THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
- Param Pandya1
ABSTRACT:
The contemporary deliberation on the comprehensive overhaul of corporate law and practice
in India has triggered an inevitable necessitation for the Indian legal fraternity to ponder
over the novel challenges and opportunities that the Companies Act, 2013 is set to offer.
This essay is to minutely scrutinize the introduction of statutory Class Action in India &
begins with the economic analysis of corporate law to provide the multifarious problems that
the minority shareholders face and delves into a critique of the Foss v. Harbottle Rule. It then
moves on to recognize Derivative Actions as an exception to the said rule. Clarifying the pre-
existence of Derivative and Representative Suits in India as a common law heritage, this
paper endeavours to enlist the evolution that this very conception went through, thereby
justifying the rationale of its rarity in terms of litigation practice in India. It then focuses on
to analyze the basis that elicited the advent of statutory Class Action in India.
Making available the panoramic view of Section 245 of the Companies Act, 2013 read in
lines with the Rules for Chapter XVI and the procedure thereof, a look at the structural
metamorphosis of Class Action in India is indispensible. The latter half is a critical scrutiny
of the dilemmas that this new Indian incarnation of Class Action is set to face in the time to
come so as to settle the unsettled domain of Class Action litigation in India.
Keywords: Class Action, Derivative Action, Representative Suits, Section 245.
1
The author is highly indebted to Prof. Dr. Umakanth Varottil, Asst. Prof. of Law, NUS, Singapore for his
guidance and support in the successful completion of this paper.
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
THE THEORETICAL DYNAMICS:
The cardinal principle of Rule of Law is to protect the ‘little guy’ against the tyranny of the
mighty. 2 Contextualizing it in a corporate narrative, the sole litmus test for the effective
enforcement of corporate laws lies in the protection of the minority shareholders of a
company.3 The propriety of enforcement is governed by a two pronged approach - public
enforcement which means state initiated proceedings or regulatory regime and private
enforcement which is victim centric legal action, however in certain atypical circumstances,
private enforcement is found to be more effectual.4 Private enforcement vide shareholder’s
actions can be either direct actions for breach of duties and obligations owed to shareholder
directly in which case the remedies flow to the shareholders, or they can be derivative actions
where shareholders bring them on behalf of the company for breach of duties owed to the
company, where remedies flow to the company.5
The Economic analysis of corporate laws reveals two major problems against achieving the
goal of effective enforcement, much evidently visible among the minority shareholders –
Agency Problem and the Collective Action Problem. The genesis of the agency problem lies
in the separation of ownership and control. 6 An entrepreneur raises funds from the
shareholders and the shareholders entrust their right to manage the affairs of the enterprise on
the Board of Directors who act as agents. Thus ownership and control are separated where
2
Richard K. Greenstein, Why the Rule of Law? 66 LOUISIANA LAW REVIEW, 63 - 94 (2006).
3
Rafael La Porta, Florencio Lopez de Silanes, Andrei Shleifer and Robert W Vishny, Investor Protection and
Corporate Governance, 58 JOURNAL OF FINANCIAL ECONOMICS, 3 – 27, (2000).
4
A prima facie advantage of private enforcement is that in cases where public authorities face information
asymmetry as to the cause and injury, victims are more informed as to the recourse and have enough incentive
to proceed for legal action. Also, effective private enforcement enhances liquidity in market and creating
confidence among investors as to the legal protection. See William Landes and Richard A. Posner, The Private
Enforcement of Law, 4 JOURNAL OF LEGAL STUDIES 1 – 46 (1975), A. Mitchell Polinsky, Private versus
Public Enforcement of Fines, (1980) 9 JOURNAL OF LEGAL STUDIES 105 – 127, A. Mitchell Polinsky and
Steven M. Shavell, The Economic Theory of Public Enforcement of Law, 38 JOURNAL OF ECONOMIC
LITERATURE 45 – 76 (2000).
5
Umakanth Varottil, Companies Bill, 2011: Class Actions, INDIANCORPLAW,
http://indiacorplaw.blogspot.in/2011/12/companies-bill-2011-class-actions.html, (December 18, 2011).
6
Andrei Shleifer & Robert W. Vishny, A Survey of Corporate Governance, 2 THE JOURNAL OF FINANCE
22, (1997).
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
conflict of interest props up. Thus when the principal depends upon the acts of the agent to
foster his interest, the agency problem arises when the agent serves his own interest instead of
his principal. 7 A conflict of interest arises between minority and majority shareholders,
creditors and majority shareholders/ management, employees and management; it is termed
as an Agency problem in the jargon of economics. Also if the incentive to comply which is
offered to the agent is less than the incentive of non-compliance, it will result in the agent
defying the instructions of the principal as the agent has direct control and more information.8
As the company would be unable to resort to legal remedies, a derivative action allows the
shareholders to act on behalf of the company when the majority in the form of the
management is itself the wrongdoer and working against larger interests of the company
thereby remedying the agency problem. 9
The Collective Action problem or shareholder’s apathy can be narrated as wherein minority
shareholders are incapable to remain active in the decision making process of the company
for they have less incentive to do so. Hence, they end up remaining absent or voting it in
favour of the majority. Since the cost of coordination is high, many emerge as ‘free riders’ for
none among the minority shareholders are positively motivated to take part in managerial
decisions and a few ‘hold out’ thereby creating a ‘minority within a minority’ making it
difficult to build consensus on a given agenda.10 Derivative action is a tool of exercise of
their rights which acts as a vigil mechanism for the wrongdoers in the company thereby
7
John Armour, Henry Hansmann & Reinier Kraakman, Agency Problems, Legal strategies and Enforcement,
THE ANATOMY OF CORPORATE LAW, 35 – 5, 737 - 783, (1st ed., 2009).
8
Steven Ross, The Economic Theory of Agency: The Principal’s Problem, 63 AMERICAN ECONOMIC
REVIEW, 134 – 139, (1973).
9
Dan W Puchniak & Harald Baum, The Derivative Action: An economic, historical and practice oriented
approach, THE DERIVATIVE ACTION IN ASIA: A COMPARATIVE AND FUNCTIONAL APPROACH, 1
-88 (1st ed., 2012).
10
Stephen M. Bainbridge, Director’s Primacy: The means and ends of Corporate Governance, 97 NW. U. L.
REV., 547 – 557, (2003). See generally, Umakanth Varotill, The Advent of Shareholder’s Activism in India, 1
JOURNAL OF GOVERNANCE, 582 - 628 (2012).
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
allowing a negative say in the affairs of the company. 11 Also it allows for aggregation of
suits thereby reducing collective action problem and since the cost of litigation is to be borne
by the company, it incentivizes minority to enforce its rights.
Though the ownership structure of corporations in India remains largely controlled as of now,
there is an eminent presence of a trend towards dispersed ownership. 12 In both these
circumstances, derivative action or its equivalent is the need of the hour. However, a question
that deserves attention is the analysis of preexisting jurisprudence of derivative action in
India which would enable to comprehend the legislative intent in framing Section 245 of the
Companies Act, 2013.
THE SAGA OF CLASS ACTION IN INDIA:
India has inherited much of its jurisprudence from its colonial masters bearing it as a
common law legacy and so has the domain of Indian corporate law & practice highly
indebted to the English. However, Indians have carried this legacy with a cautionary
approach to such a transplant thereby considering the integrities of the Indian context and
tailoring it to our needs.
The general doctrine which is ubiquitous in corporate law is the ‘Proper Plaintiff Rule’ or the
Foss v. Harbottle Rule which elucidates that for the alleged wrong committed against the
company, the company is the only proper plaintiff to initiate action against the wrongdoer. 13
A judicial extension of the same would convey that it would be fruitless to allow minority
shareholder to bring an action for harm caused to the company if a majority of shareholders
11
Roberta Romano, The Shareholder Suit: Litigation without Foundation? 7 JOURNAL OF LAW,
ECONOMICS & ORGANIZATION, 55-87, (1991).
12
Rajesh Chakrabarti, Corporate Governance in India – Evolution and Challenges, 14 - 20 (2005), available at
http://ssrn.com/abstract=649857; Shaun J. Mathew, Hostile Takeovers in India: New Prospects, Challenges, and
Regulatory Opportunities, 3 COLUM. BUS. L. REV. 800 – 832 (2007).
13
Foss v. Harbottle (1843) 2 Hare 461.
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
are able to ratify the act that caused the harm. 14 However, the English courts realizing the
cases of ‘wrongdoer’s control’ and various equitable wrongs like breach of fiduciary duties,
in the light of avoiding ‘injustice without redress’ carved out a pragmatic but principled
exception to the said rule in the form of Derivative Actions.15 However, this exception was
recognized only in the following circumstances16:-
Matters requiring Special Resolution: If by virtue of the law or Articles of Association if a
Special Resolution is required, however the business is transacted through an Ordinary
Resolution then it shall be a violation far from being remedied and beyond the powers of the
Board to transact.17
Ultra Vires transaction or illegality: This is an exception to the Foss Rule for an ultra vires
transaction or illegality for ratification of such a transaction is not provided for.18
Fraud on minority: Fraud does not here mean in the literal sense of the term but in an
equitable sense.19 It involves the unfair discrimination20 towards the minority by the majority
for obtaining benefit which is obtained the cost of the company and that the wrongdoer is still
in control of the company.21
14
MacDougal v. Gardiner (1875) 1 Ch. D 13.
15
See Russell v. Wakefield Waterworks Co (1875) LR 20 Eq 474, Wallersteiner v. Moir (No.2) QB 373
reiterated with support in Johnson v. Gore Wood & Co (2001) All ER 481 (HL).
16
See for detailed explanation on Derivative Action in Common Law – ROBERT R PENNINGTON,
COMPANY LAW, 791 – 847, (8th eds., 2001); PALMER FRANCIS BERFORT, COMPANY LAW, 8231 -
8247 (25TH eds., 2009); BRENDA HANNIGAN, COMPANY LAW, 443 – 472, (2nd eds., 2009).
17
Edwards v. Halliwell [1950] 2 All ER 1064 (CA); Nagappa Chettiar v. The Madras Race Club (1949) 1 MLJ
662 (Mad).
18
Prudential Assurance Co. Ltd. v. Newman Industries Ltd. (No. 1) [1982] Ch. 204 (CA); Bharat Insurance Co.
Ltd. v. Kanhaya Lal AIR 1935 Lah 792.
19
Arad Reisberg, DERIVATIVE ACTIONS AND CORPORATE GOVERNANCE, 225 (1st ed., 2007).
20
Margret Chew, MINORITY SHAREHOLDER’S RIGHTS AND REMEDIES, 99-102 (2nd ed., 2007). See
also, Vikramaditya Khanna & Umakanth Varottil, The rarity of Derivative Actions in India: Reasons &
Consequences, THE DERIVATIVE ACTION IN ASIA: A COMPARATIVE AND FUNCTIONAL
APPROACH, 369-397, (1st ed., 2012).
21
See also BSN (UK) Ltd. v. Janardan Mohandas Rajan Pillai, (19960 3 Comp. Cas. 371 (Bom); Spectrum
Technologies USA Inc. v. Spectrum Power Generation Company Ltd., 2000(56) DRJ 405.
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
Indian courts have accepted the proper plaintiff rule as well its exception which is evident for
there are three landmark cases of derivative action in India.22 But the sad story of rarity of
derivative actions in India in corporate litigation with only three successful actions out of the
few odd cases in our sixty five years of Indian independence raises eyebrows.23 The reasons
attributable are (i) Non-codification of derivative action; (ii) absence of statutory recognition
of director’s duties; (iii) presence of direct and effective remedies of oppression and
mismanagement; (iv) procedural barriers like doctrine of ‘clean hands’ which requires the
plaintiff not to posses any ulterior purpose or have personal considerations & (v) huge legal
costs in terms of lawyer’s fees and delays.
22
After a survey conducted (by Prof. Umakanth and Prof. Vikramaditya Khanna) from the search engine of
Indian Case laws – Manupatra it is concluded that there are only three cases upto 2013 which are successful
endeavours of derivative action within the common law framework. It excludes unreported judgments. These
cases for easy comprehension with brief facts are provided herein.
N V R Nagappa Chettiar & Anr. v. The Madras Race Club (1949) 1 MLJ 662: This case pertains to
illegality of the notice and Shareholder’s meeting. Thus basically challenge was against the Resolutions passed
in the said meeting.
Sections: Representative Suit: Order 1, Rule 8 of CPC, 1908 read with Sections 20, 81 and 81 (2) of Companies
Act, 1913.
Cases Referred: Foss v. Harbottle (1843) 2 Hare 461 & MacDougall v. Gardiner (1875) 1 Ch. D. 13.
Held: Madras High Court held the suit to be maintainable and ordered that the Special Resolution, the
Shareholder’s meeting and the election of the Members of the Management Committee as invalid. The
defendant Company was asked to bear the cost of the litigation of the plaintiff.
PPN Power Generating Company Limited v. PPN (Mauritius) Company (2004) 129 Comp. Cas. 849
(Mad): This case in its original application was in the form of an application to the Company Law Board as a
Derivative Action in order to allow Minority shareholders to file for Arbitration Proceedings against the Tamil
Nadu Electricity Board under a contract which the Company did not resort to. The final judgment is of the
Division Bench of the High Court of Madras.
Sections: Section 235, 397, 398, 402 & 403 of the Companies Act, 1956 read with Arbitration Act, 1940.
Cases Referred: N V R Nagappa Chettiar & Anr. v. The Madras Race Club, Foss v. Harbottle (1843) 2 Hare
461 & MacDougall v. Gardiner (1875) 1 Ch. D. 13
Held: The Division Bench of the Madras High Court held that Minority shareholder can file for Arbitration on
behalf of the Company and the Company Law Board and the Ld. Single Judge are correct in denying the anti-
suit injunction asked by the Company.
Nirad Amilal Mehta v. Genelec Limited (2008) 146 Comp. Cas. 481 (Bom): It is an appeal in the High Court
of Bombay to the Ld. Single Judge wherein the question is to allowing an injunction on further disposal of the
sale of the company’s property by a Third Party as it was made without confirming to the essentials of a valid
shareholder’s approval.
Sections: Sections 46,171,173 and 293 of the Companies Act, 1956.
Case Referred: Foss v. Harbottle (1843) 2 Hare 461
Held: The Court ordered that the plaintiff is entitled to an injunction from the defendant (Third Party) alienating
the sold property and further directed that the consideration be deposited with the Court until the valid procedure
for the same is followed.
23
Vikramaditya Khanna & Umakanth Varottil, The rarity of Derivative Actions in India: Reasons &
Consequences, THE DERIVATIVE ACTION IN ASIA: A COMPARATIVE AND FUNCTIONAL
APPROACH, 369-397, (1st ed., 2012).
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
These concerns were reflected in the Dr. JJ Irani Committee Report (2005) which expressed
the need for statutory recognition to derivative actions read with the Representative Suits (as
under Order I, Rule 8 of the Code of Civil Procedure, 1908).24 Also the Satyam Scam (2009)
and its aftermath which left the Indian corporate superstructure tremble, is also seen as a
failure for Indian shareholders as Satyam shareholders in USA filled for derivative action
against Satyam which was settled for $ 125 million whereas Indian shareholders did not
receive a penny.25
24
The following is the excerpt from the Dr. JJ Irani Committee Report (2005) pertaining to the suggestion of
affording statutory recognition to derivative actions and representative suits:
10.1 In case of fraud on the minority by wrongdoers, who are in control and prevent the company itself
bringing an action in its own name, derivative actions in respect of such wrong non-ratifiable decisions have
been allowed by courts. Such derivative actions are brought out by shareholder(s) on behalf of the company, and
not in their personal capacity/ies in respect of wrong done to the company. Similarly the principle of
“Class/Representative Action” by one shareholder on behalf of one or more of the shareholders of the same kind
have been allowed by courts on the grounds of persons having same locus standi.
10.2 Though these principles have been upheld by courts on many occasions, these are yet to be reflected in
Law. The Committee expresses the need for recognition of these principles.” See J J Irani, Report on Company
Law (31 May 2005), available at http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf.
25
Joel Rosenblatt and Ketaki Gokhale, Satyam Computer Agrees to Pay $125 Million to Settle U.S. Suit,
http://www.bloomberg.com/news/2011-02-17/satyam-computer-services-pays-125-million-to-settle-
shareholder-lawsuit.html, (February 17, 2011). Satyam Scam was perhaps India's biggest corporate fraud case
where M/s Satyam Computer Services Limited (M/s SCSL) caused loss to the investors to the tune of Rs.14,162
crore. The company head, Ramalinga Raju and members of his family secured illegal gains to the tune of about
Rs.2,743 crore by various tricks. The fraud was perpetrated by inflating the revenue of the company through
false sales invoices and showing corresponding gains by forging the bank statements with the connivance of the
Statutory and Internal Auditors of the company. The annual financial statements of the company with inflated
revenue were published for several years and this lead to higher price of the scrip in the market. In the process,
innocent investors were lured to invest in the company. Attempts were made to conceal the fraud by acquiring
the companies of kith and kin. For details on the Satyam Scam, See, Umakanth Varotill, A Cautionary Tale of
Transplant on Indian Corporate Governance, 21 (1) NLSI REV. 1 – 50 (2009).
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
SECTION 245, COMPANIES ACT, 2013 & RULES: A CRITICAL SCRUTINY
The Indian Class Action concept is a summation of Derivative Action and Representative
Suits (Order I, Rule 8 of the Code of Civil Procedure, 1908).
The members or depositors in the case of a company having share capital, not less than one
hundred members of the company or not less than ten per cent of the total number of its
members, whichever is less, or any member or members singly or jointly holding not less
than ten percent of the issued share capital of the company, subject to the condition that the
applicant or applicants have paid all calls and other sums due on his or their shares & in case
companies not having share capital, not less than one-fifth of the total numbers of its
members can file for Class Action under Section 245.26
Section 245 (2) provides for the grounds for invocation of this provision when the members
or depositors are of the opinion that the affairs of a company are conducted in a manner
prejudicial to their interests then they are entitled to file a complaint in the National Company
Law Tribunal (NCLT). The aggrieved shareholders can file against /claim for damages
against:
i. The company or its Directors for any fraudulent, unlawful or wrongful act or omission
or conduct or any likely act or omission or conduct on its or their part;
ii. The auditor or including the audit firm of the company for improper or misleading
statement of particulars made in his audit report or for any fraudulent, unlawful or
wrongful act or conduct; or
26
Section 245 (1) & 245 (3), Companies Act, 2013 read with Rules for Chapter XVI. Section 245 (10) provides
for aggregation of suits and allows for filling of class action by any person, group of person, group of persons or
any association of persons representing the persons affected by any act or omission, specified in sub-section (1).
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
iii. Any expert/advisor/consultant or any other person for any incorrect or misleading
statement made to the company or for any fraudulent, unlawful or wrongful act or
conduct or any likely act or conduct on his part. 27
Before the NCLT could proceed with the merits of the case, a few procedural hurdles need to
be crossed. These hurdles includes the test of good faith and absence of personal interest
whether direct or indirect of the members/depositors in carrying the said litigation,
examination of prima facie evidence on record as to involvement of any other person other
than director or officers of the company and that the cause of action is one which cannot be
pursued by the member/depositor on his own right/accord and it is also to be determined as
the probabilities of authorization of the alleged act/conduct or its subsequent ratification or
the likelihood of the same.28
The provision as to public notice, consolidation of all like proceedings and disallowance of
multiple class action suits on same cause of action is also dealt with alongwith the provision
to defray the cost or expenses as to the application for class action by the company or any
other person responsible for the oppressive act to the class of litigants. 29
The aggrieved parties can claim for passing of the following orders as relief under Section
245:30
(a) to restrain the company from committing an act which is ultra vires the articles or
memorandum of the company;
(b) to restrain the company from committing breach of any provision of the company’s
memorandum or articles;
27
Section 245 (2) (g), Companies Act, 2013.
28
Section 245 (4) (a), (b), (c), (d), (e), (f), Companies Act, 2013.
29
Section 245 (5), Companies Act, 2013.
30
Section 245 (2) (a), (b), (c), (d), (e), (f), Companies Act, 2013.
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
(c) to declare a resolution altering the memorandum or articles of the company as void if the
resolution was passed by suppression of material facts or obtained by misstatement to the
members or depositors;
(d) to restrain the company and its directors from acting on such resolution;
(e) to restrain the company from doing an act which is contrary to the provisions of this Act
or any other law for the time being in force;
(f) to restrain the company from taking action contrary to any resolution passed by the
members;
…… (h) to seek any other remedy that the Tribunal may deem fit.
The said provision makes it mandatory on all parties associated with the company to bind
itself of the order of the Tribunal failing which a fine not less than five lakh rupees and upto
twenty five lakh rupees shall be imposed on the company and every officer in default shall be
punishable with an imprisonment for a term exceeding upto three years and a fine not less
than twenty five thousand rupees upto a maximum of one lakh rupees. 31 There is a statutory
penalty for vexatious litigation under this section which may extend upto payment of cost of
opposite party and/or fine upto one lakh rupees. 32 Lastly, the section excludes the application
to a banking company by virtue of it being regulated by the Reserve Bank of India and that
inviting such a provision in the banking companies could dampen the strong Indian banking
regime.33
There exist certain crucial issues that would determine the effectiveness of the Section 245,
which are as follows: -
31
Section 245 (6) & (7), Companies Act, 2013.
32
Section 245 (8), Companies Act, 2013.
33
Section 245 (9), Companies Act, 2013.
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THE FATE OF CLASS ACTION SUITS IN INDIA: THEN & NOW?
The implementation of Companies Act, 2013 is a matter of qualm and a long
litigation battle might preclude the enforcement as to the constitution of NCLT – the
apex dispute settlement body envisaged under the Companies Act, 2013. 34
The Indian law, learning lessons from UK & Singapore has transitioned from ‘Clean
Hands’ doctrine to the ‘Good faith’ doctrine as procedural screen to class action
claims, however retaining the paradox of ‘no direct or indirect personal interest’ in
proceeding with their class action claim which if the judiciary doesn’t give a
purposive interpretation could lead to reduction of class action as a less effective
remedy.35
The definition of depositors is not mentioned in the Companies Act, 2013 and also the
grounds are almost synonymous to that of oppression and mismanagement - an
essential difference that needs to be drawn in the Indian context. Moreover the
question as to would the common law derivative action continues despite a statutory
version - all of this would require judicial attention and explanation. 36
To conclude, Class Action in the Companies Act, 2013 is a statutory embodiment of the
common law heritage of Derivative Action, procedural extension of Representative Suits and
a substantive expansion of the remedy of oppression and mismanagement Thus, it would be
important to see how these narratives shape up the domain of corporate law and practice in
India.
34
The long litigation battle would be in the form of the petition filled by Madras Bar Association for the alleged
violation of the Apex Court’s judgment in Union of India v. R. Gandhi 2010 (5) SCALE 514. See, Madras Bar
Association v. NCLT, THE FIRM, http://thefirm.moneycontrol.com/story_page.php?autono=995874,
(November 23, 2013).
35
Jennifer Payne, Clean Hands in Derivative Actions, 61 CAMBRIDGE LAW JOURNAL 76-86 (2002).
Jurisdictions adopting the statutory derivative action have transitioned towards a “good faith” requirement and
away from “clean hands”. E.g., U.K. Companies Act 2005, ss. 263(3) (a), 268(2)(a); Singapore Companies Act
(Cap. 50, 2006 Rev. Ed. Sing.), s. 216A(3)(b).
36
Mihir Naniwadekar, Class Actions in the Companies Act, 2013: a Recipe for Confusion?,
INDIANCORPLAW,http://indiacorplaw.blogspot.in/2013/09/class-actions-in-companies-act-2013.html
(September 6, 2013).
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