Wednesday, December 31, 2014

Derivative Action for Patent Infringement Disallowed

Spicy IP has a post discussing a judgment of the Bombay High Court in Darius Rutton Kavasmaneck v. Gharda Chemicals Limited, which involves a derivative claim by a shareholder of a company that traverses issues of company law and patent law. In disallowing the claim, the Bombay High Court dealt with issues pertaining to derivative actions and clarified circumstances where they would be allowed to proceed. Those circumstances were found not to exist in this case.

Facts and Ruling

The plaintiff was a shareholder holding 12% of the 1st defendant, Gharda Chemicals Limited. The principal claim lay against the 2nd defendant, Keki Hormusji Gherda, who is the chairman and managing director (CMD) of the company. The plaintiff shareholder alleged that the CMD applied for and/or obtained several patents in his own name, while those patents ought to belong to the company. Since the actions allegedly amounted a breach of fiduciary duties owed by the CMD to the company, the plaintiff argued that he was entitled to bring a derivative claim on behalf of the company since he was a minority shareholder. In terms of relief, the plaintiff sought an injunction against the CMD in relation to the utilization of the patents.

The Court began by treating this action as a representative suit as it was brought by a shareholder on behalf of the company. This principle has now been well-established in India, and the court was merely complying with accepted precedents. Although courts generally deal with such suits in terms of Order 1 Rule 8 of the Civil Procedure Code, 1908, in this case the judgment does not make any express reference to that provision or interpret it.

Given that derivative actions in India are essentially a matter of common law, the Court relied on English precedents, principally Smith v. Croft [1998] Ch. 114. In that case, a derivative claim was disallowed because the body of independent shareholders of the company were not supportive of the derivative claim. In other words, the court placed significance on the will of the majority of independent shareholders. The Bombay High Court relied on Smith v. Croft in disallowing the derivative claim in the present case as well. It was found that the plaintiff’s siblings who held 13% shares between them were against the present litigation, and effectively sided along with the defendant CMD. The fact that the plaintiff was only in the minority among the independent shareholders in bring the suit weighed heavily with the Court in arriving at its conclusion.

The Court further supported its conclusion by having regard to the conduct of the plaintiff. This approach is consistent with the requirement that any plaintiff shareholder in a derivative action must approach the court “with clean hands”. In the present case, the Court considered several circumstances that suggested the plaintiff had not met with this requirement. The plaintiff had initiated several rounds of litigation before different fora against the defendants, and that too unsuccessfully, and this action was in similar vein. Moreover, it was found that the plaintiff had not only commenced a competing business, but was also intending to transfer his shares in the company to another competitor. All of these further demonstrated the lack of bona fides on the plaintiff’s part in bringing the claim.

Finally, the Court made certain observations which indicate the unsatisfactory nature of the law relating to shareholder derivative actions in India:

The Courts should be alert in dealing with such speculative suits and shoot down such bogus litigation at an early stage. This action on the Plaintiff, it is quite obvious is inspired by vexatious motives. I observe with regret the infliction of the ordeal upon the Courts by parties like the Plaintiff by presenting a case which was disingenuous or worse. It may be a valuable contribution to the cause of justice if such speculative and frivolous litigations are dealt with a tough hand. Substantial judicial time will be saved if such parties are saddled with substantial costs so that they would not continue the onslaught on precious judicial time.

The Court also directed the plaintiff to pay a sum of Rs. 10 lakhs (Rs. 1 million) towards costs.

Broader Implications

Given the facts of the case, it would be hard to quarrel with the conclusion arrived at by the Court or its reasoning. But, the context and approach permit us to draw some broader inferences.

Shareholder derivative actions are rare in India. As a co-author and I found, “[o]ver the last sixty years only about ten derivative actions have reached the high courts or the Supreme Court. Of these, only three were allowed to be pursued by shareholders, and others were dismissed on various grounds.”[1] A number of reasons can be attributed to this result. Primary among them is the fact that shareholder derivative actions in India are still ensconced in common law. Indian courts rely heavily on English precedent, as the Bombay High Court did in the present case. The problem with this approach is that cases may be decided largely on the facts, with broader legal principles (that can be applied across situations) being rather elusive. For example, the application of the “clean hands” doctrine arises essentially as a matter of common law. It is a different matter that the English Companies Act of 2006 (and several other jurisdictions within the Commonwealth) have transitioned to a statutory form of derivative action where the legislation expressly recognises such actions and also prescribes the more specific circumstances where they can be allowed. India has, however, not chosen to adopt the statutory form. Unfortunately, the deliberations leading up to the enactment of the Companies Act, 2013 are silent regarding the reason for this approach. It is not clear whether the lack of statutory recognition for derivative actions is a conscious choice, or a mere oversight. This result will continue to permit a fact-based determination steeped in common law, as the Bombay High Court has engaged in this case.

While the lack of the statutory form of derivative actions may be a dampener on such claims, other circumstances may add to that as well. Delays in the Indian judicial system, exorbitant costs of bringing civil suits, and the lack of contingency fees (that usually motivate plaintiff law firms) all lead to the minimal utilization of shareholder derivative suits in the Indian context. A different position may ensue upon the effectiveness of the provisions relating to “class action” suits under the Companies Act, 2013, but it is not clear whether that mechanism is intended to address derivative actions. While that mechanism could be wide enough to encompass derivative actions, the provisions do not expressly cover the scope and conditions for invocation of derivative actions. Until some statutory recognition is conferred upon derivative claims, courts in India would continue to treat derivative actions in the same manner as the Bombay High Court had to in the instant case, i.e. a fact-based determination using principles of common law.

[1]     Vikramaditya Khanna & Umakanth Varottil, The rarity of derivative actions in India: reasons and consequences, in Dan. W. Puchniak, Harald Baum & Michael Ewing-Chow, The Derivative Action in Asia: A Comparative and Functional Approach (2012), at 380.

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