Prologue
More than a decade after the Companies Act, 2013 (“Companies Act” or “the Act”) introduced class action lawsuit provisions, two major applications for initiating such suits have ingressed the halls of the National Company Law Tribunal (“NCLT”).
In April 2024, more than 100 minority shareholders of a listed securities broker filed an application before the New Delhi bench of the NCLT[1] to initiate a class action suit against the broker. A similar class action suit was filed by the minority shareholders of a leading polyester, and polypropylene films company before the New Delhi bench of the NCLT.[2]
Class action suits, under the aegis of preventions of oppression and mismanagement, are a powerful tool bestowed on stakeholders, if used correctly. This article aims to discuss the intricacies of class action suits under the Companies Act.
Metamorphosis of Class Action Suits in India
The concept of class action suits is not entirely alien to the Indian context. The Code of Civil Procedure, 1908 (“CPC”) introduced the concept of class action suits, commonly known as representative suits, in India. Order I, Rule 8 of the CPC, inter alia, delineates that if numerous persons have the same interest, one or more persons from the group may sue or be sued or defend a suit on behalf of all persons interested.
Under the umbrella of the Indian companies law, the Indian Companies (Amendment) Ordinance, 1951 first introduced remedies against oppression and mismanagement, which were further strengthened with the enactment of Companies Act, 1956 (“the 1956 Act”). Although the courts had recognised class action suits by shareholders, the 1956 Act did not have any provisions that categorically dealt with the same.
Taking cognizance that the courts had allowed derivative action by shareholders in cases of fraud on the minority or other non-ratifiable decisions of the company, the JJ Irani Committee, constituted to revise the erstwhile Companies Act, 1956, proposed incorporating class action/derivative suits into the new companies law.
Resultantly, the Companies Act codified the provisions pertaining to class action suits against all but banking companies. However, the same remained in limbo until 2019 due to a lack of clarity on the thresholds and procedural aspects.
Finally in 2019, thresholds were notified for what constitutes a “class” to initiate an action under Section 245.
In addition to the CPC and Companies Act, the Consumer Protection Act, 2019 provides for class action suits. Under Section 35(1)(c) of the Consumer Protect Act, 2019, a complaint in representative capacity may be preferred where one or more consumers have the same interest. When permitted by the District Commissioner, the complaint should be filed on behalf of or for the benefit of all the consumers. Additionally, Section 38(11) of the Consumer Protection Act, 2019 inter alia, delineates that Order I, Rule 8 of the CPC shall mutatis mutandis apply to complaints filed in representative capacity.
The provisions for initiating class action suits in India are also included in the Competition Act, 2002 and the Insolvency and Bankruptcy Code, 2016.
Class Actions under the Companies Act
Section 245 of the Companies Act read in conjunction with the National Company Law Tribunal Rules, 2016, (“NCLT Rules”), inter alia, provides for:
- Class of persons who may initiate a class action lawsuit
- Threshold to initiate a class action lawsuit
- Class action lawsuit filed against the company
- Class action lawsuit filed against auditors or consultants
- Remedies that may be sought in the class action
Class of persons who may initiate a class action lawsuit
Section 245(1) of the Act, inter alia, bestows the right to file a class action lawsuit on the members, depositors or any class of them.
The Companies Act defines “members” as:
- the subscriber to the memorandum of the company who shall be deemed to have agreed to become member of the company;
- every other person who agrees in writing to become a member of the company and whose name is entered in the register of members of the company; or
- every person holding shares of the company and whose name is entered as a beneficial owner in the records of a depository.
Further, “deposit” includes any receipt of money by way of deposit or loan or in any other form by a company. Thus, any individual or entity who has deposited money in a company can also initiate a class action suit.
In Bank of Baroda vs. Aban Offshore Ltd.,[3] the National Company Law Appellate Tribunal (“NCLAT”) held that preference shareholders being aggrieved by the company’s conduct of affairs and falling within the ambit of “members” may file a petition under Section 245, as a class action suit.
It is important to note that while Section 241 of the Act provides for a relaxation of the membership qualification to initiate an action thereunder, Section 245 does not the same, thereby enabling only members and depositors to initiate a class action suit under Section 245. Consequently, a wider class of stakeholders who do not fall within the class of shareholders or depositors may not be permitted to initiate an action under this section.
Threshold to initiate a class action lawsuit
Section 245(1) and 245(3) of the Act read in conjunction with the NCLT Rules provide for the threshold of members or depositors needed to initiate a class action suit, as follows:
- For members:
- In case of a company having share capital:
- at least 5% of the total number of members of the company or 100 members, whichever of these two is lesser; or
- unlisted companies: members holding at least 5% of the issued share capital and; listed companies: members holding at least 2% of the issued share capital.
- In case of a company not having share capital:
- not less than one-fifth of the total number of its members.
- For depositors:
- at least 5% of the total number of depositors of the company or 100 depositors, whichever of these two is lesser; or
- depositors to whom the company owes 5% of its total deposits.
Class action lawsuit filed against the company
Section 245(1) of the Act, inter alia, delineates the cause of action for members/depositors to file an application before the NCLT to initiate the class action lawsuit.
The persons empowered by the Act may initiate a class action lawsuit if they are of the opinion that the management or conduct of the affairs of the company are prejudicial to the interest of the company or its members or depositors.
Further, Section 245 also states that the members/depositors may claim damages or compensation from the company or its directors for acts, omissions or conduct that is fraudulent, unlawful or wrongful.
On a narrow interpretation of the above provision, it may be construed that only instances that are deleterious to the interest of the applicants, or are fraudulent, unlawful or wrongful may be considered as a valid cause of action by the NCLT. Thus, actions of the management/company that are merely not agreeable by the shareholder or depositors may not be a valid cause of action. Further, the onus of proving that their interests is harmed or may potentially be harmed by the acts of the company also lies on the applicants.
Class action lawsuits filed against auditors or consultants
Section 245 of the Act empowers the applicant to file a class action suit not only against the company and its directors but also its directors, auditor, experts, advisors and/or consultants.
The provisions also provide the cause of action to claim damages or compensation or suitable action from the auditors as follows:
- any improper or misleading statement made in his audit reports; or
- an act or conduct that is fraudulent, unlawful or wrongful.
Recently, the Supreme Court in Union of India and Another vs. Deloitte Haskins and Sells LLP & Another[4] held that a mere resignation of the auditor from the company wouldn’t terminate criminal proceedings against him under Section 140(5) for fraud. Section 140(5) of the Act allows the NCLT to take action against an auditor who has engaged in fraud in the company. The Court also opined that auditors play a very important role in the affairs of the company, and thus, have to act in the larger public interest while considering all the other stakeholders. Although not directly connected to Section 245, this judgment highlights the emphasis placed on a higher degree of scrutiny expected from auditors when it comes to corporate governance and the detection of frauds.
Further, the applicants may initiate a class action lawsuit to claim damages against an expert, advisor or consultant of the company (“consultants“) for the following cause of actions:
- any incorrect or misleading statement made to the company; or
- an act/conduct or likely act/conduct that is fraudulent, unlawful or wrongful.
On a prima facie reading, the cause of actions against auditors and consultants may seem similar. However, there are a few key distinctions, the word “improper” has been used for auditors while the word “incorrect” has been used for consultants.
Additionally, it is also important to note that a likely act or conduct will also be reasonable grounds for initiating class actions suits against consultants. However, the same is not a ground for initiating class action suits against auditors.
Finally, for auditors the improper statement needs to be made in the audit report, a document that is generally available to the shareholders of the company. Shareholders of the company may not be privy to an “incorrect, or misleading statement made to the company” by the consultants, thereby raising a question on the effectiveness of this provision.
Remedies that may be sought in the class action
Section 245(1) provides for an indicative list of remedies that may be sought by the applicant pursuant to the class action suit. The same is as follows:
- restraining a company from committing an act which is ultra vires or in breach of its articles or memorandum;
- declaring a resolution altering the memorandum or articles of the company as void if the same was passed by suppression of material facts or obtained by misstatement to the members or depositors;
- restraining a company from doing anything which is contrary to the provisions of the Companies Act or any other law in force;
- restraining the company from acting contrary to any resolution passed by the members; and
- claiming damages, compensation or demanding any other suitable action from or against the company, its directors, auditor & any audit firm, expert, advisor or consultant for any fraudulent or unlawful conduct.
Penalties
Section 245 of the Companies Act not only provides for penalties on the Company for non-compliance but also on the applicant, if they have filed filing a frivolous or vexatious application.
Any company that fails to comply with an NCLT order can be punished with a fine of at least INR 5,00,000, which may extend to INR 25,00,000. Further, every officer of the company who is in default could face imprisonment for a term extending to three years and with a fine of at least INR 25,000, which may extend to INR 1,00,000.
Additionally, penalties upto INR 1,00,000 could also be imposed on the applicant for frivolous/vexatious applications. Lastly, the cost or expenses connected with the application for class action shall be defrayed by the company or any other person responsible for any oppressive act which forms the basis of the class action.
Conclusion
Class action lawsuits trace their origins to jurisprudence in the United Stated (“US“), where, in 1820, pursuant to West v Randall,[5] one of the earliest class action suits was litigated. Since then, US courts have seen a heap of class action lawsuits, as they have taken a liberal view towards initiation of class actions. This has resulted in a mature and well-established framework for class actions with specialised courts and comprehensive statutes. The genesis of the US being a litigious society can be attributed to this, among other factors.
However, in India, shareholders had to rely on the other provisions under Chapter XVI – Prevention of Oppression and Mismanagement of the Companies Act to initiate an action against a company. These provisions neither categorically elucidate on the right of depositors to initiate an action nor clarify whether an action can be initiated against auditors and/or consultants.
Although, class action suits are a potent option available to a class of stakeholders to hold the company accountable for its affairs and prevent actions that are detrimental to their interests, the views taken by the NCLT for these two applications will determine if the floodgates for class action under corporate laws have finally opened or will the same be relegated to mere legislation without teeth.
[1] The National Company Law Tribunal, New Delhi, CP No. 92/245/PB/2024
[2] The National Company Law Tribunal, New Delhi, CP No. 58/245/PB/2024
[3] Company Appeal (AT) No.35 of 2019
[4] 2023 SCC OnLine SC 557
[5] 29 F. Cas. 718, 2 Mason C.C. 181
