(Source: Bloomberg Quint)

Minority Shareholder Protection As A Numbers Game  

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  • It is not often that a mundane legal technicality tends to garner much attention. But, such a nuance has presented itself as a discernible roadblock in the high-profile legal action for oppression and mismanagement brought by the minority shareholders (the Mistry group) against the controlling shareholders (the Tata group) in relation to Tata Sons Ltd.

    Specifically, the Companies Act, 2013 (in Section 244) provides that a suit for oppression and mismanagement is not maintainable unless it is supported by shareholders holding at least 10 percent of the “issued share capital of the company”. This was fatal (at least preliminarily) to the maintainability issue because while the Mistry group held 18.37 percent of the equity shares in Tata Sons, that represented only 2.1 percent of the total share capital (including preference shares).

    The National Company Law Tribunal (NCLT) rejected the Mistry group’s pleas to indulge in a purposive interpretation of the law so as to entertain the action. The NCLT was left with little room to manoeuvre given the explicit mandate in the legislation.

    To the Mistry group’s relief though, Section 244 allows the NCLT to waive the requirement that the action be supported by a minimum number of shareholders. While the waiver plea is currently under consideration before the tribunal, commentators have lamented on the lack of clarity regarding the criteria to be applied by it for waivers. No matter which way the waiver plea is decided, this episode raises thorny issues that unnecessarily raise the bar for minority shareholder remedies.

    Also Read: Is Tata Sons Asking For A Trial Before A Trial?

    Inherent Problems With A Numerical Threshold

    At the outset, the rationale for introducing filters for shareholder actions is understandable. This is to prevent frivolous lawsuits that may be brought by disgruntled shareholders, with the fear that they may impinge upon the normal operations of the company. But, the use of a numerical shareholding threshold for the purpose is inherently questionable. Matters are compounded with the determining factor being “issued share capital”.

    Take the case of a shareholder holding 26 percent of the equity shares of a company, which amounts to 9 percent of the total issued share capital.

    The incongruity of the situation is that while such a shareholder can exercise powerful negative control rights (such as by defeating shareholder resolutions that require a special majority of 75 percent), the door is effectively shut when it seeks to bring an oppression action to assuage any wrongs caused to it.

    To think that holders of small parcels of shares are not entitled to assert their rights if they suffer at the hands of the majority is disingenuous. Minorities, especially in companies with a large number of shareholders, may not have the ability or the incentive to aggregate themselves to meet the required shareholding threshold. This effectively eschews their protections in corporate law.

    Enfeeblement Of The Minority

    On a more conceptual note, filters are usually applied when shareholders bring an action on behalf of the company for wrongs caused to the company, with the shareholder derivative action being the paradigmatic situation. This is because those who assume the responsibility of representing the company must do so in good faith and for the benefit of the company as a whole rather than one that is motivated by spite or a personal vendetta. Having numerical thresholds in those circumstances would be eminently sensible.

    But to install sieves for direct actions such as those for oppression, which the shareholders bring in their own names and to assert their own rights (rather than that of the company), not only goes against the grain of corporate law, but it also ends up enfeebling the minorities. It is rather paradoxical that in India, personal actions such as for oppression remedies are forestalled by numerical thresholds, while derivative actions on behalf of the company can be brought by a single shareholder.

    This oddity is perhaps attributable to the fact that oppression remedies are governed by company law, whereas derivative actions are representative suits brought under the code of civil procedure.

    Also Read: ‘Majority Is A Rule’, Says The National Company Law Tribunal In Tata-Mistry Case

    History Of The Numerical Threshold

    Comparatively speaking, corporate law in India is an outlier. None of the leading common law jurisdictions impose any kind of shareholding threshold for bringing an oppression action. To be sure, history suggests that this was by design rather than by accident. While introducing a numerical threshold, the Bhabha Committee, whose recommendations shaped the previous Companies Act, 1956, was conscious of its departure from then prevailing English law that allowed for a shareholder holding a single share to initiate an oppression action.

    The tone of the recommendations somehow suggests that the circumstances in India would point to a greater incidence of shareholder litigation, which has not turned out to be the case at all.

    Proponents of the status quo would argue that the existence of a waiver provision would cushion the impact of a rigorous threshold requirement. That is only a partial answer due to the utter lack of guidance on how the NCLT must exercise its discretion to grant a waiver.

    Also Read: Autonomy Versus Protection: A Delicate Balance For NCLT In The Tata-Mistry Battle

    Fatal Loss In Translation

    This discussion has an oblique, but severe, impact on another type of novel shareholder remedy - the class action (in Section 245 of the Companies Act, 2013). When the concept of shareholder class action was introduced in the Companies Bill, 2008, there was no threshold requirement imposed for the maintainability of such actions. Unsurprisingly, this provoked a concerted opposition from industry citing “the risk of frivolous litigation and strike-suits” and calling for safeguards to be put in place to prevent misuse.

    While a number of safeguards were discussed during the law-making process, what resulted was an inelegant solution, which was to impose for class actions the same numerical thresholds as applicable for oppression and mismanagement suits. This was done without having regard to the fundamental difference between the various types of shareholder remedies.

    More importantly, the maintainability issue for class actions suffers from a fatal loss in translation - the waiver provision applicable to oppression actions was not incorporated in the requirements in Section 245 for bringing class actions.

    In other words, the NCLT does not have explicit power to waive the threshold shareholding requirements for bringing class actions. Even through shareholder associations or similar groups are allowed to bring class actions, the tenor of the legal provision suggests that they too must be supported by the requisite number of shareholders. While class actions have been touted as a shareholder-friendly measure that instills the necessary incentives in management to act in their interests, it fails to come to the rescue of those who need it most, the exposed minority. Here, though, it is anybody’s guess whether this predicament was deliberate or an omission.

    In all, the Tata-Mistry episode has triggered an intense debate on minority protection. While the law seeks to obtain an appropriate balance between minority protection and the avoidance of abusive litigation, it is reasonable to argue that the use of numerical shareholding thresholds is inappropriate, as the concerns of minority shareholders vary and may be crucial irrespective of the number of shares they hold.

    Hence, there is a need to device other methods to weed out abusive shareholder suits from genuine ones, and that too depending on the type of shareholder action brought, for instance by providing greater guidance to adjudicating bodies to determine on a case-by-case basis. Courts and tribunals are bound by the legislative mandate, and hence it might be that one needs to look to Parliament for any reform on this count.

    Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.

    The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.

    BloombergQuint