Sunday, February 28, 2016

Delhi High Court on Directors’ Duties and Derivative Actions

It is not very often that we witness cases in India relating to intrinsic company law issues such as breaches of directors’ duties and shareholder remedies through derivative actions. However, questions of directors’ duties have been brought to the fore following the Companies Act, 2013 as they have been codified in the legislation. Derivative action, however, still remains within the realm of common law and has not been the subject matter of codification. Some of these issues were brought to light in a case before the Delhi High Court in Rajeev Saumitra v. Neetu Singh, which was decided on 27 January 2016.

This is one of several cases where matrimonial disputes often morph into significant company law issues.[1] Here, the plaintiff Rajeev Saumitra brought a shareholder derivative suit against his wife Neetu Singh and a private limited company Paramount Coaching Centre Pvt. Ltd. (“Paramount”), of which they were shareholders holding 50% shares each. Another defendant is K.D. Campus Pvt. Ltd. (“K.D. Campus”), a company set up by Neetu Singh. The primary dispute relates to the claim by Rajeev Saumitra that while Neetu Singh was a director and shareholder of Paramount, she began engaging in competing activity with that of the company, and set up K.D. Campus in parallel and began luring the students (customers) of Paramount away. It was alleged that she therefore breached her duties as a director of Paramount. There was also a dispute relating to the use of the PARAMOUNT name and mark, which is not germane to the issues at hand.

Without delving into the details of the facts, this post discusses two company law issues that arose in the case. The first relates to the breach of directors’ duties, particularly the duty to avoid conflict of interest. This might very well be one of the first few cases that deal with the issue under the new Companies Act of 2013. The second is the question of whether and shareholder derivative suits can be permitted to be brought by a shareholder on behalf of the company against a director for a breach of duties.

Breach of Directors’ Duties

The Court examined section 166 of the Companies Act, 2013 that codifies directors’ duties. Apart from requiring the director not to be involved in a situation where he or she has a direct or indirect conflict of interest with the company, the statutory provision states that if a director obtains any undue gain or advantage, the same must be paid over to the company.[2] On the facts, the Court found that Neetu Singh had sought to enter into a competing business by establishing K.D. Campus, thereby suggesting a breach of her duty as a director of Paramount under section 166 of the Companies Act. One issue that came up during the arguments of the parties, but did not receive significant attention in the judgment, is whether there could be common law duties of directors in addition to what has been expressly set out in section 166. In other words, is section 166 an exhaustive codification of directors’ duties in India? This has previously exercised our minds as well, as we have noted here and here. While the Court discussed this in passing and implies the continuance of common law duties, it appears that there was no need to rule definitively on the issue, as it found a breach of section 166.

In addition to breaches of directors’ duties, the plaintiff also alleged violations of section 88 of the Indian Trusts Act, which provides that a director who obtains a gain or advantage in any dealing that is adverse to the interest of the company must hold that for the benefit of the company. Under law, directors are strictly not trustees, although their roles may be similar as they are both fiduciaries. Section 88 of the Trusts Act specifies various relationships that are similar to trusts, and includes directorship of a company as one of them. While this is understandable, the plaintiff also alleged a violation of section 16 of the Partnership Act, which deals with account for profits arising out of a partner’s engaging in a competing business from that of the firm. This is somewhat confounding given that a private limited company was involved in this case, which is legally a different vehicle from that of a partnership. Even though a private limited company (especially one that is owned by a husband and a wife) may carry some practical features of the partnership, it is not clear if partnership law can therefore be applied to deal with disputes, especially when it comes to breaches of directors’ duties. The Court did not conclusively rule on these issues.

Derivative Actions

Shareholder derivative actions in India are few and far between. A number of reasons have been proffered for this. However, lately there have been some actions that have come up before the courts.[3] As often happens in the few cases that come up before the Indian courts, the judge is required to decide whether the action is a personal action brought by a shareholder or one that is a derivative action brought on behalf of the company. In case of a derivative action, the benefit of the action and the remedy flow to the company and not the shareholders.

In the present case, the defendants put forward the argument that the action was a personal action and that it was more appropriate to be brought before the Company Law Board as one for oppression and mismanagement under sections 397 and 398 of the Companies Act, 1956.[4] However, the Court rightly found that the breach of directors’ duties would give the plaintiff shareholder the right to initiate a derivative suit against the errant director on behalf of the company. Moreover, the Court found that the provisions relating to actions for oppression and mismanagement do not oust the jurisdiction of the civil court, which is very much entitled to hear cases such as civil suits brought in the form of shareholder derivative actions.

Based on the conclusion arrived at on the question of breach of directors’ duties as earlier and also the admissibility of a derivative law suit, the Court issued appropriate orders on injunctions relating to the defendant’s ability to carry on competing business.

Although the Court’s decision was largely dependent upon the facts of the case, and was not as such called upon to lay down any significant principle of law, it highlights some of the issues that are likely to arise under the Companies Act, 2013, and also under common law to the extent that certain aspects (such as shareholder derivative actions) are not codified under that legislation.

[1] One such significant case is the UK Supreme Court decision in Prest v. Petrodel Resources, [2013] UKSC 34, which dealt with piercing the corporate veil.

[2] Sub-section (4) and (5) of section 166.

[3] For example, see Starlite Real Estate v. Jagrati Trade Services (Calcutta High Court, 14 May 2015); Darius Rutton Kavasmaneck vs Gharda Chemicals Ltd. (Bombay High Court, 7 April 2015). There may be others as well that we are not immediately aware of.

[4] The parallel provision of section 241 of the Companies Act, 2013 is yet to come into force.

1 comment:

vswami said...

WRT the observation, selected:
“ highlights some of the issues that are likely to arise under the Companies Act, 2013, and also under common law to the extent that CERTAIN ASPECTS (SUCH AS SHAREHOLDER DERIVATIVE ACTIONS) ARE NOT CODIFIED UNDER THAT LEGISLATION.”
Going by common sense reasoning, and having regard to the wisdom open to be gathered in hindsight from past experience, there is, in one’s conviction, no substance , much less remedy hopefully lies, in ‘codifying’ such aspects, whatever that means or is meant to say. For, howsoever sincere an attempt is made, no such or similar issue could be expected to be resolved, ‘objectively’, and even through resort to either civil court or CLB as chosen by the disputants, mostly under expert advice of a lawyer. And, to be noted, court has not ruled whether or not the two lines of action are alternative, or either, could be emphatically said to be mutually exclusive. In this view of the matter, perhaps, the only way to minimise scope for litigation, -lawyer stimulated or otherwise, -would be to, without scope left for a choice, specially provide that recourse should be had ONLY to CLB or CIVIL COURT, as is considered to be idealistic in any situation; keeping in mind that, in today’s context, for obvious reasons, the uppermost must be the saving of cost and time. CLB being the designated authority for company law matters that, as viewed, could be the preferred recourse to be mandated. As , otherwise, such disputes as to which one is more appropriate course of action, by selves, apart from merits of each case, would involve an inconclusive litigation, and vexing prolongation to eternity.