Company Law: Derivative Action

(Source: Law and Legal Developments)

 

A recent Calcutta High Court decision, Jaideep Halwasiya v. Rasoi Ltd., (2009) 150 Comp Cas 1 (Cal), explains the distinction thus:

17. A company and its functioning have been compared to the parliamentary system of democracy with the company's general body as the Legislature and the board of directors as the executive. A company functions under its constitution consisting of its memorandum and articles of association and the applicable provisions of the Companies Act. The individual rights of a member stem from the implied contract between the member and the company. A shareholder may bring an action against a company for a wrong done to him personally or he may invoke his corporate rights. If a shareholder alleges that a wrong has been done to the company by persons in control thereof, he may bring a derivative action where he derives the authority from his corporate right to sue on behalf of the company. The company is impleaded as a defendant in such action and the premise on which the court entertains this extraordinary form of action is upon the complaining shareholder's assertion that the company cannot sue as persons at its helm would not bring an action on its behalf or for its benefit for these are the wrongdoers.

18. Though at one point of time derivative and representative actions were used as interchangeable expressions, there is yet another form of action other than personal and derivative action that a shareholder may bring against the company. A shareholder (or even a debenture-holder) may sue the company (and its directors or persons in control) for a perceived wrong done to a particular class to which the plaintiff belongs. Such form of action is now regarded as a representative action in corporate jurisprudence.

19. The distinction between personal and representative action on the one hand and derivative action on the other appears to be that for a derivative action to be brought or to succeed the wrongdoing complained of and ultimately to be established has to be a wrong done to the company. In the purest form of derivative action no personal benefit would accrue to the plaintiff shareholder upon a decree being passed save as a member of the company. It is the company, notwithstanding it being shown as a defendant, that gets a voice through the plaintiff shareholder and the action is solely for the company's benefit. A personal cause of action, or even a representative action, may be combined with a derivative action, with or without leave of court, but subject to the distinct causes of action pertaining to the same transaction or series of transactions.

20. A decree in a derivative action is binding on all members of the company. A decree in a representative action binds all whom the plaintiff seeks to represent, unless fraud or collusion is urged against the plaintiff. In both the derivative action and the representative action the plaintiff will invariably sue upon obtaining leave under Order 1, Rule 8 of the Code of Civil Procedure. But while in the classical form of derivative action the plaintiff will sue on behalf of all the shareholders of the company except the recalcitrant shareholders who are impleaded as defendants, in the representative action the plaintiff has to identify the class that he seeks to represent.

Now, the question which was before the Hong Kong Court was whether a multiple derivative action could be maintained. In other words, can a shareholder of a holding company bring a derivative action complaining of wrings done to the subsidiary company? The Hong Kong Court held that such an action would be possible. Shantanu comments on this decision in detail here.

Interestingly, Indian law appears to have considered the question earlier in at least one case, and seems to have answered it differently – BSN UK v. Janardan Pillai, (1996) 86 Comp Cas 371 (Bom). The shareholding pattern in the facts of that case was as follows:

'Plaintiff' – holds 50% shares of ABIH ltd. – holds 100% of ABIL ltd. – holds 38.15% of 'Company'.

'Plaintiff' tried to bring derivative action on behalf of 'Company'. An application was filed for striking out the particular plaintiff (there were other plaintiffs; hence the suit itself was maintainable – the question arose as to whether this particular plaintiff should be struck out). The Court allowed the application. In doing so, it was observed:

14. .... Neither the courts in India nor in UK have allowed a non-member to maintain a derivative action. 

The basis of the decision was that it was not alleged in the plaint that the wrongdoers were in control of the company. So no derivative action was possible at all; and the issue of by whom a derivative action could be brought was arguably irrelevant. Nonetheless, the Court considered the issue of multiple derivative actions in detail, and stated:

On behalf of the plaintiffs, Mr. Chinoy has fairly contended that there is no Indian or English authority which allows a non-shareholder/member to maintain a derivative action. However, efforts were made to justify the action of plaintiffs Nos. 1 and 2 by relying on the judgments of American courts where in some American States "double" or "triple" derivative actions have been permitted. Reliance has been placed on HFG Company v. Pioneer Pub. Co. 162 Fd 536 (State of Illinois); Goldstein v. Groesbreck 142 Fd 422 (State of New York); U. S. Lines Inc. 96 Fd 148 (State of New York) and Kaufman v. Wolfson 151 NYS 530 (State of New York) which are all State decisions where State substantive law does not prohibit a non-member from maintaining such an action. Under Indian Law, it is settled that only a member on the register of members can sue and, therefore, the American cases relied upon by the plaintiffs can have no application… Under section 153B of the said Act, it is provided that where shares are held in trust by any person, a declaration shall be made in the manner prescribed and a copy thereof sent by the trustee to the company concerned. Under section 187C(1) of the said Act, a person whose name is entered on the register of members but who does not hold the beneficial interest in those shares shall make a declaration to the company specifying the name and particulars of the person who holds the beneficial interest in such shares. Also a person holding a beneficial interest in the shares of a company shall make a declaration to the company under sub-section 187C(2) of the said Act within 30 days after becoming such beneficial owner. In the instant case, the first plaintiff which claims to be the beneficial owner of the shares in the seventh defendant company, has not made any declaration either under section 153B or under section 187C(2) of the said Act nor has ABIL which is registered as the holder of 38.15% shares of the seventh defendant company…

Given this reasoning, the only way to allow the derivative action was by lifting the veil over the parent. On principles of lifting of the veil, the Court refused to do so. Thus, following this decision, the position seems to be that multiple derivative actions are not allowed under Indian law. Shantanu will be analysing the issues which arise in this connection in subsequent posts on Indian Corporate Law.