Class Action or Derivative Action in Indian Company Law? Who Owns the Claim When the Wrong Is Done to the Company

A shareholder discovers that the promoters have diverted the company’s assets. The loss is the company’s; the board will not sue itself; the shareholder wants it back. In most systems that is the paradigm case for a derivative action, and the derivative action in Indian company law is a subject that attracts a great deal of confident writing. Almost none of it addresses the question that decides the case: which forum, under which provision, and who gets the money.

The Derivative Action in Indian Company Law: The Proper-Plaintiff Rule and its Reception

Foss v. Harbottle (1843) establishes two rules. Where a wrong is committed against a company, the company alone may sue under the proper-plaintiff rule. The court also generally refrains from intervening in matters of internal management that can be ratified by the majority. Both principles form the foundation of derivative actions in Indian company law, but their application requires recognised exceptions because those controlling the company may themselves be responsible for the wrong.

The foundational Indian statement is Dr Satya Charan Law v. Rameshwar Prosad Bajoria, AIR 1950 FC 133. At paragraph 17 the Federal Court held that ordinarily the directors are the only persons who can conduct litigation in the company’s name, “but when they are themselves the wrongdoers against the company and have acted mala fide or beyond their powers”, the majority of shareholders must be entitled to take steps to redress the wrong. In a companion decision, Ramkissendas Dhanuka v. Satya Charan Law, the Privy Council held that internal management does not save an act requiring a special majority done by ordinary resolution.

The fullest Indian enumeration is in Marikar (Motors) v. M.I. Ravikumar (Kerala High Court, 1 June 1981), reported at [1982] 52 Comp Cas 362, where five heads were adopted: acts that are ultra vires or illegal; acts requiring more than a simple majority; infringement of personal membership rights; fraud on the minority by those in control; and “any other case where the interests of justice require that the general rule, requiring suit by a company, should be disregarded”. The list is not unanimous: the Madras High Court has held there can “at best be only three exceptions”, so plead the exception rather than assume it.

Two Indian glosses are worth having. In ICICI v. Parasrampuria Synthetics Ltd, [1998] 92 Comp Cas 238, the Delhi High Court held that a “mechanical and automatic application” of Foss v Harbottle to Indian corporate realities would be improper, Indian companies being predominantly institution-funded rather than funded by small individual investors. And in Starlight Real Estate (Ascot) Mauritius Ltd v. Jagrati Trade Services Pvt Ltd (Calcutta High Court, 14 May 2015), the Court set out the cleanest Indian taxonomy of company, derivative, representative and personal actions, holding that where the action is to restrain a continuing wrong to the company or to recover its property, damages or compensation, it is a derivative action and “the company is the only true plaintiff”.

What Section 245 Actually Provides

Section 245 came into force on 1 June 2016. It permits a qualifying number of members or depositors, of the opinion that the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors, to apply to the Tribunal on behalf of the members or depositors.

The prescribed percentages are not in the Companies (Management and Administration) Rules, where practitioners often look for them, but in Rule 84(3) and (4) of the NCLT Rules 2016, inserted by G.S.R. 351(E) dated 8 May 2019: five per cent of members or 100 members, whichever is less; five per cent of issued share capital for an unlisted company and two per cent for a listed company. The opt-out mechanism and the admissibility criteria of numerosity, commonality, typicality and adequacy are likewise in the Rules, not the Act.

Does Section 245 Carry a Corporate Claim?

The relationship between Section 245 and derivative actions remains an open question under Indian company law.

The argument that it does is textual and strong. Section 245(1)(g)(iii) permits a claim against an expert or advisor for an incorrect or misleading statement made to the company. A statement made to the company can only have injured the company; members suing on it are necessarily suing on a corporate cause of action. Clause (g)(i) runs against directors for wrongful acts — the paradigm derivative claim. And section 245(4) directs the Tribunal to consider whether the cause of action is one the member “could pursue in his own right rather than through an order under this section”, which makes sense only if the section’s ordinary province is claims the member could not pursue personally. On this reading section 245 is a codified derivative action wearing class-action clothes.

The argument the other way is structural. Section 245 is built as a members’ and depositors’ remedy: triggered by their opinion, gated by their numbers, publicised to their class and binding on them. And, decisively, it nowhere says where the money goes. Contrast section 242(2)(i), which expressly directs recovery of a director’s undue gains to the Investor Education and Protection Fund or to identifiable victims. If a class of self-selected members can recover a loss suffered by the company and keep it, the section defeats the very rule it is said to implement. No decided case has resolved the point, so an applicant should plead the destination of the recovery expressly.

Where Does a Derivative Suit go Now?

Before 2016 the answer was the civil court. That changed when section 430 of the Companies Act 2013 — barring the civil court’s jurisdiction in matters the NCLT is empowered to determine — came into force on 1 June 2016. Its predecessor under the 1956 Act was never notified, so all earlier derivative-suit case law was decided in a world with no operative bar.

In Shashi Prakash Khemka v. NEPC Micon (Supreme Court, order dated 8 January 2019), the Court held that in matters in respect of which power has been conferred on the NCLT, the civil court’s jurisdiction is “completely barred”, noting the wide wording of section 430. That is a short order rather than a reasoned judgment, and did not overrule the earlier line on company-court jurisdiction.

Two High Courts have applied that to derivative claims directly. In ICP Investments (Mauritius) Ltd v. Uppal Housing Pvt Ltd (Delhi High Court, 30 August 2019), the Court held that the derivative action is of common-law origin with no express statutory remedy in India, but that the corporate-wrong and personal-wrong distinction “disappears” here, so that a derivative action falls within section 241 and, to the extent the oppression and mismanagement regime is equipped to deal with it, is no longer maintainable as a civil suit. The Madras High Court reached the same conclusion more emphatically in Valluvar Kuzhumam Pvt Ltd v. APC Drilling (30 November 2022), holding that the Act is a self-contained code and the civil court has no jurisdiction over such matters, “which is inclusive of derivative claims as well”.

Three consequences follow. The derivative claim now travels, if at all, through sections 241 and 242 — which require section 244 eligibility, ordinarily one-tenth of the members or one-tenth of the issued share capital, and are framed around prejudice to members. Or it travels through section 245, which requires a class. Or it does not travel: a single shareholder holding below the section 244 threshold, with a pure corporate claim and no class to assemble, may have no forum at all. No authority addresses that gap, and it is the strongest practical argument for a waiver under section 244(1).

How Sections 241 and 242 Differ?

The section 242 gateway is cumulative: the Tribunal must be of opinion both that the company’s affairs are being conducted in a manner prejudicial or oppressive, and that winding up would unfairly prejudice the member although the facts would otherwise justify a just-and-equitable winding up. In Tata Consultancy Services Ltd v. Cyrus Investments Pvt Ltd, (2021) 9 SCC 449, the Supreme Court set out that structure and held that sections 241 and 242 do not confer, expressly or by implication, a power of reinstatement — a reminder that section 242 is not an open reservoir of remedial power.

That said, several section 242(2) powers do benefit the company rather than the complaining member: terminating, setting aside or modifying agreements; setting aside a fraudulent preference made within three months before the application; and recovering undue gains made by a managing director, manager or director. These provisions allow the Tribunal to restore value to the company, even though they do not create an express statutory derivative action under Indian company law.

The Comparative Position, and What India Did not Adopt

The United States keeps the two devices rigorously apart. Federal Rule 23.1 governs derivative actions: the complaint must be verified, must plead contemporaneous ownership, and must state with particularity any demand on the directors or the reasons for not making it. Rule 23 is the separate class-action rule, with its own numerosity, commonality, typicality and adequacy requirements and, for damages classes, an opt-out right.

The United Kingdom took the opposite path from India and codified the derivative claim. Sections 260 to 264 of the Companies Act 2006 define a derivative claim as one in respect of a cause of action vested in the company and seeking relief on behalf of the company, available only for negligence, default, breach of duty or breach of trust by a director, with no contemporaneous-ownership requirement and a two-stage permission filter that the court must apply before the claim proceeds.

India did neither. The J.J. Irani Committee, reporting in 2005, recommended that the law “should recognize ‘Class suits’ and ‘Derivative Actions'”, and expressly noted that although the courts had upheld these principles, they were “yet to be reflected in Law”. Parliament legislated for one and not the other. The result is a class action with no permission stage, no demand requirement and no funding mechanism, alongside a derivative action that exists in the case law but has no statute, no procedure and, on the current High Court view, no civil forum.

What Remains Genuinely Unsettled

Whether Section 245 displaces or supplements derivative actions under Indian company law. The two High Court decisions above absorb the derivative claim into section 241 without analysing section 245 at all. No judgment has yet construed section 245(1)(g).

Where the recovery goes. The absence of a destination provision is a real defect, not a drafting nicety.

Whether the opt-out mechanism can bind absent members. Section 245(6) makes the order binding, but the opt-out machinery sits in a subordinate rule, while representative-suit practice under Order I Rule 8 of the Civil Procedure Code is opt-in by leave and notice. Whether a rule can create that res judicata is untested.

Why the section is unused. The thresholds are not obviously prohibitive for a listed company. The likelier explanation is cost: there is no contingency-fee mechanism, no common-fund doctrine and no litigation-funding framework, while section 245(8) exposes an unsuccessful applicant to costs. Anyone advising on a section 245 application should say plainly that it is close to untrodden ground.

Sources

• Companies Act 2013, sections 241, 242, 244, 245 and 430 — India Code.
• National Company Law Tribunal Rules 2016, Rules 84 to 87; Rule 84(3) and (4) inserted by G.S.R. 351(E) dated 8 May 2019.
• Code of Civil Procedure 1908, Order I Rule 8.
• Foss v Harbottle (1843) 2 Hare 461.
• Dr Satya Charan Law v. Rameshwar Prosad Bajoria, AIR 1950 FC 133, paragraph 17.
• Ramkissendas Dhanuka v. Satya Charan Law, Privy Council, 15 December 1949.
• Marikar (Motors) v. M.I. Ravikumar, Kerala High Court, 1 June 1981, reported at [1982] 52 Comp Cas 362.
• ICICI v. Parasrampuria Synthetics Ltd, [1998] 92 Comp Cas 238 (Delhi High Court).
• Starlight Real Estate (Ascot) Mauritius Ltd v. Jagrati Trade Services Pvt Ltd, Calcutta High Court, 14 May 2015.
• Shashi Prakash Khemka v. NEPC Micon, Supreme Court, Civil Appeal Nos. 1965–1966 of 2014, order dated 8 January 2019.
• ICP Investments (Mauritius) Ltd v. Uppal Housing Pvt Ltd, Delhi High Court, CS(COMM) 1079/2018, decided 30 August 2019.
• Valluvar Kuzhumam Pvt Ltd v. APC Drilling, Madras High Court, decided 30 November 2022.
• Tata Consultancy Services Ltd v. Cyrus Investments Pvt Ltd, (2021) 9 SCC 449.
• Federal Rules of Civil Procedure (United States), Rules 23 and 23.1.
• Companies Act 2006 (United Kingdom), sections 260 to 264.
• Report of the Expert Committee on Company Law (J.J. Irani Committee), 2005, Chapter VI and the Summary of Recommendations.