13 March, 2016
On January 27, 2016, in the case of Rajeev Saumitra v. Neetu Singh & Ors.1, the Delhi High Court (‘Delhi HC’) passed a significant order dealing with the two issues lying at the core of company law (i) breach of directors’ duties; and (ii) the sustainability of a derivative action as a shareholder remedy.
The issue of directors’ duties has been particularly highlighted since specific codification under Section 166 of the Companies Act, 2013 (‘Companies Act’), while the issue of derivative action continues to be a subject addressed under common law.
Facts
The plaintiff Rajeev Saumitra and the defendant Neetu Singh (husband and wife) were both di- rectors of Paramount Coaching Centre (‘Paramount’), each holding 50% shareholding in Paramount. While the defendant continued as a significant shareholder and director in joint control of Paramount, she also incorporated two other companies carrying out businesses competing with that of Paramount and allegedly lured away students (customers) of Paramount to her new ventures. The primary dispute, therefore, relates to a claim by the plaintiff that by setting up a competing business the defendant had breached her duties as a director of Paramount. The manner in which the plaintiff chose to bring this claim was by way of a derivative suit, the argument being that Paramount would be unable to institute a suit in its own name since the defendant was a 50% shareholder, and in joint control of it.
Directors’ Duty to Avoid Conflict of Interest
This is one of the first cases to deal with Section 166 of the Companies Act which codifies direc- tors’ duties (for the first time under Indian law) and prescribes penalties for breach of the same. One such duty of a director being the duty to not be involved in a situation in which he/she may have a direct or indirect interest that conflicts with the interest of the company, and if the direc- tor makes any undue gain, then he/she will be liable to pay an amount equal to such gain to the company.2
The Court also examined the Indian Trusts Act, 1882 (‘Trusts Act’) which provides that a director of a company who, in violation of his fiduciary character, gains for himself any pecuniary advantage or enters into any dealing in which his own interest is adverse to the interest of the company and, thereby, gains a pecuniary advantage to himself, is required to hold such advan- tage gained for the benefit of the company.3 It is interesting that the Trusts Act was brought up, as under law, strictly, directors are not trustees, although roles may be similar with both offices carrying fiduciary obligations.
The plaintiff also brought up Section 16 of the Partnership Act, 1932 which deals with profit arising out of a partner engaging in a competing business. Given a partnership is a very different legal entity from a private company, it would have been interesting to understand if such law could be applied to deal with disputes in relation to a corporate vehicle. The Court did not conclusively rule on this issue.
Based on the evidence on record, the Delhi HC observed that the defendant, as the director of Paramount, had not acted in good faith and that her actions were in violation of her fiduciary duty as a director and a 50% majority shareholder, thereby violating Section 166 of the Compa- nies Act and Section 88 of the Trusts Act.
One interesting issue that came up in the course of this case, but on which no definitive pronouncement was made was whether there would continue to be common law duties of directors in addition to what has been specifically codified under Section 166 of the Companies Act. While the Court discussed this issue in passing and appeared to imply that the same would continue, no definitive ruling was made on this subject.
Maintainability of Derivative Suit
There have been very few shareholder derivative actions in India.A derivative suit is one which is filed by a shareholder in his own name but on behalf of the company and for the benefit and advantage of the company against a third party (usually insiders such as directors etc.), who is acting against the interests of the company. In a derivative action the benefit of the action and the remedy flow to the company, and not the relevant shareholder.
The defendant objected to the maintainability of the derivative action on several grounds, including that (i) the appropriate remedy in the given circumstances was to approach the Company Law Board for oppression and mismanagement under Sections 397 and 398 of the Com- panies Act; (ii) the suit filed was in respect of the plaintiff ’s individual membership rights; and (iii) the defendant had started a competing business under certain compelling circumstances.
The Court found that the breach of directors’ duties would give the plaintiff shareholder the right to initiate a derivative suit on behalf of the company. Further, with respect to the bar- ring of jurisdiction of civil courts, the Court observed that the jurisdiction of the Company Law Board under the provisions of Sections 397 and 398 of the Companies Act is a concurrent jurisdiction and does not take away the jurisdiction of the civil courts to hear cases brought in the form of shareholders derivative action.
Order
Taking into account the facts and circumstances of the case, the Delhi HC disposed off the interim application with appropriate orders of injunction with respect to the defendant carrying on competing business, and found that any undue gain made by the defendant was payable to the Company.
Implications
While the decision here was based largely on the facts, this case serves to highlight some of the issues likely to arise under the Companies Act, and specifically with regard to further share- holder activism by way of derivative actions. Also, with regard to nominee directors, such a director would need to ensure that the interests of the relevant company and that of his/her nominating entity are aligned, and in the case of conflict it is likely that the interests of the com- pany would need to be seen as paramount.
1 Rajeev Saumitra v. Neetu Singh and Ors., I.A. No. 17545/2015 in CS(OS) No. 2528/2015.
2 Sections 166(4) and 166(5) of the Companies Act.
3 Section 88 of the Trusts Act.
For further information, please contact:
Zia Mody, Partner, AZB & Partners
zia.mody@azbpartners.com
