The Rarity of Derivative Actions in India: Reasons and Consequences

In Dan W. Puchniak, Harald Baum & Michael Ewing-Chow (eds.), The Derivative Action in Asia: A Comparative and Functional Approach (Cambridge University Press, 2012)

25 Pages Posted: 1 Dec 2015

See all articles by Vikramaditya S. Khanna

Vikramaditya S. Khanna

University of Michigan Law School

Umakanth Varottil

National University of Singapore (NUS) - Faculty of Law

Date Written: November 25, 2015

Abstract

The law relating to derivative actions in India draws inspiration from English common law. While the Indian Companies Act, 1956 does not expressly provide for derivative actions, Indian courts have entertained, on the rare occasion, such actions applying principles of common law through judicial precedents. There is yet no serious attempt to statutorily recognize derivative actions although several other jurisdictions in the Commonwealth have adopted that path.

The rarity of derivative actions in India can be attributed to a number of reasons. First, the substantive law governing such actions imposes a significant burden on plaintiff shareholders. Courts firmly rely on the rule in Foss v. Harbottle, which generally prohibits such actions and are willing to entertain actions only if they fall within any of its rather limited and nebulous exceptions.

Second, there is no clear procedure for bringing derivative actions apart from general rules regarding joinder of parties. Courts also generally do not entertain derivative actions where alternate remedies are available. Those pertain to actions for oppression and mismanagement before the Company Law Board and complaints to the Ministry of Company Affairs to initiate investigations. Further, in the case of public listed companies, there are applications to the Securities and Exchange Board of India (SEBI) under appropriate securities laws and there are prohibitions on civil courts entertaining cases where SEBI is empowered to act. Moreover, the failure of case law to clearly distinguish direct personal actions from derivative actions has only precipitated the obscurity of the latter.

Third, the requisite economic incentives that engender derivative actions are absent in India. U.S.-style contingency fees are not permissible, due to which a plaintiff bar is non-existent. Plaintiff shareholders are entitled to recover costs only if they are specifically indemnified by the company or are awarded costs by the court, although the benefit of recovery inures to the company. On the other hand, plaintiffs risk payment of costs if they are unsuccessful. These factors limit the applicability of derivative actions. While SEBI has recently introduced a funding mechanism to assist investor associations, not individual shareholders, to initiate actions, there are severe limitations with that approach.

This chapter examines these and other general factors pertaining to the Indian legal system and local corporate structures and culture that affect derivative actions, economic theories for when such actions might be desirable, and makes recommendations for reforms.

Keywords: Corporate Law, Derivative Actions, Shareholders, India

JEL Classification: K22

Suggested Citation

Khanna, Vikramaditya S. and Varottil, Umakanth, The Rarity of Derivative Actions in India: Reasons and Consequences (November 25, 2015). In Dan W. Puchniak, Harald Baum & Michael Ewing-Chow (eds.), The Derivative Action in Asia: A Comparative and Functional Approach (Cambridge University Press, 2012). Available at SSRN: https://ssrn.com/abstract=2695599

Vikramaditya S. Khanna

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-615-6959 (Phone)

Umakanth Varottil (Contact Author)

National University of Singapore (NUS) - Faculty of Law ( email )

469G Bukit Timah Road
Eu Tong Sen Building
Singapore, 259776
Singapore

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