A class action suit is one that allows a large number of people having a common cause of action to jointly file or pursue a litigation.
Puneet Shah and Niharika Rao
The time is ripe for the first class action suit in India.
The allegations of oppression and mismanagement in the entities connected to the Singh brothers, promoters of Fortis Healthcare and Religare Enterprises, suggest reasonable grounds for initiating a class action suit by shareholders of these firms.
A class action suit is one that allows a large number of people having a common cause of action to jointly file or pursue a litigation. Under the Companies Act 2013, 100 or more shareholders, or shareholders having 10 percent or more voting interest in the company can collectively approach National Company Law Tribunal (NCLT) for redressal of their grievances.
In the Singh brothers case, the allegations primarily relate to two loans: One, an inter-corporate deposit of Rs 473 crore by Fortis Healthcare in three entities connected to the Singh brothers. Two, an alleged diversion of Rs 750 crore from Religare Finvest (a non-banking finance arm of listed Religare Enterprise) to RHC Holding, the flagship holding company of the Singh brothers.
Earlier this month, Shivinder Singh, the former promoter of Fortis Healthcare, moved the National Company Law Tribunal (NCLT) against older brother Malvinder, and a former employee of Religare Enterprise alleging oppression and mismanagement into the affairs of Fortis Healthcare. The NCLT application was subsequently withdrawn, but these kinds of allegations require closer scrutiny.
Undertaking related party transactions without appropriate approvals in place and siphoning of funds for the benefits of promoters’ related entities indicate a serious governance failure at these entities and questions the role of audit committee, independent directors, statutory and internal auditors in ensuring the transparency and adequacy of internal control.
While SEBI and SFIO have started probing the dealings of these firms, should the aggrieved shareholders consider a class action?
In the developed world, class actions are the most prominent form of shareholder activism. The USD 6.1-billion settlement in shareholder fraud litigation in the WorldCom case, the USD 7.2-billion verdict in favour of Enron’s defrauded shareholders, and the USD 3.1-billion settlement in favour of investors in the Cendant case are a few noticeable examples.
India had its first brush with class action suits in 2009 when the Satyam Computer Services scam erupted. While shareholders of Satyam in the US (it was also listed on the New York Stock Exchange) successfully filed class action suits against Satyam and its defaulting promoters, and were swiftly awarded compensation, Indian shareowners were helplessly chasing capital market regulator Securities and Exchange Board of India (SEBI) and the Serious Fraud Investigation Office (SFIO). That’s because the erstwhile 1956 Companies Act which was in force at that time had no specific provisions allowing class action or derivative suits against the delinquent promoters and expert advisors involved in wrongdoings.
Unlike 1956 Act, the 2013 Companies Act allows shareholders to seek damages or compensation from the company, its directors, auditors and even advisors for any fraudulent, unlawful or wrongful act or omission.
Apart from class action, the law also provides an individual holding at least ten percent voting interest to approach NCLT for redressing oppression and mismanagement in a company. This was the provision used by the family investment firms of Cyrus Mistry that alleged oppression and mismanagement in Tata Sons.
However, such a remedy comes with its own set of limitations. First, shareowners holding less than ten percent voting interest cannot take any such action. Second, multiple suits instituted by interested shareholders, each holding at least ten percent of the voting interest will lead to multiple court proceedings that may delay the resolution process and may prove to be financially inefficient. Other alternatives are approaching SEBI, other regulatory authorities, filing a public interest litigation, initiating a collective civil action, and so on are all inefficient.
Despite such clear benefits, not a single class action suit has been filed in India so far. One key reason is that Indian lawyers are not allowed to charge a contingent fee on a case-success basis. In other words, clients don’t have to pay any upfront fee unless the case is won. Such a practice is prevalent in the US, but the current Indian law prohibits such payments to lawyers. In the US, it acts as a natural incentive and encourages aggrieved parties to approach law firms to initiate class action without worrying about the potential outcome of the case as they don’t need to bear any upfront cost of litigation. Litigating lawyers, on the other hand, are incentivised to win the case as their fee depends on the case success.
It’s high time that India allows lawyers to charge their fee on success basis. In the meantime, SEBI and other regulatory authorities in India should utilise the investor education and protection corpus to fund such expenses for class action.
In India, despite having strong and lengthy legal provisions in the rulebook, the protection of investor interest through efficient enforcement mechanisms has always been missing. Although, of late, there is a wave of increasing shareholders’ activism and any such class action by the aggrieved parties may set a precedent in the right direction.Shah is partner and Rao, an associate with law firm IC Universal Legal. Views are personal.