[Kiara Dsouza and Sharun Salvi are third year law students at NALSAR University of Law]
“Legal transplantation” refers to the phenomena of transferring a rule or system of law from one jurisdiction to another. Diverse viewpoints have been expressed regarding this idea of "legal transplants," and while some scholarship has strongly supported the theory, many others have cautioned against it. Although the genesis of Indian Corporate law may have been in our colonial past; India gradually moved away from its British roots, and the divergence between Indian and English Corporate Law has only increased, culminating in the Companies Act, 2013.
This article discusses the perils of “legal transplantation” in light of the recent ruling in Terrascope Ventures Limited v. Securities and Exchange Board of India (“Terrascope Ventures”). The Securities Appellate Tribunal (“SAT”), Mumbai Bench, appears to have applied this doctrine, without much consideration for the unique socio-economic circumstances of India. The author aims to draw attention to the risks of legal transplant in such scenarios and makes the case that the SAT should uphold the letter of the law, while taking into account the current socio-economic conditions in Indian society.
Terrascope Ventures v. SEBI – What did the SAT say?
Terrascope Ventures Limited (“Company”), through a special resolution, issued preferential shares under Section 81(1A) of the Companies Act, 2013 (“The Act”), informing the shareholders that the money raised would go towards:
i) Capital expenditures, purchase of businesses or companies
ii) Setting up foreign offices
iii) Funding long-term working capital requirements
v) Other authorised purposes.
The funds were, however, used to procure shares and extend loans to other companies. Pursuant to this, the Securities and Exchange Board of India (“SEBI”) conducted an inquiry into the Company’s operations from 2013-14, and discovered that the Company’s practices had violated a variety of regulations.
In 2017 however, the shareholders approved a special resolution, ratifying all actions by the Company relating to the use of funds. While the SEBI held that such ratification for acts already performed is unlawful, the Tribunal overturned this ruling and upheld the legality of a Post-facto ratification of a director’s breach of duty.
The Principle of Ratification, and its Understanding Abroad
What is Ratification?
Duties can either be fiduciary or duties of care, requiring directors to act in accordance with the interests of the Company and its shareholders. The principle of ratification is a process by which an irregularity in the Company may be authorised by its shareholders. In the context of a breach of duty by directors, such an act would absolve them of the liability that would have normally been attached with their actions.
In common law, director’s actions have been ratified by the shareholders of the company, absolving the former from subsequent liability. This principle flows from the concept of allowing individuals to be relieved from obligations by the people to whom those obligations were owed. While common law has, through various judgements backed by statutes, laid down specific instances wherein directors may avail the benefits of ratification, Indian law has not formulated such provisions.
The Principle as laid down in other jurisdictions
In the United Kingdom, the House of Lords had upheld the principle of ratification in Regal (Hastings) Limited v. Gulliver. However, this principle is backed by statute. Under the United Kingdom Companies Act of 2006,shareholders can ratify a director’s breach of duty through the procedure and rules set out in Section 239 of the Act. It provides that “ratification by a company of conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company” must be done through a resolution by its members. The statute also forbid the concerned director and other “connected” parties from voting as well as provide for scenarios where such a situation may result in the shareholders being unable to form a quorum. Likewise, other jurisdictions which allow for such ratification, such as Australia, also have statutory provisions in place, detailing the process through which such ratification may be undertaken or the considerations that must be kept in mind while making such a decision.
Extracting the Principle – Not so efficient?
The Act does in fact provide for ratification in certain instances such as during instances where directors are absent for decisions taken at a board meeting. However, with regard to the ratification of acts undertaken by directors which violate the duty of care, the Act remains silent. Even in Indian jurisprudence, the only mention of this principle being used in such contexts, has been in a case where the Bombay High Court held that directors cannot use the principle to justify a breach if they are the sole shareholders.
The SAT Mumbai, in Terrascope, has failed to appreciate not only the lack of jurisprudence on the matter, but also the lack of statutory backing for the principle. The only reference to directors being released from their liabilities arising out of default, breach, etc., can only be found in Section 463, which empowers the courts to provide relief, at its discretion, depending on the circumstances of the case. Apart from this, the principle of ratification remains uncodified, suggesting that the legislative intent in excluding a specific provision was to prevent director liability arising out of a breach of duty from being cured by shareholder ratification.
In such a situation, the extraction and transplantation of the principle from English Law, without paying attention to India’s unique circumstances, will result in a situation where directors use this ruling to avail the benefits of shareholder ratification for unsanctioned acts. Such importations of doctrine or law, without adapting it to suit the specific conditions of Indian society, is highly susceptible to failure.
In other common law jurisdictions, there are specific processes and conditions wherein a breach of duty by the directors can be ratified by the shareholders. A lack of statutory provisions in the Act, means that there is also a lack of any enabling mechanisms which could lay down conditions for a valid ratification. In a situation such as this, the author is of the opinion that an attempt to simply transplant foreign principles into Indian jurisprudence, without the corresponding legal mechanisms or social framework, could have drastic effects.
The order by the SAT therefore, in the author’s opinion, sets a dangerous precedent. Since it lacks the necessary statutory backing, such a ruling could pave the way for misuse of the principle of ratification. It is also important to bear in mind the rights of minority shareholders, in cases where the majority shareholders choose to ratify acts constituting a breach of the director’s duty. Allowing such ratification would jeopardize the rights and interests of minority shareholders, especially owing to the fact that the Act does not contain many provisions to protect their interests.
The author is of the view that the decision of SEBI’s adjudicating officer, which held that post-facto shareholder ratification exonerating directors from liability is bad in law was correct. The SAT should have upheld this decision, owing to the fact that Indian law lacks judicial-recognition of the principle of ratification. Director’s duties must be given paramount importance, disallowing directors from easily evading their responsibilities.
The SAT should have observed the importance of fiduciary duties, preventing erring directors from escaping liability as a consequence of breach. Instead, the ruling legally transplanted the principle of ratification into Indian jurisprudence, without any legislative backing. This offers directors a loophole, allowing them to avoid liability arising from a breach of the duty of care, or a breach of fiduciary duty. It would have been better if the SAT had refrained from simply transplanting the common law principle without regard for the specificities of Indian Company law.