May 04,2020 | 8 min read

Can Derivative Claims Be Referred for Arbitration?

Author - Advocate Angad Mehta, Associate Author Anjana Sridharan

What Are Derivative Claims?

Derivative claims are claims of such a nature that the shareholder derives their right to sue from their position as a shareholder of a company. The shareholder is suing, not for their direct, individual right, but to protect the interests of the company. Suits/petitions arising out of derivative claims are usually brought when the majority shareholders of the company oppress the minority shareholders and/or mismanage the affairs of the company and/or when the management of the company is acting in bad faith or against the best interests of the company and/or its shareholders. In such a scenario, as the company itself will not file a suit/petition to protect its interests, a member/shareholder is permitted to bring an action in a representative capacity by way of either a suit (before a court) or a petition (before the NCLT), and the company is arrayed as Respondent No. 1 in the suit/petition, and the oppressing shareholders/management are arrayed as the remaining Respondents. 

Derivative Claims in India What the Law Says:

Oppression, mismanagement and prejudice claims, which are usually the grounds for filing a representative suit/petition are encapsulated in Section 241 of the Companies Act, 2013. Prior to 2013, the Indian Companies Act did not provide for representative (class action) suits by shareholders. In 2009, the Satyam scam proved to be an unfortunate but effective demonstration of why a specific provision is necessary in relation to representative suits on behalf of a company by its shareholders. Thereafter, Sections 245 and 246 were included in the Companies Act, 2013 (“the Act”) in order to deal with representative suits/petitions. 

Section 241 and 245, Birds of a Feather, With A Few Differences:

It is pertinent to understand the differences between Section 241 and 245 where there is significant overlap. Section 241 allows only members to file a suit/petition, and such a suit/petition can only be filed against the company and the oppressing shareholders. It is not done in a representative capacity, however, since any decree would affect the management of the company, all the shareholders stand to benefit from such an action. Any action under Section 241 still amounts to derivative action. With respect to Section 245, a suit/petition can be filed against members, directors, auditors and audit firm of the company, external consultants, etc., This means that the rule of privity of contract is not followed here. A claim against a person who is not a party to the contract (between the shareholder and the company) can be made. While claims under Sections 241 and 245 both amount to derivative claims, Section 245 supplements Section 241 as a provision for representative suits.

Arbitration and Derivative Suits/Petitions: 

One of the fundamental principles for arbitration is the existence of a written and signed arbitration agreement. Whilst initially, courts were reluctant to refer non-signatory parties to arbitration1, the law has evolved with greater complications that have arisen.2 Having taken a look at the nature of derivative action, it is evident that the outcome of a derivative claim could have a significant effect on persons other than those making the claim (especially in cases where the entire affected class of shareholders are not making the claim). Whilst the remedy of Sections 241-242 of the Companies Act, 2013 is no doubt preferable, it comes with a limitation, i.e., the Petitioners must constitute not less than one hundred members of the company or not less than one-tenth of the total number of its members, whichever is less, or any member or members holding not less than one-tenth of the issued share capital of the company.3 Shareholders not meeting the criteria set out in Section 244 are therefore automatically relegated to filing regular suits. What happens, however, when the Articles of Association (AoA) of a company contains an arbitration clause? The AoA constitutes a binding agreement between a company and its members/shareholders.4 Extending this jurisprudence, it can then be contended that a derivative action seeking to protect the interests of the company must also necessarily have to be referred to arbitration. The person who brings the derivative action invokes the arbitral clause not for himself but for and on behalf of the company. The action though not in form by the company is for all intents and purposes an action by and for and on behalf of the company. The person bringing the derivative action is therefore equally not only entitled to invoke but bound by, the arbitration clause qua the action.5 That having been said, there are certain risks involved. For instance, the remedies offered under Section 241-242 and 245 of the Companies Act, 2013 are equitable in nature, and an arbitral tribunal, bound by the agreement, can only grant contractual reliefs. In addition to this, there are certain classes of disputes which are absolutely non-arbitrable, for e.g. fraud, and testamentary issues. Furthermore, the power which a court or NCLT can exercise is far greater than the power which an arbitral tribunal can exercise. Therefore, one must be very careful in opting for arbitration in derivative actions. Notwithstanding this, the law in India itself remains in its nascent, and it would be interesting to see how the courts/NCLT deals with the issue as and when they arise.

BIBLIOGRAPHY:

  • Companies Act, 2013
  • Arbitration and Conciliation Act, 1996

WEBLIOGRAPHY:


1-  Smt. Sudershan Chopra v. Company Law Board, (2004) 118 Comp Cas 341
2- Chloro Controls (I) P. Ltd. vs. Severn Trent Water Purification Inc. and Ors., 2013 (1) SCC 641 and Purple Medical Solutions Pvt. Ltd. vs. MIV Therapeutics Inc. and Anr., 2015 15 SCC 622
3- See S. 244, Companies Act, 2013
4- V. B. Rangaraj vs V.B. Gopalakrishnan, AIR 1992 SC 453
5- Rashmi Mehra v. EAC Trading Ltd., 2006 SCC OnLine Bom. 1105. Interestingly, however, a contrary opinion has been delivered in Onyx Musicabsolute.com Pvt. Ltd. v. Yash Raj Films Pvt. Ltd., (2008) 6 Bom CR 418

 


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ABOUT THE AUTHOR


Angad Mehta

Graduated in 2010 from NALSAR University of Law, Hyderabad and have been practicing since. I specialise in property and company disputes. I regularly appear at the National Company Law Tribunal my area of focus is the insolvency and bankruptcy code and arbitrations.

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