Power to the people

A class action suit (CAS) allows a group of people with common interest in a matter to sue a company or auditors or advisors for compensation against illegal or inappropriate or incorrect actions. Pursuing a legal suit as a group lowers the cost of litigation, and makes it worthwhile as against going solo.

CAS is prevalent in more than 20 countries including Australia, Brazil, Canada, Chile, Italy, Mexico, Poland, Portugal, South Africa, Taiwan, and US. US class action litigation can broadly be categorised into two different groups: securities class action and consumer class action or employee class action. Securities CAS could relate to many matters, such as falsification of financial statements, IPO laddering, insider trading, acquisitions, etc. For example, a CAS was filed against Mark Zukerberg by investors as they suffered heavy losses due to drastic fall in the script price after initial listing. They argued that Zukerberg had overvalued the shares.

Chasing the money CAS causes fund diversion from productive investment to litigation. For example, between 1999 and 2004, aUS drug pharma company spent about $25 billion to fight CAS as against $19 billion spent on R&D. One of the studies has indicated that mere filing of a CAS against the company causes its stock value to drop by an average of 3.5 per cent. In many cases, the potential size of damages force defendants for out-of-court settlements even if they have strong defences or the claims made by litigants are meritless.

Unfortunately, insurance coverage will be restricted by policy terms and conditions, and limited within a certain maximum limit of coverage. This varies greatly and is one of the prime factors in underwriting such a policy.

Many smaller companies with annual revenues of Euro 10 million purchase a limit of up to Euro 2 million. Fortune 500 companies with US listings have over $500 million of cover. This is not a good enough cover in a major CAS and could cause companies to go belly-up (example, Enron or Worldcom). Such is the debilitating effect.

More litigations In India, section 245 was introduced in the new Companies Act to allow members/depositors to file CAS. In accordance with the Act, only 100 members/depositors are required to file a CAS. Even one member can file a CAS provided he/she holds at least 10 per cent of the issued share capital of the company.

If the tribunal decides that the case is frivolous, the applicants are required to pay Rs 1 lakh to the company. This is hardly a hurdle against filing CAS. India is a highly litigious country. There are currently 30 million cases outstanding in various courts. More than 300 PILs are filed each year in the Supreme Court alone. About 100 PILs are filed in Delhi HC. Clearly, CAS is likely to significantly scale up the level of litigations in India.

CAS was introduced in the new Act as the government felt that in the case of Satyam Computer, while the US shareholders got compensation, Indian shareholders did not receive any relief. The intent of providing the levers in the hands of the minority, who have otherwise very little say in company administration, is good. However, this may not always be the case. In the absence of strict anti-abuse measures, this could be misused by professional bodies and institutional investors, and companies or auditors could be exposed to unnecessary litigation and blackmailing. The threat of CAS can deter management to go slow on big decisions and, hence, could slow M&A transactions, deter significant foreign investment and slow medical and other R&D.

India scene A significant difference between US and Indian legal framework is that in the US, law firms pursue litigants as they have a contingency/success fee arrangement. Lawyers in the US are referred to as ambulance chasers as they specialise in bringing cases seeking damages by using an event or large scale disasters to find legal clients.

In India, the Bar council rules prohibit contingent fee arrangements. Hence the situation may not be as bad as the US, but it is always susceptible to change.

Indian companies should take appropriate measures to reduce the risk of becoming a target of CAS. Firstly, they should have a clear policy for timely and accurate disclosures of material information. They should conduct regular reviews of business practices to identify potential areas of vulnerability.

They should protect themselves through insurance policies, and should keep their ears to the ground and should promptly address any issues that are brewing and have the potential of blowing up.

Given the potential size of CAS, most companies prefer to settle the case. However, doing this frequently may identify the company as a soft target and a potential target for similar suits. Therefore, each company should evaluate this and have an appropriate policy on how to deal with CAS.

More importantly, they should anticipate and be prepared for litigations.

( The author is Partner in a member firm of Ernst & Young Global.)

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