Rajeev Saumitra v. Neetu Singh (2016): derivative action and the s.166 duty

When a company is split fifty-fifty between two warring directors, the ordinary machinery for redressing a wrong done to the company seizes up: the board cannot resolve to sue, and a general meeting cannot pass a resolution either. The rule in Foss v. Harbottle — that the proper plaintiff for a wrong to a company is the company itself — then threatens to leave the company remediless precisely because its own wrongdoers hold the controls. In Rajeev Saumitra v. Neetu Singh, decided on 27 January 2016, a single judge of the Delhi High Court (Manmohan Singh, J.) confronted this situation and held that the common-law derivative action remains available in India, and that a director who diverts the company's business to a rival of her own breaches the statutory fiduciary duties now spelt out in Section 166 of the Companies Act, 2013.

The facts in brief

The plaintiff, Rajeev Saumitra, and the first defendant, Neetu Singh — husband and wife — were the only two directors of Paramount Coaching Centre Pvt. Ltd., each holding a fifty per cent shareholding. Paramount was in the business of imparting coaching and training for competitive examinations and traded under the "PARAMOUNT" mark and goodwill it had built up. The relationship between the two directors broke down. The plaintiff alleged that the first defendant had, while still a director of Paramount, floated and run a competing coaching company — K.D. Campus Pvt. Ltd. — and used it to siphon away Paramount's business, staff, students and goodwill, including the value attached to the "PARAMOUNT" name.

The plaintiff sued for declaratory relief, rendition of accounts, damages and injunctions, and moved an interlocutory application restraining the first defendant from continuing the competing venture and from exploiting Paramount's name and goodwill for her personal benefit. Because the company was deadlocked, the suit was framed in substance as a derivative action — the plaintiff suing to vindicate a wrong done to the company that the company, controlled by the alleged wrongdoer, would not itself pursue.

The question

Two questions had to be answered. First, in the absence of an express statutory remedy of the English type, was a common-law derivative action maintainable in India, or did the rule in Foss v. Harbottle bar a shareholder from suing on the company's behalf? Second, did a director who set up and ran a directly competing business, while still on the board, breach the fiduciary duties codified in Section 166 of the Companies Act, 2013 — and if so, what was the consequence for the gains she had made?

What the Court held

The Court held that the derivative action is firmly part of Indian company law. The rule in Foss v. Harbottle is subject to well-recognised exceptions, and the most relevant here is the fraud-on-the-minority / wrongdoer-control exception: where those in control of the company are themselves the wrongdoers and their personal interest is in conflict with their duty in such a way that they will not cause the company to seek redress, a shareholder may step in. The Court framed the principle in the classic terms:

On the substance, the Court held that Section 166 of the 2013 Act now codifies the fiduciary obligations of a director in statutory form. A director must act in good faith to promote the objects of the company, must not place himself in a position where his personal interest conflicts, or may conflict, with the interest of the company, and must not achieve or attempt to achieve any undue gain or advantage to himself or his relatives. A director who carries on a business in direct competition with the company offends each of these limbs. On the facts pleaded, the first defendant had set up and operated a rival coaching company while still a director of Paramount; that was a breach of duty. The statutory consequence followed: a director who makes an undue gain in breach of Section 166 is liable to pay an amount equal to that gain to the company. In the language the Court borrowed from the equity tradition, such a director must pay over to the company which he or she has betrayed by disloyalty. The Court accordingly granted interlocutory protection to Paramount, restraining the first defendant from exploiting the company's name and goodwill for the competing venture.

Analysis

The decision is significant for taking the two strands — procedural standing and substantive duty — and weaving them together. On standing, the judgment confirms that the absence of an English-style statutory derivative claim does not leave Indian minorities without a remedy; the common-law derivative action, built on the exceptions to Foss v. Harbottle, continues to operate. That matters most in the deadlocked, two-director company, where the oppression-and-mismanagement jurisdiction may be available but the simplest answer is often a suit by one shareholder to recover for the company what the other has taken.

On substance, Rajeev Saumitra was among the first decisions to give working content to Section 166, which had only recently replaced the largely uncodified common-law duties that cases such as Dale & Carrington Investment v. P.K. Prathapan had articulated. By reading the no-conflict rule and the no-undue-gain rule as a single fiduciary code, and by attaching to breach the statutory remedy of accounting for the gain, the Court showed that Section 166 is not a hortatory recital but an enforceable source of liability. The reasoning also draws on the equity principle that a fiduciary who profits from disloyalty holds those profits for the principal — here, the company — which is why the relief is restitutionary rather than merely compensatory.

The judgment is, of course, interlocutory: the findings were made at the stage of granting interim relief and on the pleaded and prima facie material, not after a full trial. Its value lies in the framework it sets — that a director cannot use a deadlock to entrench a diversion of the company's business, and that a co-shareholder has standing to call that diversion to account on the company's behalf.

Why it matters

For closely-held and family companies — the dominant form of Indian incorporation — the case is a practical charter. It tells a fifty-per-cent shareholder facing a director who has set up a rival that the derivative action is a live route to protect the company, and it tells directors that running a competing business is not a private matter but a breach of a codified duty that exposes their gains to recovery. It situates Section 166 alongside the oppression jurisdiction explored in Needle Industries v. Needle Industries Newey and Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad as part of the toolkit for policing conduct inside the company, while reaffirming the older distinction — drawn in Bacha F. Guzdar v. CIT, Bombay — between the company and those who own and run it. The wrong is done to the company; the gain belongs to the company; and where the wrongdoer controls the company, the shareholder may sue to recover it.

Related on Valkya

• Dale & Carrington Investment v. P.K. Prathapan: directors' fiduciary duty and allotment to gain control
• Needle Industries v. Needle Industries Newey: oppression, rights issues and equitable justice
• Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad: the oppression standard in a family company
• Bacha F. Guzdar v. CIT, Bombay: a shareholder is not a part-owner of the company's assets

Sources

• Bar & Bench, "The Viewpoint: Nominee Director — the tug of war between duty to company and nominator"
• SCC Online Blog, "Shareholder Derivative Action Suits in India: Avoiding the Influence of Foss v. Harbottle and Taking Cue from the UK Law"