Class actions under Section 245 of the new Companies Act, 2013 are evidently distinctive and separate and were brought in as additional tool for investor protection. This is first part of a three part series
Very generally speaking, class action suit is a lawsuit that allows a large number of people with a common interest in a matter to sue or be sued as a group.
A Short History
The class action suit began in the equity courts of seventeenth-century England as a bill of peace. English courts would allow a bill of peace to be heard if the number of litigants was so large that joining their claims in a lawsuit was not possible or practical; the members of the group possessed a joint interest in the question to be adjudicated; and the parties named in the suit could adequately represent the interests of persons who were absent from the action but whose rights would be affected by the outcome. If a court allowed a bill of peace to proceed, the judgment that resulted would bind all members of the group.
Justice Story, who served on the US Supreme Court from 1811 to 1845 wrote that in equity courts, "all persons materially interested, either as plaintiffs or defendants in the subject matter of a bill ought to be made parties to the suit, however numerous they may be," so that the court could "make a complete decree between the parties [and] prevent future litigation by taking away the necessity of a multiplicity of suits" (West v. Randall).
The bill of peace, and later the class action, provided a convenient and efficient vehicle for resolving legal disputes affecting a number of parties with similar claims. Common issues that could have similar outcomes did not have to be tried piecemeal in separate actions, thus saving the courts and the litigants’ time and money.
Initially, a class action could be brought only in equity cases, disputes in which the parties did not necessarily seek monetary damages but instead might desire some other type of relief. The adoption of Rule 23 of the Federal Rules of Civil Procedure in 1938 broadened the scope of the class action suit, providing that cases in law seeking money damages as well as cases in equity could be brought as class actions. In 1966, the scope of the class action was again clarified and expanded when Rule 23 was amended to provide that unnamed parties to a class action were bound by the final judgment in the action so long as their interests were adequately represented.
Rule 23 of the Federal Rules of Civil Procedure defines three kinds of class actions:
The Indian Scenario
The Satyam Computers’ fallout had created uproar in the country. Investors of the company abroad brought in several class actions seeking damage, while investors in India did not have any such recourse to legal remedies. This steered the Ministry to incorporate and include proactive measures for the protection of the shareholders and investors and thus the provisions of class action suits were incorporated under the Companies Act 2013.
Prior to the enactment of Companies Act 2013, class actions suits have been filed as “representative suits” under Civil Procedure Code 1908 or under the pretext of public interest litigations (PILs). The laws were not well defined with respect to class action and thus were unable to be described as “sui generis”.
This article is an attempt to reflect upon the provisions pertaining to class action as detailed under the Companies Act 2013(Act) and to ascertain the effectiveness of the new redressal mechanism.
Relevant Provisions under Companies Act, 2013
The Companies Act, 2013 introduces the concept of class action under Section 245, detailed in Chapter XVI – Prevention of Oppression and Mismanagement. However, this is not to be misunderstood with provisions governing oppression and mismanagement as set out under sections 241-244. Class actions under 245 are evidently distinctive and separate and were brought in as additional tool for investor protection.
Default of one small solar company or one medium sized steel mill does not foretell an immediate collapse of the Chinese bond market. But it is a very clear warning of its direction
It finally happened. A Chinese domestic bond has defaulted. It was the first default since the Chinese central bank (PBOC) started regulating the market in 1997. The unlucky company was Shanghai Chaori Solar Energy Science and Technology (Chaori). The major question though is this a sign of healthy maturing market or the beginning of a major problem?
If you had to choose allow a bond to default, Chaori was certainly a prime candidate. First it is small. It has only 1,500 employees. Second it is a private company, not a large state owned firm. Third, it is in the struggling solar industry with substantial over capacity. Fourth, its issues were well known. Some sort of default was expected. Trading in the bonds was suspended last June. At that time they were trading at only 50% of their face value. The total issue is $160 million and the missed payment was only $15 million.
China’s premier Li Kequiang warned that Chaori was not the last. He said on 12th March last week that future defaults of financial products are “unavoidable”. He pointed out that allowing defaults was a natural part of the financial deregulation process. There is also the issue of moral hazard, which the authorities are trying to address. In essence if you don’t allow companies to default, the markets assumes that they will never take place. With the certainty that companies cannot go under, investors will continue to pour money into risky assets.
But that is not the only problem. The other part is that local governments simply cannot afford to bail companies out. They have their own problems. There are 388 financing arms of municipal authorities. They owe Rmb 9.7 trillion ($1.6 trillion) as of the middle of last year. Only 53% have enough cash to cover estimated debt and interest payments this year without refinancing.
Statistics published this week show a weakening economy. The numbers for industrial production, retail sales and urban fixed asset investment all badly missed forecasts. Industrial output slowed from 9.7% in December to just 8.6% the lowest reading since August 2009. Prices for iron ore and copper markets, usually barometers of the Chinese economy, have been dropping to new lows.
Much worse are the statistics for the real estate. Beijing’s new home sales for the month of February dropped 61% compared to the same period last year. Price acceleration in China’s biggest cities showed the first slowdown in a year. Some hard up developers are beginning to discount prices by up to 40%. Although the official news agency has denied it, banks are growing cautious about lending to developers especially those in smaller cities.
The slowdown in real estate could be devastating. With the exception of a few experiments, there are no real estate taxes in China. Local governments depend on land sales for revenue. Revenue desperately needed to pay off debts. Income from land sales was Rmb 4.1 trillion ($.067 trillion) 33% of national income. The cost of land used to be only 20% of the cost of housing. To feed local coffers it has grown to 60%. So as the real estate sector slows, so will the desire to bail out the bond market.
The problem with defaults is that you cannot have just one. The circumstances that lead to the first one have affected other companies as well. So as Li Kequiang warned, there will be other defaults. The muted reaction to the Chaori is supposed to be a positive, but it may encourage other defaults and there are a bunch of companies in line. Baoding Tianwei Baobian Electric is a company owned by central government. Its bond was just suspended from trading. Haixin Steel, a privately owned medium-sized mill in the heart of China’s coal country failed to repay loans that came due last week.
But this is China, so a default can have different ramifications. Haixin steel is part of a web of triangle debt. These are methods of providing financing between suppliers, manufacturers and customers. Each business provides the next business in the supply chain with credit. For example a coal company would sell the steel mill coal on credit. The steel mill would then sell its products onto a real estate developer also on credit. Then the companies would guarantee each other’s debt.
A recent example of how the collapse of one company can have a much broader impact occurred in 2012 near the eastern city of Hangzhou. When a single property developer collapsed, local governments and banks had to provide bridge loans to 62 different companies to keep them afloat.
The situation is made infinitely worse by the lack of information. The Chinese government’s need to restrict information creates its own set of problems. No one really knows how many of these agreements there are or with whom. So if one company goes under, no one is sure how many more it will take with it. Insolvent local governments won’t be able to provide the usual help. Without the government guarantees, investors may dump everything, the good along with the bad.
But it doesn’t end there. Most of the debt is held long term by the banks. Secondary trading is very thin. So there is virtually no market and no price discovery mechanism. Without liquidity markets can fall a long way.
Is this China’s Bear Stearns moment? Perhaps but what must be remembered about the collapse of Bear Stearns was that it had a very limited impact. Bear Stearns was once a highly respected investment bank in the US. It collapsed on 31 March 2008. It was subsequently bailed out by a loan from the Federal Reserve and a quick sale to another investment bank, JP Morgan. The important point about Bear Stearns is that the market totally ignored the lesson. A month after the collapse the market rose 4% before it continued its way down.
So the default of one small solar company or one medium sized steel mill does not foretell an immediate collapse of the Chinese bond market. But it is a very clear warning of its direction. It isn’t up.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)