[By Dhiren Gupta]
The author is a student of Rajiv Gandhi National University of Law.
Introduction
Evolution of the Indian corporate structure has gone through several stages. From the Companies Act of 1956 to the economic reforms of 1991, which underscored the need for greater corporate transparency and accountability, which was addressed by bringing in the Companies Act, 2013. A plethora of changes were bought in by the new legislation which imposed additional compliances on the companies, but the issue of shareholder litigation persists due to the sophisticated growth of corporate malpractices for which the current legal system seems increasingly ill-equipped.
There has been a large number of cases pertaining to corporate mismanagement and fraud, where the shareholders, especially the minority, have suffered due to Sections 241, 242 and 245 being riddled with procedural flaws leading to an excessive burden of proof on the shareholders. In this piece, the author will discuss the shortcomings of shareholder litigation in India and how improvements can be made while analysing different jurisdictions and how they deal with derivative and double derivative suits.
Shortcomings of the Indian Shareholder Litigation System
The inclusion of Sections 241, 242 and 245 was a step forward for corporate litigation in India which theoretically aligning them with other jurisdictions. However, the practical approach reveals the actual issues.
Section 245, which deals with class action suits, empowers the shareholders to move against companies, directors, auditors and other associated persons against their deleterious effects on the company or shareholders. This section was formulated to provide support to the minority shareholders. But it soon became an underutilized legal tool as most of the shareholders were unaware that they possessed such an entitlement within the Act. Additionally, structural complexities, like the minimum number of applicants required to institute a suit is difficult to attain – especially in companies where the shareholding is diffused with minority shareholdersbeing present. Lastly, it only covers harm caused by direct actions of a company and excludes any indirect harm that may be caused by the actions of a subsidiary or the parent company.
Section 241 lets shareholders approach the National Company Law Tribunal (NCLT) if they feel the company is being run poorly or in a way that harms the company or its members. Section 242 gives the NCLT the power to take corrective action, which can include serious steps like removing directors or even shutting down the company in severe situations. However, the success of either of these sections has been limited because of the disproportionate burden of proof on the shareholders. The essential of providing substantial evidence to prove oppression against the minority shareholders is complicated, as the management may act elusive and take decisions which might not seem wrong on paper. Additionally, the implementation of these sections extends to the company where the shares of the person lie and not when the harm is done to a subsidiary, leaving a significant gap in corporate governance remedies.
Therefore, these provisions of the Companies Act, 2013, reflect a sincere effort to strengthen shareholder protection. A large number of procedural impediments, coupled with ineffective judicial operations and labyrinthine of corporate structures, will frustrate the aforementioned provisions in law that protect shareholders’ rights and prevent oppression, which is worse in case of minority shareholders. In India, a multitude of companies operate through highly complex holding structures, often involving a large number of minority shareholders. When such multilayered parent-subsidiary frameworks exist, the key concern becomes identifying those minority shareholders who are unable to establish their locus standi at the subsidiary level. This point therefore highlights the urgent need for a complete overhaul that shall transform litigation processes and offer relaxation in evidentiary requirements, along with policy changes to truly ascertain that these laws protect shareholder rights and enforce corporate responsibility.
The Absence of Double Derivative Suits in Indian Law
The exclusion of double derivative suits from the Companies Act creates a significant legislative gap, especially given India’s complex corporate structures. Such provisions would empower shareholders of the parent company to sue the holding company on behalf of the subsidiary. Governance and ownership structures often become opaque because subsidiaries can have other subsidiaries beneath them.
Minority shareholders of the parent company find themselves unable to do anything when a wrong occurs at the subsidiary level and the parent company chooses not to act. This creates an accountability vacuum, which allows for misconduct in the subsidiaries to run amok. The absence of double derivative suits thus aggravates the plight of minority shareholders, practically leaving them bare to any kind of corporate malpractice, whilst reiterating the inherent weaknesses within the corporate governance system of India.
The Case for Introducing Double Derivative Suits
While layered corporate structures in India allow conglomerates to administer operational flexibility and incorporate risk management benefits, they also pose significant challenges to shareholder oversight and accountability. By allowing deals that may amount to fraud or mismanagement to take place at the subsidiary level, shareholders of the parent company, with no direct holding in the shares of that particular subsidiary, become deprived of any meaningful remedy regarding the wrongdoing. In order to redress such imbalance, it is pertinent that India include provisions for double derivative suits, i.e. suits wherein the shareholders of the parent firm are entitled to sue a subsidiary on whose behalf they have a substantial interest.
Such provisions shall not only be useful for providing remedy but would also act as a deterrent against such corporate malpractices. Wrongdoers exploit the separation of parent and subsidiary companies to shield themselves from liability, knowing that normally only the direct shareholders of a subsidiary can avail this right. However, in the light of modern corporate governance, particularly in India’s rapidly changing economy, it is increasingly clear that double derivative suits are more a matter of necessity than some legal novelty.
While layered corporate structures grant large conglomerates increased operational flexibility and help in managing risks, they also create significant hurdles for shareholder oversight and accountability. When mismanagement or fraud occurs at the subsidiary level, shareholders of the parent company may find themselves without effective remedies, as they do not directly own shares in the entity where the wrongdoing took place. To address this, India needs to bring double derivative suits into the business place, that is a situation when shareholders of the parent firm can sue on behalf of a subsidiary in which they hold a significant share.
The exclusion of such provision in the Companies Act, 2013 leaves a big loophole in the present framework but largely falls short of recognition when it comes to protecting such shareholders. This can be seen especially where the malfeasance by the subsidiaries at the lower level directly impacts the financial health of the parent company and threby its shareholders. It cannot bring double-derivative suits and without this ability, shareholders of the parent company become powerless to respond to misconduct that ultimately affects their investments.
Significant examples like the Tata Sons v. Cyrus Mistry (2016) or the Satyam Computer Services (SCS) Scam (2009) show how subsidiary-parent company relation affects shareholders on all levels. In the former scenario, when Cyrus Mistry was ousted, he accused Tata & Sons of oppression and mismanagement. Later on, some issues were raised about how Tata & Sons influenced decisions across various Tata Group subsidiaries, potentially to the detriment of shareholder’s rights and their locus standi in court.
While in the latter scenario, SCS was involved in one of the biggest accounting scams in India, where the impact was significant for the subsidiaries and parent company. At that time, the company oversaw a network of subsidiaries and affiliated entities, each functioning as a separate legal entity. While the primary fraud was uncovered within Satyam itself, the mismanagement extended into its subsidiaries, where illicit fund transfers and fraudulent activities were systematically carried out. Despite suffering substantial financial losses due to the collapse of the corporate group, shareholders of Satyam’s parent entity had no legal standing to initiate derivative actions in relation to the subsidiaries where a sizeable portion of the financial misconduct took place.
Now, if the mechanism of double derivative suits were not excluded, shareholders could have pursued legal remedies not only against the parent company’s management but also in response to the misconduct within the subsidiaries. Therefore, the absence of such a law leaves the investors with no choice but to approach Indian courts, leading to years of litigation and an additional burden on courts.
Way Forward
Thus, the exclusion of such a provision from the Companies Act, 2013 reflects a broader weakness in India’s corporate governance system as it does not adequately protect shareholders from serious misconduct that occurs within subsidiaries, especially as Indian companies expand and adopt more complex corporate structures.
Hence, introducing provisions for double derivative suits in Indian law would be a major step toward aligning with global standards in shareholder protection. Countries like the UK, USA and Singapore have already recognized the importance of such legal tools, especially in dealing with wrongdoing hidden within complex corporate group structures.
As compared to successful implementation of the provision, the US and UK have recognized double derivative through cases and common law principles, However The corporate and legal landscapes of the US, UK, and India differ significantly as India’s judiciary, while robust, faces delays and inconsistencies in applying judge-made doctrines uniformly, making a statutory provision like Singapore’s Section 216A of Companies Act, 1967 is a more viable solution. Familiar to Singapore in Koh Keng Chew v. Lien Foundation, India should lay down a similar test as Singapore’s approach provides structured yet flexible safeguards, requiring prima facie evidence and a clear parent-subsidiary relationship to prevent frivolous litigation. So, from the perspective of India’s corporate environment which consists of family-owned conglomerates, besides multinational subsidiary companies, it should create a similar statutory test to ensure that only bona fide claims go through. There is also the fact that parent and subsidiary companies in India are differentiated under the rigid company law of India, unlike in the US, where the tendency is to consider them all as single economic entities. Thus, the development gaps in India with the heavy load of litigation require safeguards such as Prima facie evidence and cost penalties to avert unchecked misuse.
While they differ in some aspects, a hybrid model combining statutory recognition with judicial discretion would be the most sustainable path for India. Clarity, reduction of frivolous suits and alignment with global best practices in ensuring accountability across confusing corporate structures would then result while balancing shareholder rights with corporate stability.
Conclusion
Therefore, to say that the absence of statutory recognition of double derivative actions in India is a great gap in corporate governance would imply that, under that structure, there would be sufficient shelter under which misconduct will be able to find continuance outside the reach of any remedy. Such regulatory vacuums give room for wrongful acts carried out at the subsidiary level to be free from scrutiny, leaving minority shareholders cases without recourse. The inclusion of double derivative actions within the Companies Act, 2013, would fill this gaping hole by enabling shareholders to seek remedy from all levels of corporate groups. Such a reform would be a vigorous deterrent against mismanagement, furthering transparency and accountability in India’s corporate ecosystem. In doing so, India could be adding an elixir to the governance regime to become consistent internationally and provide an invaluable tool to shareholders in their quest against corporate malfeasance.