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ABBISHEK.

R
BC0140003
IIIrd year, B.com LLB

THE SIGNIFICANCE OF CREDITORS CLASS ACTION SUITS: A CRITICAL


ANALYSIS OF SECTION 245 OF THE COMPANIES ACT,2013

Chapter 1 : INTRODUCTION

The idea is like anything in our democracy - the more people you have speaking as one
voice, the louder that voice becomes.1

- Attorney Christopher Gilreath2

Class Action Suit also known as Class Suit, which has been defined as a lawsuit that allows a
large number of people with a common interest in a matter, to sue or be sued as a group. For the
protection of members or depositors or any class of them from fraud, illegality and wrongful
conduct towards them, the class action suit has been inserted in the Companies Act, 20133. A suit
of class action suits can be filed against the Company, any of its directors, Auditor, including
audit firm, Expert or advisor or consultant or any other person for the management or control of
the affairs of the company that are being conducted in a manner prejudicial to the interests of the
company4. Although the concept of class action suits under section 245 of the Indian Companies
Act, 2013 has brought a positive change to Indian corporate law, the act only empowers
depositors and shareholders to proceed under class action suits. It fails to include other
stakeholders of the company such as creditors, debenture holders, suppliers, and other persons
who hold interest in the company. In India, a class action suits cannot be brought by a creditor of

1
Class Action allows stronger collective voice, Memphis Daily News, Extracted from:
www.memphisdailynews.com/editorial/ArticleEmail.aspx?id=31000, extracted on April 14th, 2014 at 11:01 AM.
2
Managing Attorney, Gilreath & Associates, Memphis, Tennessee, United States.
3
See, Section 245 of the Indian Companies Act, 2013.
4
Id.
the company as there is no provision for creditors because creditors can enforce their claims
through contracts or agreements with debtor companies. But the flaw in this argument is, that a
fraudulent act by a director could affect the whole company and all interested parties including
creditors, not only the shareholder and depositors. It should also be noted, that creditors can
enforce their claims through contracts or agreements only when the debtor companies cannot
repay their debts and each and every creditor's individual filing is too burdensome. This concept
of Class Action Lawsuit by stakeholders is prevalent in developed countries comprising the
United States, United Kingdom and Singapore. It is a procedural device enabling one or more
plaintiffs to file and prosecute litigation on behalf of a larger group or class, wherein such class
has common rights and grievances.5 There can be no right without a corresponding duty, or duty
without a corresponding right. So, if the directors have a duty to protect the interests of the
creditors, then creditors have a right to file a class action suit against the directors for fraud.
Therefore, other stakeholders like creditors who have interests in the company should be
permitted under the ambit of section 245 of the Indian Companies Act,2013.

5
Ibid, Footnote 4.
Chapter 2: 'WRONGS' COMMITTED AND 'DUTIES' TO BE
PERFORMED BY THE DIRECTORS

Before attempting to define a right, however it is necessary to define two other terms which are
closely related connected with it, namely, wrongs and duty.6 A wrong is simply a wrong act - an
act contrary to the rule of right and justice. A wrong is when there is a fraud, mismanagement,
dishonesty and corruption by the directors while dealing in the company's affairs. Whereas, a
duty is an obligatory act, that is to say, it is an act the opposite of which would be a wrong.
Duties and wrongs are correlatives. The commission of a wrong is the breach of a duty, and the
performance of a duty is the avoidance of a wrong.7 The commission of mismanagement and
fraud committed by the directors is a breach of duty to the creditors.

A. Directors have to protect the interests of creditors over shareholders in a Insolvent


Corporation:

The directors committing fraud and mismanagement is a breach of duty to all the stakeholders
and does not only affect shareholders and depositors but also other stakeholders like creditors,
suppliers and debenture holders. The directors have to perform their duties to protect the interest
of the stakeholders to avoid 'wrongs' in company affairs. The directors protection includes for
creditors and creditors have a right for direct claim against directors when the company is
solvent when the directors have intentionally involved in fraudulent activities and the courts have
held unequivocally that where a company is insolvent, its directors must consider the interests of
creditors.8 The Court held in Brady v. Brady9, that where a company is insolvent, the creditors
interests override the interests of shareholders.10 The most recent case of Re Pantone Ltd.11 and
Gwyer v. London Wharf Ltd. 12 have indicated that when a company is insolvent then the
creditors interests are paramount. 13 But where a company is insolvent the interests of the
creditors intrude. The Irish Supreme Court said that, because of the insolvency of the companies

6
Salmond on Jurisprudence, pp: 179-198
7
Id.
8
Liquidator of West Mercia Safetywear Ltd v. Dodd. (1988) 4 B.C.C. 30.
9
Brady v. Brady AC 755, 2 WLR 1308, BCLC 20; (1988) 3 BCC 535, 2 All ER 617
10
Supra note no.4
11
Re Pantone Ltd. 27 [2002] 1 B.C.L.C. 266
12
Gwyer v. London Wharf Ltd 28 [2003] 2 B.C.L.C. 153, 178; [2002] EWHC 274
13
Professors LoPucki and Whitford, ("Corporate Governance in the Bankruptcy Reorganization
of Large Publicly Held Companies" (1993) 141 U. Pa. L. Rev.
the shareholders had no longer any interest.14 The only parties with an interest were the creditors.
The draft clauses in the latest Company Law Reform White Paper that the interests of the
members should be replaced by those of the creditors when a company is insolvent. 15 In the
Jurisdictions of Canada, Delaware and England, Creditors are not permitted to file a direct suit
on behalf of directors but they are permitted to file a class action suit on behalf of the corporation
because the directors have a duty of care towards creditors and the company to take creditors
interest into account, immaterial whether it is a solvent or insolvent corporation.16 The company
owes a duty to its creditors to keep its property inviolate and available for the repayment of its
debts. A duty is owed by the directors to the company and to the creditors of the company to
ensure that, its property is not dissipated or exploited.17

So, if creditor's interests are paramount, directors have to put aside the shareholder primacy
principle and rather than seeking to maximise shareholder wealth, the directors should maximise
creditor wealth. Directors will do so by eliminating the high risk policies that they might have
followed when implementing shareholder primacy. The company's affairs are to be administered
in such a way as to ensure that actions will enhance the wealth of creditors, that creditors will be
repaid more of the funds that are owed to them. The court held that when a corporation becomes
insolvent, the creditors replace the stockholders as the equitable owners of the firms assets and
the initial beneficiaries of any increases in value. Thus, the corporations insolvency makes the
creditors the principal constituency injured by any fiduciary breaches that diminish the firms
value.

B. Even if the company is solvent, a creditor will retain his standing for a Derivative claim:

In Quadrant Structured Products Co., Ltd v. Vertin, 18 A creditor will retain standing for a
derivative claim made while the corporation is insolvent, even if the corporation is ultimately
able to repay its debt. Since creditors have an interest in the credit worthiness of a corporation, a
creditor will have the standing to bring a derivative suit against a corporation's board, even if the
corporation returns to solvency and expects that it will be able to pay the creditors in full. The

14
Re Frederick Inns Ltd. (1993) I.E.S.C 1 at [47]
15
Clause B19 of the Company Law Reform Bill
16
Mehreen Rehmen "Directors duties to creditors - mapping the twilight zone"
17
Winkworth v. Edward Baron Development Co. Ltd, As per Lord Templem, [1987] 1 All E.R. 114,118
18
Quadrant Structured Products Co., Ltd v. Vertin 106 A.3d 992 (Del. 2013)
court held that a creditor need only establish that the company was balance sheet insolvent at the
time the suit was filed and that the creditors standing will not be extinguished if the company
rides back into solvency during the litigation.

Therefore, it has been established that directors have a fiduciary duty towards creditors during
the time of solvency, when the directors have acted in an intentional manner to defraud the
investors and during the time of insolvency, the directors have to not only protect the interests of
the creditors but also shareholders simultaneously because both play a vital key role in the
company's functioning, instead of focusing on just one depending on the circumstances. There
can be no right without a corresponding duty, or duty without a corresponding right. For every
duty must be a duty toward some person or persons, in whom, therefore, a correlative right is
vested and conversely every right must be a right against some person or persons, upon whom, a
correlative duty is imposed.
Chapter 3: CREDITORS HAVE A RIGHT TO FILE A CLASS ACTION
LAWSUIT AGAINST THE DIRECTORS FOR MISMANAGEMENT
UNDER SECTION 245 OF THE INDIAN COMPANIES ACT,2013

"A right is an interest recognized and protected by a rule of right. It is any interest, respect for
which is a duty, and the disregard of which is a wrong." 19 The interest which thus receive
recognition and protection from the rules of right are called rights. There can be no right without
a corresponding duty, or duty without a corresponding right. There can be no duty unless there is
someone to whom it is due; there can be no right unless there is someone from whom it is
claimed; and there can be no wrong unless there is someone who is wronged, that is to say,
whose right has been violated.

A class action lawsuit is one in which a group of people with the same or similar injuries caused
by the same product or action sue the defendant for breach of interests as a group. Every man
who has a right to any thing has an interest in it also. "whether his interest amounts to a right
depends on whether there exists with respect to it a duty imposed upon any other person. In other
words, a right is an interest the violation of which is a wrong. So, If a creditor has suffered
damages financial or otherwise or who has been deceived by the directors due to fraudulent
tactic may file a class action lawsuit. The provision of class suit gives stakeholders an edge in
retrenching their rights.

To file a class action suit- the creditors will need to establish that the management's conduct of
the company's affairs are prejudicial to their or the company's interests.

Directors mismanagement depletes corporate assets, upon which creditors rely for
repayment. As creditor cushion shrinks, their risk increases. Within reasonable limits,
most creditors could be compensated for increased risk-bearing by an increase in the rate
of return, but unless they are able to renegotiate their contracts and agreements, it would
not be possible. The injury that creditors suffer thereby is thus comparable to a decline in
the rate of return. So, this unexpected change in the rate of return confers upon creditors a
right of action against directors.

19
Salmond On Jurisprudence, pp 179-198
Creditors are clearly troubled by the prospect of intentional or negligent mismanagement
depleting corporate assets during the term of their loans, particularly in small
corporations in which there are few assets to deplete. Every bad loans weakens the
lender's portfolio and ultimately lessens his chance of competitive success. A creditor
concerned by mismanagement have to bring class action suits because a class action suit
would attach a new legal right to creditors investments that would allow creditors to
control mismanagement more effectively. The existence of such a right would benefit
creditors both directly and indirectly. Creditors with the resources and inclination to bring
suits against directors would attack mismanagement by legal process and less litigious
creditors could shelter under the protection provided by such suits.

In some cases, an entrepreneur to shield himself from the claims of creditors,


expropriates corporate property for his personal benefit. The insolvency remedies have
evolved to deter this sort of conduct and to compensate creditors injured by it. But these
remedies reach only occurring at or near the point of insolvency. A creditors class action
lawsuits could close this important gap in creditors remedies and serve society's interest
in promoting honest conduct on the part of corporate management.

The directors mismanagement leads to all the above which makes the management's
conduct of the company's affairs prejudicial to creditors or the company's interests.
Rights and duties and wrongs are essentially correlative, and if a creditor has a natural
right to receive his debts, the debtor is under a moral duty to pay it to him. The very
existence of a creditors class action suit would invite closer supervision of debtors, before
mismanagement can be prosecuted it will be detected. Creditors class action suits will
encourage creditors like banks and large suppliers to monitor the finances and oversee the
operations of their debtors more closely than before. poor management is a problem in
many countries and in one form or another it is responsible for a great number of business
failures each year. But this can be overcome by careful insight by commercially
sophisticated creditors whose financial interest is coupled with working knowledge of the
debtor's affairs could help to correct sloppy business practices. The result might be fewer
failures and less disruption in the business community. Offering a class action suit to
creditors would allow private enforcement actions to reach a large class of corporations
from which they are foreclosed today, thereby encouraging more honest behavior on the
part of corporate management.
Chapter 4: CONCLUSION

Stakeholders such as debenture holders, suppliers, and creditors play a key role in the company.
Although, not owners of the company, they are essential for the company's functioning. It is true
that companies do have a contractual obligation towards depositors and shareholders and the
same could be said of creditors as well. The provisions of Section 245 simply ensures a straight
forward remedy to a set of aggrieved stakeholders of only members and shareholders of a
company. Undoubtedly, as of now it could be said that the incorporation of the concept of class
action suit is a much welcomed step towards the betterment of the Indian corporate industry,
Stakeholders will definitely benefit from class action lawsuits, Debenture holders who had no
option but to file a civil suit so far, can also take action against any wrongful act by the company
or other specified persons. This should make them feel more secure, however, its failure in the
industry is still certain, reason being the exclusion of a major class of stakeholders comprising of
creditors, bankers, suppliers and debenture holders from its purview. Further, the regulatory
authorities and banking companies have been kept out of the ambit of this section and they are
not entitled to file a class action suit, which has been criticized throughout the country. To oust
creditors from that set of stakeholders would be unjust and detrimental to them. This provision of
class action suits is a boon for investors and other stakeholders like creditors and debenture
holders as it gives them an edge in retrenching their rights. The concept of collective creditor
class action brings creditors together with common interest or common platform, it also increases
the efficiency of the legal process and lowers down the cost of litigation. Aggregating large
number of complaints together makes cost and effort involved in a legal process worthwhile.
This threat of class action suits by creditors tends to enhance sense of responsibility and
diligence of the defendant towards the interest of stakeholders. Since, jurisprudentially directors
have a duty to protect the interest of the creditors and avoid wrongs, in turn, creditors have a
right to file a class action suit against the directors.
Therefore, These stakeholders like creditors and debenture holders should also be included under
the ambit of Section 245 of Indian Companies Act, 2013
Chapter 5 : RECOMMENDATIONS

Other stakeholders such as debenture holders, suppliers, and creditors play a key role and
are essential for company's functioning. These stakeholders should also be included
under the ambit of Section 245 of the Indian Companies Act,2013.

The power should be given to creditors, also for those fraudulent activities which are yet
to occur in the future against the management because it affects the proper repayment of
debts by debtors. So far, creditors filing a case of oppression and mismanagement was
the only recourse available to aggrieved creditors. Creditor class action suits gives them
additional rights and grounds to fight for their rights and any abuse of powers by the
company, its management or its directors.

Creditors should also be allowed to file class action suits against professionals such as
auditors, experts, advisors or consultants for their wrongs and misstatements so that they
will exercise more independence, diligence and efficiency in their work. Manipulations
by professionals to the company will also decline.

Since, there are rights and duties imposed on directors, they should also be liability for
anyone who fails to comply, will be liable for a minimum penalty of Rs. 5 Lakh but not
more than 25 Lakh and in case along with imprisonment of not less than 3 years.

The fine of rupees one lakh imposed on stakeholders under section 245(8) should be
removed because stakeholders may refrain from taking action against fraudulent
directors as a result of such a fine imposed on them, resulting in lower shareholder
activism and involvement in the company.

Banking companies and regulatory authorities should be included under the ambit of
section 245 and should be entitled to file a class action suit.
Lastly, Unlike members and depositors, there shouldn't be any limit to the minimum
number of creditors required to file a class action suit because there might not be as
many creditors as the number of members and shareholders.