SHAREHOLDER DERIVATIVE ACTION SUITS- TIME TO TAKE INSPIRATION

FROM THE U.K?

Ishani Mukherjee

ABSTRACT

Derivative action suits are one mode of remedy exercisable by shareholders to safeguard the
interests of the company on behalf of the company. The origin of derivative action suits lies
in common law, in the celebrated case of Foss v. Harbottle. This paper intends to dissect the
grounds upon which derivative action suits may be instituted in two common law countries;
India and the U.K. It does not delve into an analysis of procedural requirements. The
motivation to select these two specific countries is simple- despite India and the U.K being
common law countries, and the Indian Companies Act being largely derived from the U.K,
both countries understand the grounds for locus standi in a derivative claim.

The article proceeds in four major sections. Part I will introduce the context and nature of
derivative action suits. Part II will delve into the grounds upon which derivative action suits
may be instituted in India and explore some case laws that have further clarified the same.
Part III will analyse the UK Companies Act, 2006, and undertake an analytical tone to
highlight how it differs from the grounds recognised in India. Part IV will conclude the
article.

Keywords: derivative action, India, U.K, common law, locus standi

Introduction

The degree of managerial accountability owed to shareholders of a company has been a

highly contested question in corporate law. Minority shareholders often find themselves
walking an onerous path of having to ferret out and consequently fight for their right to
remedy corporate wrongdoing.1 Indian law gives minority shareholders certain statutory
remedies, such as seeking action against oppression and mismanagement. The purpose of this
paper is to focus on one such common law remedy- that of derivative action suits.

Part I- Derivative Action Suits: Evolution and essence

The seminal ruling in Foss v Harbottle (‘Foss’) as well as in Mozley v Alston strengthened
two principles of company law; the “proper plaintiff rule” and the “majority rule”. Sir
Wigram VC held that since it is the corporation that has been the victim of wrongdoing2, it is

1
Umakanth Varottil ‘The Continued Influence of Foss v Harbottle in India’ (IndiaCorpLaw, 8 March 2021)
<https://indiacorplaw.in/2021/03/the-continued-influence-of-foss-v-harbottle-in-india.html> accessed 2 October
2022
2
Kershaw David, ‘The Rule in Foss v. Harbottle is Dead; Long Live the Rule in Foss v. Harbottle’, Law Society
Economy Working Papers 5/2013 at 5, <http://ssrn.com/abstract=2209061> accessed 6 October 2022

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 SHAREHOLDER DERIVATIVE ACTION SUITS- TIME TO TAKE INSPIRATION
FROM THE U.K?

only the corporation, not the shareholders, that is the “proper plaintiff” who may initiate a
suit to seek redressal for that wrong.3 And therefore, logically, Foss held that the court would
not interfere in cases where actions taken by the wrongdoers are “ratifiable”4 i.e, can be
ratified at a subsequent time by the majority shareholders5. The rationale behind both of these
propositions goes back to the holding in Salomon v Salomon that the company is a separate
legal personality and therefore the decision-maker and the actor who protects its interests.6

Over time, courts became cognisant of the problem that could arise with a blanket application
of the seemingly inflexible proper plaintiff rule, which was over the years whittled down by
judicially carved out exceptions. These exceptions would allow for a deviation from the
proper plaintiff rule by allowing minority shareholders to have locus standi on behalf of the
company in the form of derivative action suits.

Derivative suits are those where minority shareholders are allowed to seek redressal for
wrongs done against the company, by stepping into its shoes7 where the company itself is
unable or reluctant to enforce its rights.8 This “necessity”9 of allowing shareholders to sue in
the name of the company and seek relief to the same extent that the company would be
entitled to10 arises because the wrongdoing is done by those who are at the helm of the
Company (think directors and other key managerial persons), thereby making it unlikely that
they would pursue any action against themselves.11

The company is named as the nominal co-defendant in such suits so that, first, it’s bound by
the judgment; second, it can enforce orders against the substantive co-defendants (the
wrongdoers in question);12 and third, because the plaintiff is essentially compelling the
company to pursue its cause of action.13 Jessica Erickson writes that the company in such
suits is the “functional plaintiff”14 in that it’s the real party whose interest is in question. The

3
Umakanth Varottil ‘The Continued Influence of Foss v Harbottle in India’ (IndiaCorpLaw, 8 March 2021)
<https://indiacorplaw.in/2021/03/the-continued-influence-of-foss-v-harbottle-in-india.html> accessed 2 October
2022
4
MacDougal v. Gardiner, [1875] 1 Ch. D 13.
5
Kershaw David, ‘The Rule in Foss v. Harbottle is Dead; Long Live the Rule in Foss v. Harbottle’, Law Society
Economy Working Papers 5/2013 at 5, <http://ssrn.com/abstract=2209061> accessed 6 October 2022
6
Salomon v. Salomon [1897] AC 22 HL
7
Thomas P. Kinney, ‘Stockholder Derivative Suits: Demand and Futility Where the Board Fails to Stop
Wrongdoers’, 78 Marq. L. Rev. 172 (1994)
8
Arad Reisberg, Derivative Actions and Corporate Governance at 1(para-3), 1st edition (2007), Oxford
University Press (London)
9
Smith v. Croft, [1988] Ch. 114
10
Anil Madhavdas Ahuja v Marvel Fragrances Private Limited, 2011(113)Bom.L.R.3142
11
Umakanth Varottil ‘The Continued Influence of Foss v Harbottle in India’ (IndiaCorpLaw, 8 March 2021)
<https://indiacorplaw.in/2021/03/the-continued-influence-of-foss-v-harbottle-in-india.html> accessed 2 October
2022
12
V. Shyam Kishore and Sunil Kumar Gupta, ‘Derivative Actions in India: Problems and Prospects’(2014)
<https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3802327> accessed 8 October 2022
13
Shnell H. James, ‘A Procedural Treatment of Derivative Suit Dismissals by Minority Directors’, 69 (3) Cal. L.
Rev. 885, 888 (1981).
14
Jessica Erickson, ‘Corporate Governance in the Courtroom: An Empirical Analysis’, 51 William & Mary L.
Rev. 1749, 1756 (2010).

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 SHAREHOLDER DERIVATIVE ACTION SUITS- TIME TO TAKE INSPIRATION
FROM THE U.K?

outcome of such suits is that any relief sought goes only to the company, rather than to the
shareholders who instituted the suit15. The plaintiff in such suits only “derive” their right to
sue from the fact that they’re a member of the company and that the company is unable to
protect itself.16 Logically, therefore, it can be gleaned that this dissuades frivolous and
self-serving litigation that attempts to use derivative action suits for personal motives.

Part II- Derivative action suits in common law

The exceptions to the rule of majority were cemented in later judgements, the initial one
being MacDougall v. Gardiner17 where James L.J listed these exceptions in the following
manner “........unless something illegal, oppressive, or fraudulent–unless there is something
‘ultra vires’ on the part of Co ‘qua Co.’or on the part of the majority of the Co.,....”18 and
these grounds were recognised by the Indian courts, such as the Madras High Court in
Nagappa Chettiar v The Madras Race Club19

The first exception is when the alleged wrongdoing is ultra vires or illegal. The logic behind
allowing derivative claims here is that such acts, by virtue of their illegality, are not ratifiable
by majority shareholders, thereby meaning that allowing minority shareholders to litigate
against such wrongful acts becomes both important and plausible from a corporate
governance point of view.20

The second exception is when there’s fraud against the minority in the sense that there is an
equitable interest that the minority has in taking up the remedy of derivative action21 because
there has been an unfair benefit to the majority at the expense of the company. Indian courts
have clarified that this “benefit” shouldn’t just be an incidental one but one that operates as
opposed to the company’s interest. Such ‘fraud’ constitutes a breach of duty that disloyally
only serves the personal interests of the director/wrongdoer. In Needle Industries (India) Ltd.
v. Needle Industries Newey (India) Holding Ltd.22, the court held that an issuance of further
shares, even if it was incidentally benefiting the wrongdoers, was not a sufficient ground to
take recourse to a derivative action claim because it could be proved that it was also
benefiting the company. It can be gleaned that this exception wasn’t a radical departure from
the Foss rule because Foss only held that ratifiable wrongs were beyond the purview of
derivative action; some argue that such ‘fraud on the minority’ has been thought to be

15
Narendra Kumar Berlia v Om Prakash Berlia [2011] (3) CHN 147
16
Farnham v. Fingold [1972]3 O.R. 688
17
Mac Dougall v. Gardiner', (1875) 1 Ch. D. 13: 45 LJ Ch 27
18
Mac Dougall v. Gardiner', (1875) 1 Ch. D. 13: 45 LJ Ch 27
19
Nagappa Chettiar v The Madras Race Club AIR 1951 Mad 831
20
Vikramaditya Khanna and Umakanth Varottil, ‘The Rarity of Derivative Actions in India: Reasons and
Consequences’<https://www.researchgate.net/publication/288443261_The_rarity_of_derivative_actions_in_Indi
a_Reasons_and_consequences> accessed 28 September 2022
21
Reisberg, Arad, Derivative Actions and Corporate Governance, (New York: Oxford University Press, 2007) at
90
22
AIR 1981 SC 1298

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 SHAREHOLDER DERIVATIVE ACTION SUITS- TIME TO TAKE INSPIRATION
FROM THE U.K?

non-ratifiable thereby relieving the courts of a scenario where shareholder ratification

undermines its holding.23

Prof. Umakanth Varottil explains that this exception is actually intertwined with another
exception24- that the “fraud on minority” exception becomes applicable only when the
wrongdoers are actually in control of the company.25 This could be advanced by the logic that
it's only in such circumstances that a fraud like this wouldn’t be taken up by the company
itself26 because the wrongdoer controls the general meeting, thereby incapacitating the
company.27 The fourth, and subsequently developed exception recognised by Indian courts is
if the wrongdoing is one where a simple majority was used to pass an ordinary resolution for
a matter that required a special resolution in compliance with either 1) the company’s articles
of association or 2) the Companies Act.28

Part III- Derivative Action in the U.K (and its divergence from India)

As can be gleaned from the previous section, India continues to recognise the common law
exceptions to Foss, making it one of the few common law countries that has resisted the step
to codify shareholders' remedies for derivative actions. This is despite the fact that in 2005
the J J Irani Committee29 and subsequently, in 2011, the Standing Committee on Finance30
both recommended the incorporation of an express provision for derivative actions so that
this remedy isn’t reliant on the hope that precedent is opportune enough to allow derivative
suits to be admitted. The extensive revamping of the Companies Act in 2013 overlooked such
considerations.31

The U.K, on the other hand, did take the recommendations of the Law Commission, which
said that the exceptions to Foss coming from case law were inflexible, outmoded and
ambiguous given that they left open uncertainties in how “wrongdoers control” would be
23
Kershaw David, ‘The Rule in Foss v. Harbottle is Dead; Long Live the Rule in Foss v. Harbottle’, Law
Society Economy Working Papers 5/2013 at 5, <http://ssrn.com/abstract=2209061> accessed 6 October 2022
24
Umakanth Varottil ‘The Continued Influence of Foss v Harbottle in India’ (IndiaCorpLaw, 8 March 2021)
<https://indiacorplaw.in/2021/03/the-continued-influence-of-foss-v-harbottle-in-india.html> accessed 2 October
2022
25
Vikramaditya Khanna and Umakanth Varottil, ‘The Rarity of Derivative Actions in India: Reasons and
Consequences’<https://www.researchgate.net/publication/288443261_The_rarity_of_derivative_actions_in_Indi
a_Reasons_and_consequences> accessed 28 September 2022
26
Prudential Assurance Co. Ltd v Newman Industries Ltd. (No.2)[1982] Ch. 204 at 211
27
Kershaw David, ‘The Rule in Foss v. Harbottle is Dead; Long Live the Rule in Foss v. Harbottle’, Law
Society Economy Working Papers 5/2013 at 5, <http://ssrn.com/abstract=2209061> accessed 6 October 2022
28
N.V.R. Nagappa Chettiar and Ors. vs. The Madras Race Club and Ors. [1949] 1 MLJ 662
29
J.J. Irani Committee Report on Company Law(2005), Chapter VI, Recommendation 10.2, available at
<http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf> accessed 10 October 2022
30
57th Report of Standing Committee on Finance (2011-12), Part I, Chapter IV, SN 124(I),
<http://www.icsi.edu/docs/WebModules/LinksOfWeeks/57_Report_Companies_Bill_11.pdf> accessed on
January 23, 2013)
31
Umakanth Varottil ‘The Continued Influence of Foss v Harbottle in India’ (IndiaCorpLaw, 8 March 2021)
<https://indiacorplaw.in/2021/03/the-continued-influence-of-foss-v-harbottle-in-india.html> accessed 2 October
2022

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 SHAREHOLDER DERIVATIVE ACTION SUITS- TIME TO TAKE INSPIRATION
FROM THE U.K?

ascertained in such cases.32 Derivative suits were incorporated in Part 11 of the Companies
Act, 2006 as a step geared towards improving access to shareholders by modernising the
law.33 Regardless,the U.K. has also left open the applicability of the CLDA to how the courts
interpret the Act as there hasn’t really been an express abolition of the same.34

Section 260(1) defines derivative claims as those that are initiated by members of a company
who seek relief on behalf of the company for a cause of action that originally vests in the
company.35 Principally, we can establish that what constitutes a derivative claim remains the
same as the common law derivative claim. Furthermore, the common law requirement of the
court not entertaining such claims that are ratifiable is found even within the UK Companies
Act where the court has to consider (before granting leave) whether an act or omission that
has already happened or is envisaged to happen, is ratified or is likely to be ratified36. This
signals the judicial intention to avoid cases where the judicial decision regarding a claim
could be negated by lawful ratification.

Where U.K law fundamentally diverges from common law derivative claims is in the kind of
grounds under which a party can initiate a derivative suit. Section 260(2) makes it clear that
derivative claims can only be brought under the Act, either under the conditions stipulated
under Chapter 11 itself or pursuant to an order of the court in proceedings for the protection
of members against unfair prejudice given under Section 994.37 A bare perusal of Section
260(3) shows that, as opposed to the common law derivative claim, the UK Act envisages a
broad spectrum of instances that can give rise to a legitimate derivative action claim—--such
claims may be brought in relation to any act or omission by the director that has already
happened or is proposed and is in the nature of a breach of trust, breach of duty, negligence,
or default.38 We see that the requirement of there having been done an “actual wrong” is also
expanded to now include any of the actions that the shareholder envisages that the director
would engage in.39 Furthermore, as per Section 260(4), the cause of action could have arisen
even before the shareholder became a member of the company, thereby further expanding the
scope of wrongs that a shareholder can litigate against. A cumulative reading of these
provisions shows that the instances in which the shareholder can initiate action are much
more flexible as compared to the common law exceptions.

32
Law Commission, Shareholder Remedies (Consultation Paper No. 142 1996) at para. 14.1.
33
Andrew Keay & Joan Loughrey, Something Old,Something Borrowed: An Analysis of the New Derivative
Action under the Companies Act 2006, 124 L.Q. Rev. 469, 469 (2008)
34
Kershaw David, ‘The Rule in Foss v. Harbottle is Dead; Long Live the Rule in Foss v. Harbottle’, Law
Society Economy Working Papers 5/2013 at 5, <http://ssrn.com/abstract=2209061> accessed 6 October 2022
35
Section 260(1) Companies Act 2006
36
Section 263(3) Companies Act 2006
37
Section 260(2) Companies Act 2006
38
Section 260(3) Companies Act 2006.
39
Wiseman Ubochioma, ‘A Comparative Analysis of Shareholders’ Derivative Action under the United
Kingdom and Nigerian Companies Acts’ (2016)
<https://kluwerlawonline.com/journalarticle/Business+Law+Review/37.4/BULA2016028> accessed 7 October
2022

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 SHAREHOLDER DERIVATIVE ACTION SUITS- TIME TO TAKE INSPIRATION
FROM THE U.K?

For example, a derivative claim could now be made from an action that need not necessarily
be taken by a director who is in control of the general meetings. The case in Prudential
Assurance Co. Ltd v Newman Industries Ltd40 where loss suffered by the company at the
behest of a director breaching his fiduciary duty was held to not come under the exceptions to
Foss because the wrongdoer was not in control of the company, would now, under the
expanded scope of cause of action under the UK Act be allowed to be covered under section
260(3). Similarly, as opposed to the common law requirement of negligence falling within the
exception of “fraud on minority” only if a personal benefit is also accrued to the wrongdoer,
this was removed as held in Iesini v Westrip Holdings Ltd41

Similarly, allowing derivative claims by shareholders for wrongdoing before they became
members of the company is also a giving provision, which makes it a more powerful tool for
shareholders to monitor actions hindering the interests of the company that may have
happened before they were in the picture —a stronger corporate governance mechanism.

PART IV- Conclusion

The following conclusion can safely be propounded- the viability of derivative action suits is
much greater in the U.K. as opposed to India. This claim is substantiated by the fact that the
grounds for establishing locus standi in India are fairly limited to the age-old Foss
exceptions, with courts being reluctant to add any radical grounds to the pre-existing list. As
opposed to this, the statutory codification of derivative claims in the U.K has led to almost an
“all-encompassing” scope for shareholders to exercise their right of derivative claims. The
author wishes to leave you with a proposition- India, is one of the fastest growing economies
in the world with a model that is day by day looking more in the nature of dispersed
shareholding. While existing remedies for minority shareholders, such as the incorporation of
class action suits, are laudable, we need to take a moment and think: wouldn’t allowing for a
broader scope to access derivative claims allow for a more robust accountability mechanism?
However, we also need to tread with caution and realise that a balance has to be maintained
so that activist shareholders don’t get an opportunity to use a meaningful remedy such as
derivative claims to institute frivolous lawsuits.

40
(No2) [1982] Ch 204
41
Iesini v Westrip [2011] BCLC 498

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