Lack of timely resolution, legal costs may hold back class action suits

A combination of legal costs, which would be significant for minority shareholders, and the lack of timely resolution may stymie the use of class action suits for some time to come.

Shareholders are likely to continue voting with their feet when faced with issues in their companies, according to experts. News of shareholders of a large conglomerate, reportedly planning class action suit against an auditor whose resignation allegedly led to a decline in share price, may well mark more of an exception than the rule.

A class action suit allows depositors or shareholders to collectively seek compensation following wrongdoing by a company, its directors, auditors or any other consultant.

Shriram Subramanian, founder and managing director of domestic proxy advisor InGovern Research Services, said such suits would catch on if there are investors who wish to pursue these to their logical conclusion and are willing to bear the costs of extended litigation.

“If there is a motivated shareholder, then it may come into the picture,” said Subramanian. But such investors may not be common, he added.

This is more likely to happen with those having concentrated portfolios. Institutional investors, with 100 or more companies in their portfolio, are unlikely to lead the first forays into such class action suits, said Subramanian. They are more likely to seek an exit in the stock market rather than a protracted legal battle over company decisions that they feel would negatively impact shareholder value.

There have been a few instances in recent times where companies have backtracked following such a fall in share prices.

Sun Pharmaceutical Industries had to clarify on governance issues after fresh allegations of impropriety led to selling pressure in January 2019. The stock had fallen to a six-year low.

Jubilant FoodWorks, which runs Domino’s Pizza India and Dunkin’ Donuts, retracted a decision by the company to pay owners royalty for the use of the Jubilant brand in February 2019. The stock fell 6.45 per cent, and the decision was retracted within hours of the announcement.

Automotive component manufacturer Endurance Technologies fell 20 per cent on August 8 after it announced that it would get into tyre manufacturing. The company subsequently reversed its decision.

The Ministry of Corporate Affairs threw light on norms on May 8. The rules now put a clear threshold on who can file a class action suit in the National Company Law Tribunal (NCLT). The NCLT is a body which deals with company-related cases.

The lower of 100 shareholders, or 5 per cent of the total number of shareholders by number, can now collectively file a suit. It can be also be filed by any shareholder or group of shareholders who collectively own 2 per cent of the total stake in the company.

Meanwhile, cases have also been taking time to make their way through the NCLT, which may further deter minority shareholders.  Minister of Finance and Corporate Affairs Nirmala Sitharaman had said in a recent Parliament session that efforts were ongoing to unclog the tribunal.

The success of class action suits will also depend on factors such as how soon such cases will be decided and the ability of members or depositors to fund the costs and expenses of litigation, according to Yogesh Chande, partner at legal firm Shardul Amarchand Mangaldas.

 “It will also depend on the willingness of law firms to take up such matters which can’t be contingency- or success-based, considering how advertising is currently prohibited,” said Chande.

Law firms in other countries are allowed to advertise and take fees based on the results that they deliver. This allows them to take up class action suits without any upfront payment, lowering the entry barriers for litigants.