In this blog post, Athar Ali Khan, pursuing M.A. in business law from NUJS, Kolkata, discusses the concept of class action suit, the need for class action suits and it’s viability in India.
What is a Class Action Suit?
Does this sound a strange or uncommon term to you? Yes, it might as these types of suits are not that common in India unlike in Europe or other foreign countries.
Class action suit, as it goes by name is for a group of people filing a suit against a defendant who has caused common harm to the entire group or class. This is not like a common litigation method where one defendant files a case or charges against another defendant while both the parties are available in court. In the case of class action suit, the class or the group of people filing the case need not be present in the court and can be represented by one petitioner. The benefit of these type of suits is that if several people have been injured by one defendant, each one of the injured people need not file a case separately but all of the people can file one single case together against the defendant, known as class action suit.
At the start, it is necessary to deal with a delusion that class actions are not viable in India. That is not true at all. The civil law has always allowed a blend of suits that convey to the same cause of action, and hence it is possible for plaintiffs to bring suits which are quite similar to class actions in the U.S. But there is a catch to it. The Contingence fees charged by the lawyers in the US are not permitted in Indian Legal System, which is highly responsible for the absence of a plaintiff bar. Also, since there is no certainty regarding recovery, the plaintiff (Small & Minority Shareholders) are not motivated enough to file these class action suits. More so, there is a major risk of the plaintiff not only losing and not getting compensated but above that may end up bearing the legal cost of Defendant Company as well in India.
This is the reason why SEBI has taken the initiative to create an Investor Education and Protection Fund regulation, which is a mandatory fund to be created by a company as per the provisions of the 2013 Act. It has to reimburse the legal fee of such class action which aids the associations fighting the legal cases on behalf of investor organisations in protecting the rights of small and minority investors. The legal aid by this fund can be to the tune of 75% of total expenditure in a legal proceeding as stated above.
The fund, i.e., Investor Education and Protection Fund can be utilised for the following purposes.
- For making an investor more aware & educated in the context of the securities
- If a reimbursement is sanctioned by the NCLT under a class action suit against legal expenses, it is done through the fund itself.
- Other incidental purposes.
Besides, there can be issues arising in the execution of such a proposal. Which class actions could be funded? Who will establish that and what will be the basis? Will the amounts allocated in this fund be adequate to cater to a vast number of suits? Will SEBI have a role in deciding who the plaintiff lawyers will be, and how to fix the fees for them? These and several other issues need careful deliberation before any structure of this sort is established.
Need for Class Action Suits
The need for these types of suits was first felt in the context of securities market during the time of Satyam Scam, where a large group of people were cheated regarding their hard earned money invested in Stock Market. During that time it was felt that it was not at all viable regarding cost effectiveness for a small stakeholder to file a case independently against the defendant. Millions of cheated investors during that time formed a large group and filed the case against the company, but since there was no available legal remedy or law which can actually support this type of litigation of a group filing charges, it became tough for those investors to take a recourse or gain advantage in the Indian Judicial System by this method. Class action suits in India were so far filed under the guise of public interest litigations. Courts were free to dismiss these. These shareholders ran pillar to post right from the National Consumer Disputes Redressal Commission up to the extent of Supreme Court and had their claims rejected. But, ironically, the US shareholders of Satyam were able to claim about Rs 675 crore from the company leaving Indian shareholders rather frustrated without any remedy offered to them by Indian Judicial System.
This gave rise to the concept of class action suits in Indian Judicial System which was introduced formally in companies’ act 2013.
Conditions to File a Class Action Suit
Conditions, as mentioned below, are followed as a prerequisite to filing a Class Action Suit.
- For companies having a share capital, or members –
- 100 members minimum of such company can file the case against that company for any type of
- At least 10% of the total members can file the case against the company/management
- Member holding 10% of issued share capital can file the case against the company/management
- For companies not having share capital –
- At least 1/5th of the members can file the complaint against the company under class action suit for any misconduct of management regarding running the company.
The class action suits are filed in National Company Law Tribunal (NCLT). An application is filed before the NCLT against the directors of the company, or the company, the auditors, or the audit firm or the consultants in case where the class of members or depositors are of the opinion that the management or conduct of the affairs of the company are not conducted in a proper way and is prejudicial to the interests of the company, and a relief may be sought.
Any organisation, which does not comply with the order passed by NCLT under said section, is punishable up to the tune of Rs. 25 Lakhs. Also, management of the company who are identified by NCLT as been in default, shall be punishable with imprisonment for a term up to three years and fine up to Rs. 1,00,000/-.
Under relevant sections of the Companies Act, 2013, NCLT is conferred with the same jurisdiction, powers and authority as a High Court under the Contempt of Courts Act, 1971.
Now, the question arises, how feasible are the class action suits in Indian legal system. Is it really a viable remedy for the retail investors in India? How good can it protect the retail investor’s interests against misconduct or fraud exercised by the companies or its management in the context of the securities market?
First of all, before we start questioning the class action suit, we need to ask ourselves regarding how much active is the retail investor in India in comparison to its US counterparts. The basic problem with Indian Retail Investor is, they are not really informed, educated and lack activism when it comes to investing in companies.
By concept, a shareholder is an owner of the company, but is he the owner in Indian Context?
Most of the listed companies in India are run by families’ generation after generation, basically controlled by a promoter. These companies are doing whatever they can not to lose control over the governing of the company. And they take advantage of the fact that majority of the retail investors in India lack in-depth knowledge about securities market and are highly isolated from each other. Also, since they have very small holdings, the confidence to contest against the controlling shareholders is minimal and almost null & void, even though each & every investor is having similar rights and ownership where differences are decided by majority vote.
Even Supreme Court in their judgments has acknowledged and upheld the powers of the majority of the shareholders thereby, not leaving much space and powers for small investors even if all the shareholders carry the same powers. Any & every sane mind knows that in Indian context most of the funding is done by financial institutions thereby leaving very small space for retail investors, and the system not taking care of those little investors is highly cruel, even though certain safeguards have already been provided in the previous acts.
Now, as per companies act 2013, shareholders may apply to National Company Law Tribunal (herein after referred as NCLT) against any oppression and mismanagement. NCLT is a highly powerful tribunal which has all the authority to pass orders up to the greatest extent included but not limited to removal of directors, allotment of shares, etc. NCLT can even order recovery of money from directors in case it considers it as undue gains generated by directors during their tenure.
In continuation of the same, a class action suit can also be filed in NCLT by minority shareholders against oppression committed by directors of the company OR the company itself. They will seek justice by bringing in people who are seeking remedy for the same cause against defenders, unlike conventional law where the plaintiff is individual. This is largely important in the context of an imperfect legal system or a regulatory not able to handle the genuine cases of proper claims, against the misconduct of powerful management. In this scenario, the feasibility of fighting the case as a group or class becomes more viable.
Based on the recommendation of JJ Irani Committee, several provisions were brought in Companies Act 2013 to protect the interests of the said small & minority shareholder from the powerful controlling majority shareholders. Finally, the class action suits found its way under Section 245 of Companies Act 2013.
The procedure for class action suit is that all the effected parties should participate in a single rejoinder. One lead member may represent the entire class in front of NCLT.
In the context of US market, we all have seen how this has empowered to sue all the parties involved in cases related to fraud and misstatements regarding dealing with securities. In previous days, when there was no recourse available such as that of class action suit in India, millions lost their hard earned money when thousands of companies vanished with the IPO money of investors primarily from 1992-1996.
We all know regarding how a “promoter run company” operates in an Indian environment. Passing resolutions through company boards and shareholders are a cake walk for a promoter controlled environment, even if it is related to utilizing the funds for the purpose other than that for which funds were collected, thereby misleading the investors, more so small and minority shareholders. This type of decisions has to lead to severe losses to the investors in the past.
Now with the arrival of companies’ act 2013 having the provisions of class action suit, the retail investors can file class action suits against the directors and management of the company in the case of issuance of prospectus for instances such as misstatements, and any inclusion or exclusion if done for the purpose of diversion of funds.
This has successfully instilled a sort of fear and more responsibility in the minds of the issuers in terms of funds utilised for the intended purpose only, thereby disciplined the underwriters & issuers.
Also, the company act 2013 also gives direction that any changes whatsoever if desired by the company to be made in the prospectus, has to be done through a special resolution passed at the general meeting. In case any shareholder does not agree to the said changes, they are offered an exit option on an exit price as determined by SEBI. This will give a hard time to the directors & promoters in case they wish to bring in a change in the contract or objects in the prospectus.
Ironically, one of the major exclusion in this class act is that the banks are not made responsible and cannot be prosecuted under this act, even though they have a major role to play in the public issue process but are not made accountable in the class action suits.
In terms of the viability of class suits in India, initially before the company law 2013 was implemented, it was tough to get a judicial recourse in any such situations like Satyam, but with the implementation of company law 2013, it has become very viable in the context of Indian Judicial Systems. People have started opting for these class suits since they have received an additional ground while fighting against any abuse of powers by the company management, against initial days where the only recourse available was a civil suit, which was not at all viable being highly time & cost consuming.
Even though it is a highly complex scenario, the courts must determine initially that the particular class action suit was brought in good faith, and second, it has a good possibility of success. It should tackle the problem of the aggrieved party in very rational manner. Class Action Suits are still in an emerging stage and for most of the regulators from various Securities and Investments Commissions; Financial Service Authorities & European Union are facing jurisdictional problems. These problems can arise in India as well, and courts have to be very careful during the litigations under this act.
Small and retail investors who otherwise not take any recourse under litigations; now have a great tool as class action suits. This mechanism empowers small investors to seek claims on their small investments which might have been tough Now since the inception of company law 2013, people or rather group of people will start getting faster actions and speedy disposal of cases which require immediate attention. These remedies are more effective than the earlier ones offered under oppression and mismanagement. The remedies are punitive and injunctive in nature.
Huge penalties and imprisonment chances will also act as a deterrent for the wrongdoers against any fraudulent acts. Investors need to be more vigil and alert against any misdoings of management. The investor’s associations need to display more activism, which has successfully led to many amendments in the laws in the past.
It will also successfully reduce the number of lawsuits since it has allowed the group of people to file the case against one defendant on common grounds. This has also helped in increasing the efficiency of the legal process in India.
Class actions suits in India will become a highly beneficial place for stakeholders to raise complaints if any against the management for the unlawful & wrong acts, as it will act as a redressal tool for people having a common interest against the mighty management of companies.
However, on the divergent, such a notion may be open to misuse by dishonest minority shareholders in the continuance of their vested interest thereby impeding the proper functioning of the company. Keeping this in mind, it could be said that the government failed to consider the negative consequences of class action suit as it is evident by the absenteeism of provision to check its misuse.
As of now, incorporation of the concept of class action suit is a highly welcomed step for the betterment of the Indian society in general and Indian corporate industry in particular, however, its victory in the industry is still indeterminate, reason being the exclusion of key class of stakeholders mainly creditors, bankers and debenture holders. Other reasons which have acted as a hindrance for the community was the elimination of banking companies from the scope of this Section as mentioned before as well. Further, even the regulatory authorities have been kept out of the ambit of class action suit as they are not entitled to file a case under this law, which has been widely criticised throughout India.
Other major challenges for the minority stakeholders are the delays observed during the constitution of NCLT, because of which the serious cases of the class action were filed in the civil courts, now delaying those further due to long queue in those courts.
Nevertheless, on reading the provision of this Section and further analysing it, it can be said that the suit may indeed prove to be a powerful tool to keep a check on the culpability of a company and contain any likely bias against the minority & small shareholders.
It is also concluded that class action suits will be a beneficial platform for small & minority shareholders to raise their grievance against the company including its managing director, directors, auditors, consultants, etc. for acts or omission that is wrongful & unlawful to the interest of the company and its shareholders. Minority shareholders may undertake class action suit as a redressal for those having a common interest for the promotion of proper corporate governance.
Apart from the technical and procedural facet, there are lots of changes required in securities laws in case class actions suits are to be successful in India. The present rules on various fronts, mostly in areas such as insider trading and price manipulation necessitate plaintiffs to hold a relatively high burden of evidence. Just by giving encouragement to class actions alone may not be adequate, and may require addressing some of the substantiate issues as well.
Last but not the least, though this class action suit seems to be an armament in the hands of the minority shareholders, the real strength can only be measured by giving it full effect upon the constitution of NCLT.
Till then, it is not justified to treat it as a proper step towards a better legal system regarding class action suit. We all should also remember that, a shareholder, class action suit, would mean five to seven years of original court (suit) followed by another three years of division bench appeal and followed by another three years of appeal in the Supreme Court which in total makes in at least an eleven years process if not more to get a final determination.
We all can only hope that class actions suits will come to the rescue of small & minority shareholders when they need it, to avoid another Satyam-like fiasco. It is still to be seen if companies in India are becoming more careful when it comes to change in business and make sure that whatever indeed is needed to be disclosed is done so as per the law.