Clear Case

Clear Case
Clear Case

397/398 – Oppression and Mismanagement – Bona fides – a Case Study – Indian Company Law

I have been continuously writing on issues touching the corporate world and sharing my personal experience and views with the readers, my colleagues and people connected to the corporate world. While there are many legal issues and the law touching the corporate world and functioning of companies in India, I have written considerably on sections 397/398 of the Companies Act, 1956. I was always of the opinion that the listed public companies are well regulated to a great extent. SEBI has a considerable role in regulating the capital markets and no listed public company dare to ignore the commitments under listing agreement entered into with the stock exchanges. Despite well regulated set-up to regulate the capital markets and the listed public companies in India, we tend to see some irregularities and they tend to happen and there are limitations.

I was concentrating more on private companies or the closely held companies. It is not easy for everyone to go for big expansions and establishing a big corporate entity instantly. We know the requirements for getting a public company listed in a stock exchange and we are aware of SEBI (DIP) regulations. A business gets established and expanded step-by-step and as such Private Limited Companies or the closely held companies occupy greater significance. We see many private companies owned by a family and there tend to be many groups and interesting corporate arrangements in closely held private companies. In view of the fact that there are no strict regulations governing the shareholding pattern in private companies, we very often see that many private companies are controlled by two groups and even otherwise, there tend arise groupism in the Company. When the trust is lost between or among groups in the Private Limited Companies, then, one group tend to oppress other and in some cases, a group will always try to create problems to the majority in the Company and try to take-over the Company too. These differences between or among groups in a Private Limited Company may lead to approaching the Company Law Board under section 397/398 of the Companies Act, 1956. Section 397/398 of the Companies Act, 1956 provides protection to the minority against oppression and mismanagement in the Company. Though, only a group of minority shareholders in the Company who are qualified to approach the Company Law Board under section 399, can approach Company Law Board under section 397/398 of the Companies Act, 1956 seeking preventing measures to put an end to the matters complained of, even the majority approaches Company Law Board alleging oppression and mismanagement typically. The Company Law is very complicated and it is not easy for an adjudicating forum to decide and give directions to the Company or the Shareholders. An adjudicatory forum should concentrate on the concept of company law and various other stake-holders who are not before it and it makes a proceeding before the Company Law Board delayed at times. There will not be any difficulty in entertaining an application seeking to condone the delay in filing the required documents with the Authorities and such applications can easy be disposed of by imposing fine etc.

Though, there is so much logic behind mandating the companies to maintain some registers and file certain documents with the Registrar of Companies, many private companies may not be able to show strict adherence to the provisions of Companies Act, 1956. Taking note of the factual issue with regard to filing of documents with the Registrar of Companies etc, the Ministry has not proposed a Scheme to compel the companies to comply with the filing requirements now.

I have heard from the corporates, seen the proceedings and perceived the things and often feel that the majority in a Company is being troubled by minority and at times the minority is not able to get their rights effectively safeguarded despite establishing a clear case of oppression and mismanagement in the Company.

Though, a lot can be discussed on Company Law in India, the issue of redressel mechanism, the issue of civil courts jurisdiction, the issue of constitution of National Company Law Tribunal, the issue of effectiveness of the remedy etc., I would like to confine myself in this Article to a case study on an issue under section 397/398 of the Companies Act, 1956.

I would like deal with the issue of requirement to see the bonafides on the parties approaching the Company Law Board under section 397/398 of the Companies Act, 1956. Majority of the companies in India and especially Private Limited Companies may not be able show strict adherence to the provisions of Companies Act, 1956. As such, for everyone, it is very easy to point-out the irregularities in a Company and a group sometimes tries to create problems to the majority citing the irregularities by approaching the Company Law Board under section 397/398 of the Companies Act, 1956.

We can find so many judgments of Constitutional Courts on section 397/398 of the Companies Act, 1956 and the courts have ruled and maintained some principles as to how the provisions of section 397/398 of the Companies Act, 1956 are to be interpreted. I feel that despite the settled legal principles, the facts of each case to be carefully gone into in a petition under section 397/398 of the Companies Act, 1956 and many directions or orders are passed based on facts. We know as to how the judgments of the Constitutional Courts are sought be interpreted in Subordinate Courts and High Courts despite the mandate under Constitution of India.

I would like to present a case study followed by an analysis on section 397/398 of the Companies Act, 1956 and the facts of the case are as follows:

1. There are two groups in a Company wherein group ‘A’ holds 85% of the shareholding and the group ‘B’ holds the remaining 15%.

2. The Company was in existence for more than 10 years and was doing well.

3. The Company’s Board comprises two directors from the minority group too.

4. All the decisions in the Company were taken with consensus in the Board and in the AGM as required under the provisions of Companies Act, 1956.

5. There were no concealment of transactions or arrangements in the Company and both groups clearly aware of all the transactions and arrangements and everything was done in the Company with consensus.

6. After 10 years, difference of opinion arose between the parties.

7. The minority group has listed-out so many transactions of the Company in the past 10 years in its petition to the Board under section 397/398 of the Companies Act, 1956 and alleges oppression and mismanagement on the part of majority group in the Company.

8. All the transactions listed-out by the minority in its petition to the Board were taken place with the consent and the knowledge of the minority.

9. Admittedly, there were few irregularities in the functioning of the Company and these irregularities were taken place in the past 10 years and were with the knowledge of all the shareholders including the minority.

Issue: The issue for consideration is that as to whether the minority group can take advantage of the irregularities in the Company and which were with the knowledge of the minority all along?

Analysis:

Dealing with the object of the chapter laudably, the High Court of Bombay, in Mauli Chand Sharma and another Vs. Union of India and others, (1977) 47 Com Cases 92, was pleased to observe that” chapter II of the Act, which includes section 255, deals with corporate management of the company through directors in normal circumstances, while Chapter VI, which contains sections 397, 398 and 402, deals with emergent situations or extraordinary circumstances where the normal corporate management has failed and has run into oppression or mismanagement and steps are required to be taken to prevent oppression and/or mismanagement in the conduct of the affairs of the company”.

Dealing with the issue as to how the word ‘oppression’ is to be construed for the purpose of granting relief under section 397 or 398, the Supreme Court of India, in Sangramsinh P.Gaekwad and others. Vs. Shantadevi P.Gaekwad (Decd.) by Lrs. And others (2005) 123 Comp Cases 566,was pleased to observe that “the expression “oppressive”, it is now well settled, would mean burdensome, harsh and wrongful. “Oppression” complained of must relate to the manner in which the affairs of the company are being conducted and the conduct complained of must be such as to oppress the minority members. By reason of such acts of oppression, it must be shown that the majority members obtained a predominant voting power in the conduct of the company’s affairs. The remedy under section 397 of the Companies Act is not an ordinary one. The acts of oppression must be harsh and wrongful. An isolated incident may not be enough for grant of relief and a continuous course of oppressive conduct on the part of the majority shareholders, is, thus, necessary to be proved. The acts complained of may either be designed to secure pecuniary advantage to the detriment of the oppressors or wrongful usurpation of authority”. The court went on observing that “but this would not mean that section 397 provide for a remedy for every act of omission or commission on the apart of the board of directors. Relief must be granted having regard to the exigencies of the situation and the court must arrive at a conclusion upon analyzing the materials brought on record that the affairs of the company were such that it would be just and equitable to order winding up thereof and that the majority acting through the board of directors by reason of abusing their dominant position had oppressed the minority shareholders. The conduct, thus, complained of must be such so as to oppress a minority of the members including the petitioners vis-à-vis the shareholders which a fortiori must be an act of the majority. Furthermore, the fact situation obtaining in the a case must enable the court to invoke just and equitable rules even if a case has been made out for passing an order of winding up of the company but such winding up order would be unfair to be minority members”. Again, the court laudably concluding the issue was pleased to proceed that “when a complaint is made as regards violation of a statutory or contractual right, the shareholder may initiate a proceeding in a civil court but a proceeding under section 397 of the Act would be maintainable only when an extraordinary situation is brought to the notice of the court keeping in view the wide and far-reaching power of the court in relation to the affairs of the company. In this situation, it is necessary that the alleged illegality in the conduct of the majority shareholders is pleaded and proved adduced in the proceedings remain unsatisfactory to arrive at a definite conclusion of oppression or mismanagement, the petition must be rejected”.

Dealing with the concept of Company Law and the precious rights of the shareholders, the Supreme Court of India, in Dale and Carrington Invt. P.Ltd. and another Vs. P.K.Prathapan and others, (2004) 122 Comp Cases 161, was pleased to observe that “a company is a juristic person, it acts through its directors who are collectively referred to as the board of directors. An individual director has no power to act on behalf of a company of which he is a director unless by some resolution of the board of directors of the company specific power is given to him. The directors act on behalf of a company in a fiduciary capacity and their acts and deeds have to be exercised for the benefit of the company. To the extent the power of the directors is delineated in the Memorandum and Articles of Association of the company, the directors are bound to act accordingly. The fiduciary capacity within which the directors have to act enjoins upon them a duty to act on behalf of a company with utmost good faith, utmost care and skill and due diligence and in the interest of the company they represent. They have duty to make full and honest disclosure to the shareholders regarding all important matters relating to the company. It follows that in the matter of issue of additional shares, the directors owe a fiduciary duty to issue shares for a proper purpose. This duty is owned by them to the shareholders of the company. Therefore, even though section 81 of the Companies Act, 1956, which contains certain requirements in the matter of issue of further share capital by a company, does not apply to private limited companies, the directors in a private limited company are expected to make a disclosure to the shareholders of such a company when further shares are being issued. The acts of directors in a private limited company are required to be tested on a much finer scale in order to rule out any misuse of power for personal gains or ulterior motives thus casting a heavier burden on its directors”.

My opinion on the issue:

Though, there are so many judgments of Company Law Board, the High Court and the Supreme Court as to how section 397/398 of the Companies Act, 1956 are to be interpreted and as I feel, there is no deviation in reiterating the legal position so far on the issue. Despite reiterating the concept, the interpretation of the judgments and understanding the concept is a complicated thing always.

But, there is no judgment, as far my knowledge goes, as to whether the minority group can allege their own acts as oppressive in order to get a relief against majority. If the minority was having the knowledge of all the transactions in the Company for a considerable time, then, though, there exist irregularities in the company, the minority may not be right in using their own acts or the consented acts for getting a relief under section 397/398 of the Companies Act, 1956 as it is against the object of the Chapter in my opinion. It is an important issue to deal with and the authority of the Company Law Board to pass orders in such matters will depend upon the shareholding pattern of the Company and also other stake-holders.

Note: The views expressed are my personal and I am aware of the plethora of concepts under the Chapter.

About the Author

V.DURGA RAO, Advocate, Madras High Court.

Email: vdrao_attorney@yahoo.co.in

http://indiancorporatelaws.blogspot.com/

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