markets, Institutions and Services, 757, Dorling Kindersley (3rd ed., 2011).
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