Understanding Derivative Action under the Companies Act, 2013

Introduction

The Companies Act, 2013 provides multiple remedies to shareholders when corporate affairs are conducted improperly. However, not every wrongdoing can be addressed through the same legal route. One concept that is frequently misunderstood and often confused with class action proceedings is the derivative action.

Indian courts and tribunals have consistently clarified that a derivative action is fundamentally different from a class action under Section 245 of the Companies Act. Understanding this distinction is critical for shareholders and practitioners to ensure that the correct remedy is invoked.

What Is a Derivative Action?

A derivative action is a legal proceeding initiated by a shareholder on behalf of the company, rather than for the personal benefit of the shareholder.

In simple terms:

• The company is the real victim of the wrongdoing
• The company should ideally file the case
• However, the company cannot act because the alleged wrongdoers are its own directors or controlling shareholders
• A shareholder, therefore, steps in to protect the company’s interest

Any relief or compensation granted in a derivative action belongs to the company, not to the shareholder who initiated the proceedings.

Why Does the Law Recognise Derivative Actions?

Under general company law principles:

• A company acts through its Board of Directors
• Only the company can sue for a wrong done to it

This framework fails when:

• Directors themselves are involved in the wrongdoing
• Management is conflicted or deliberately inactive
• The company is effectively disabled from taking action

To prevent such injustice, the law recognises derivative action as an exception. It ensures that corporate wrongs do not go unaddressed merely because those in control are also the wrongdoers.

Judicial Recognition of Derivative Action in India

Approach of Indian Courts

Indian courts have explained the derivative action by referring to the American Jurisprudence as:

• Is taken in the interest of the company
• May be filed by one or more shareholders
• Typically impleads the company as a defendant, though it is the real beneficiary

The reasoning is since the company cannot sue itself through compromised directors, the shareholder is treated as representing the company’s interest. Substantively, the company is regarded as the true plaintiff, despite its procedural position.

The Jindal Poly Case: Limits of Section 245

In Ankit Jain & Ors. v. Jindal Poly Films Ltd. & Ors., shareholders filed a petition under Section 245 seeking restoration of the company’s financial health.

The respondents argued that:

• The relief sought was for the benefit of the company
• Such relief is derivative in nature
• A derivative action cannot be pursued under Section 245
• Section 245 cannot be used to bypass the statutory framework of Sections 241–242

In Ankit Jain and Ors. v. Jindal Poly Films Ltd. and Ors., the National Company Law Tribunal examined the argument that the principles laid down in Patrick Tooley and Kevin Lewis v. Donaldson, Lufkin & Jenrette Inc., as reiterated by the Madras High Court in Valluvar Kuzhumam Pvt. Ltd. v. APC Drilling & Construction Pvt. Ltd., would bar a petition under Section 245 of the Companies Act, 2013. The Tribunal clarified that the Madras High Court decision merely extracted the distinction between derivative actions and class actions in the context of American law and did not deal with class action suits as specifically contemplated under Section 245 of the Indian Companies Act. The Tribunal emphasised that Section 245 has been consciously drafted in a manner distinct from American jurisprudence, keeping in mind the realities of Indian corporates and investor protection. It observed that Section 245 is a benevolent provision intended to grant wide-ranging reliefs to shareholders and depositors, including reliefs that may incidentally benefit the company itself, provided the statutory requirements are satisfied. The mere availability of remedies under Sections 241–242 does not invalidate a petition under Section 245, so long as the petitioners meet the prescribed threshold namely, holding at least 2% of the issued share capital under Rule 84(3)(ii)(b) of the NCLT Rules, 2016 and form a prima facie justifiable opinion that the affairs of the company are being conducted in a prejudicial manner. The Tribunal therefore held that a class action under Section 245 cannot be discredited merely because the relief sought may also benefit the company, as the provision expressly enables shareholders to initiate proceedings for such benefit within the Indian statutory framework.

Conclusion

In Ankit Jain and Ors. v. Jindal Poly Films Ltd. and Ors., the National Company Law Tribunal held that, at the present stage, the primary issue before it was only the maintainability of the petition and not the merits. The Tribunal observed that the petitioners’ concerns regarding the management and conduct of the company’s affairs being prejudicial to the interests of the company or its members are squarely covered by the broad and enabling language of Section 245 of the Companies Act, 2013. It was satisfied that the petitioners met the statutory threshold prescribed under Rule 84 of the NCLT Rules, 2016, and that the issues raised clearly fall within the scope of Section 245. The Tribunal emphasised that Section 245 is specifically designed for Indian investors and therefore there is no need to be guided by U.S. jurisprudence, even though the provision may incidentally carry some features similar to derivative actions recognised under American law. It clarified that Section 245 is capable of addressing the concerns raised by the petitioners in relation to the affairs of the company, while making it clear that all such issues are yet to be examined on merits and that the respondents are fully entitled to contest and deny the allegations at the appropriate stage. The Tribunal further rejected the respondent’s argument that past actions cannot be the subject of a class action, holding that such an interpretation would defeat the object of Section 245. It noted that denying shareholders the right to even initiate proceedings at the threshold, based on a prima facie opinion, would be unfair and contrary to the intent of the law. Accordingly, without expressing any view on the factual merits, the Tribunal rejected the objection on maintainability and directed issuance of notice to the respondents.

-Dixit Mehta, Ductus Legal