Class Action Suits

Introduction

Class action suits have been for a long time a tool to serve the needs of victims wronged by a company. Justice Story in West v. Randall (29) F. Cas. 718 (R.I, 1820) said, “all persons materially interested, either as plaintiffs or defendants in the subject matter of the bill out to be made parties to the suit, however numerous they may be.”

A Class action is a representative or derivative action in the form of law suit where large numbers of people collectively bring a claim through group action. A class action suit works over the disadvantages of the traditional methods which have been found to be ineffective in bringing justice to aggrieved individuals in an affordable manner with judicial efficiency.

Class action suits have their advantages over conventional suits. They create pressure on companies to meet the just claims of individuals, by pooling the individuals together into a bundle. This pressure may even be in the form of possible embarrassment in the market and related effects. The suits make the micro level claims of individuals into a huge amount, thereby increasing the chances of recovery, even though after equitable distribution of the same the amount left may be very small to individuals.

In terms of company, the method of class action suits has been primarily a tool of shareholder activism. Shareholders of companies have used this tool to bring derivative suits and representative suits. It has led to active role of the shareholders in ensuring ethical practices by companies. The recent inclusion of Clause 245 in the Chapter pertaining to oppression and mismanagement of the Companies Act, 1956, reflects an effort on part of the legislature in India to bring forth a change in the redressal mechanism available to shareholders and depositors of a company. There is requirement to understand the rationale behind such an inclusion, and for this purpose a look into the meaning and usage of class action as well as various committee recommendations becomes necessary.

Class action suits under US law

Class action suits are wherein a plaintiff seeks to bring justice to a class of individuals wronged in a similar manner by the same company. Therefore the class action enables individuals to increase the chances of their claims being met through the economics of aggregation. The claims are thus of huge amounts. For example, a claim in USA is required to be exceeding $ 500 million for a suit to be certified as federal Class action suit. Further different legislation put down a requirement of particular number of individuals to file a class action suit.

The concept was first introduced in US in 1938 through the Federal Rules of Civil Procedure under Rule 23. The requirements to bring class action are:

1. The class is so numerous that joinder of all members is impracticable;

2. There are questions of law or fact common to the class;

3. The claims or defences of the representative parties are typically of the claims or defences of the class; and

4. The representative parties will fairly and adequately protect the interest of the class.

Then the Class Action Fairness Act of 2005 was introduced leading to expansion of federal jurisdiction over many large class action lawsuits. Shareholders class action arises generally in matters such as breach of employment terms by the company, unfair labour practices by the company, destruction of wealth due to mismanagement of company affairs, accounting fraud, violation of securities regulations etc. USA has witnessed such a tremendous growth in class actions lawsuits that firms have come up specializing in organization of class actions. Lawyers called as contingency lawyers are also in demand- these lawyers charge their fee based on outcome of the case. Thus there has been a growth of an entire industry around class actions.

As mentioned above shareholders have been bringing suits in the USA for a variety of claims. Claims involving breach of securities regulations, accounting fraud etc., are called as securities class litigation. These involve disputes around the violation of Rule 10b-5 of the Securities Exchange Commission, which provides that:

“It shall be unlawful for any person, directly or indirectly, by use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

a. To employ any device, scheme, or artifice to defraud,

b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

The Supreme Court in Dura Pharmaceuticals, Inc v. Broudo held that to establish a prima facie case under Rule10b-5, a private plaintiff must generally plead-

·  a material misrepresentation or omission by the defendant;

·  scienter;

· a connection between the misrepresentation or omission and the purchase or sale of a security;

·  reliance upon the misrepresentation or omission;

· economic laws, and

· loss causation.

The Rule 10b-5 class actions are criticized for not providing sufficient deterrence or compensatory benefits to justify their costs. Further they are said to involve such transactions imposing a wealth transfer upon public shareholders, resulting in a net loss to investors after accounting for transaction costs, including attorneys’ fees. Private Securities Litigation Reform Act (PSLRA), 1995 provides for plaintiff criteria and severe procedural hurdles for Rule10b-5 class action plaintiffs. For example, in order to defeat a motion to dismiss, plaintiffs must, before discovery, state with particularity facts detailing the fraud and giving rise to a strong inference that the defendant acted with the required state of mind (scienter).

European jurisdictions allow class action to be pursued by consumer associations only and not by individuals. This has been considered reasonable as the objective is to restrict entrepreneurial pursuit by firms.

Class actions suits and Company law in India

The company law in India recognizes the importance of the protection of minority shareholders from oppression and mismanagement and at the same time follows the cardinal rule laid down in the case of Foss v. Harbottle which upholds rule of majority over minority. The recent amendment is a positive action towards increasing company accountability for its actions affecting the shareholders and depositors.

The Code of Civil Procedure, 1908 under Order I Rule 8 provides for joinder or representative actions whereby a large body of persons who are interested in a matter can bring action as a group and one or several of them shall act as a representative on behalf of the group. However the long adjudication period involved discourages claims through this provision. Thus the lack of a provision under the Companies Act, 1956 for class action suits was necessary to be filled. This was specially felt when in the much discussed Satyam case the small investors were left to witness their money go down the drain while the American depositors of the Company were able to receive $ 125mn in settlement as a result of a strong class action framework in US.

While recommending class action suits in India the Standing Committee on Finance in its 57th Report on the Companies Bill, 2011 said that the same is to be permitted on the application of member and members only. It stated that:

“It has been felt that since creditors can enforce their claims through contracts/ agreements with borrow companies, they may not be given statutory right for class action. On the other hand since depositors do not have any contractual rights and are mainly of unsecured nature, they are being proposed to be empowered with right to file class action petitions before Tribunal.”

The J.J.Irani Expert Committee on Company Law in 2005 while talking about class action/ derivative suits stated that:

“In case of fraud on the minority by wrongdoers, who are in control and prevent the company itself bringing an action in its own name, derivative actions in respect of such wrong non-ratifiable decisions have been allowed by courts. Such derivative actions are brought out by shareholder(s) on behalf of the company, and not in their personal capacity (ies), in respect of wrong done to the company. Similarly the principles of “Class/Representative Action” by one shareholder on behalf of one or more of the shareholders of the same kind have been allowed by courts on the grounds of persons having same locus standi.”

The JJ Irani Committee pointed out that while these principles have been upheld by courts on various occasions but the same need to be expressly laid down in the law. The Company Law Bill, 2009 provided that:

“(1) Any one or more members or class of members or one or more creditors or any class of creditors may, if they are of the opinion that the management or control of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or creditors, file an application before the Tribunal on behalf of the members and creditors for seeking all or any of the following orders, namely:-

(a) to restrain the company from committing an act which is ultra vires the articles or memorandum of the company;

(b) to restrain the company from committing breach of any provision of the company’s memorandum or articles;

(c) to declare a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained by misstatement to the members or creditors;

(d) to restrain the company and its directors from acting on such resolution;

(e) to restrain the company from doing an act which is contrary to the provisions of this Act or any other law for the time being in force;

(f) to restrain the company from taking action contrary to any resolution passed by the members.

(2) Any order passed by the Tribunal shall be binding on the company and all its members and creditors.

(3) Any company which fails to comply with an order passed by the Tribunal under this section shall be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees, or with both.”

This provision though allowed class action to be undertaken by depositors and creditors but it failed to answer to issues such as the funding of these actions, the distribution of the claim amongst the class, restrictions on unwarranted individual actions in name of class action. Further it did not focus on compensating the shareholders and creditors.

In a positive step, to meet the requirement of funding the SEBI in 2009 notified the Securities Exchange Board of India (Investor Protection and Education Fund) Regulations, whereby an Investor Protection and Education Fund was established for aiding investor’s associations recognized by the Board to undertake legal proceedings in the interest of investors in securities that are listed or proposed to be listed, subject to limitations laid down in the Regulations. Further under Section 250C of the Companies Act, 1956 guidelines were given for funding of NGO’s to fight class action suit.

The Section 245 under the new Company Law provides for such number of members or members, depositor or depositors or any class of them, as the case may be, as are indicated in sub-section (2) of the Section, if they are of the opinion that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors to file an application before the Tribunal on behalf of the members or depositors for seeking all or any of the following orders-

(a) to restrain the company from committing an act which is ultra vires the articles or memorandum of the company;

(b) to restrain the company from committing breach of any provision of the company’s memorandum or articles;

(c) to declare a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained y misstatement to the members r depositors;

(d) to restrain the company and its directors from acting on such resolution;

(e) to restrain the company from doing an act which is contrary to the provisions of this Act or any other law for the time being in force;

(f) to restrain the company from taking action contrary to any resolution passed by the members;

The requisite number of members and depositors required as per class of companies according to the provision are-

1. In case of companies limited by shares-

a) At least 100 depositors or specified percentage of number of depositors whichever is lower or any depositor or depositors to whom the company owes such percentage of total deposits.

b) At least 100 members or specified percentage of numbers of members whichever is lower or any member or members holding specified Percentage of the issued share capital of the company.

2. In case of companies not having share capital-

a)  At least 100 depositors or specified percentage of number of depositors whichever is lower or any depositor or depositors to whom the company owes such percentage of total deposits.

b) 1/5th of the total number of its members

The Section makes the order of the Tribunal binding on the company and all its members, depositors and auditors including audit firm or expert or consultant or advisor or any other person associated with the company. The considerations to be taken into account by the Tribunal while taking its decision on the application are also laid down in the section. They are:-

(a) whether the member or depositor is acting in good faith in making the application for seeking an order;

(b) any evidence before it as to the involvement of any person other than directors or officers of the company on any of the matters provided in clauses (a) to (f) of subsection (1);

(c) whether the cause of action is one which the member or depositor could pursue in his own right rather than through an order under this section;

(d) any evidence before it as to the views of the members or depositors of the company who have no personal interest, direct or indirect, in the matter being proceeded under this section;

(e) where the cause of action is an act or omission that is yet to occur, whether the act or omission could be, and in the circumstances would be likely to be—

(i) authorised by the company before it occurs; or

(ii) ratified by the company after it occurs;

(f) where the cause of action is an act or omission that has already occurred, whether the act or omission could be, and in the circumstances would be likely to be, ratified by the company.

The procedure on admission of application is also laid down in the Section. Future hopes on success of class action suits concept in India depends on various factors such as the expansion of the number of investors associations as the funding of class actions is being sought through Investor Protection and Education Fund. This is pertinent as the contingency fee system prevalent in USA goes against the provisions under Bar Council of India Rules on Ethics and Professional Conduct and the Advocates Act, 1961. Strict rules are required to ensure that NCLT is required to entertain only pertinent matters and that this provision does not add to the list of pending cases.

References

·  Fifty- seventh Report, The Companies Bill, 2011, Standing Committee on Finance (2011-2012), Ministry of Corporate Affairs - http://www.icsi.edu/docs/WebModules/LinksOfWeeks/57_Report_Companies_Bill_11.pdf, last accessed on 1 /3/2013

· Will Aggregate Litigation Come to Europe?, by Samuel Issacharoff & Geoffrey P. Miller, Vanderbilt Law Review, Vol.62:1:179

· The Companies,2009 -

http://www.mca.gov.in/Ministry/actsbills/pdf/Companies_Bill_2009_24Aug2009.pdf, last accessed on 28/2/2013

· The Companies,2011 -

http://www.mca.gov.in/Ministry/pdf/The_Companies_Bill_2011.pdf, last accessed on 28/2/2013

· Bar Council of India, Rules on Professional standards -

http://www.barcouncilofindia.org/about/professional-standards/rules-on-professional-standards/, last accessed on 27/2/2013

· California Class Action Classics, by Elizabeth J.Cabraser -

http://www.lieffcabraser.com/media/pnc/2/media.302.pdf, last accessed 27/2/2013

· Securities Class Actions in State Court, by Jennifer Johnson, University of Cincinnati Law Review, Volume 80 | Issue 2 Article 4 - http://scholarship.law.uc.edu/cgi/viewcontent.cgi?article=1094&context=uclr, last accessed on 27/2/2013

· Class Action under Companies Bill 2012: Wide ranging injunctive and punitive powers against companies, Vinod Kothari & Company -

http://india-financing.com/Class_Action_under_Companies_Bill_2012.pdf, last accessed on 28/1/2013

· Dr. Jamshed J. Irani, Expert Committee on Company Law, Report on Company Law - http://www.iias.in/downloads/JJ_Irani_Report_MCA.pdf, last accessed on 27/2/2013

· An overview of progressive activism- the class action suit, by Mrs. Parimala V., Indian Journal of Applied Research, Volume 2, Issue3 -

http://www.theglobaljournals.com/ijar/file.php?val=ODgy, last accessed on 28/2/2013

· Satyam’s Class Action Suit, by Shantanu Surpure -

http://www.vccircle.com/byinvitation/2009/01/19/satyams-class-action-law-suit, last accessed on 27/2/2013

· A class action culture, by Aju John -

http://www.mylaw.net/Article/A_class_action_culture/, last visited on 28/2/2013

· Class action suits are up against challenges, by Samar Srivastava - http://www.moneycontrol.com/news/features/class-action-suitsup-against-challenges_829991.html, last visited on 27/2/2013