Oppression & Mismanagement: Proceeding against subsidiaries under section 397/398 of Companies Act, 1956?

It is very frequently alleged that the remedy available to shareholders under section 397/398 of the Companies Act, 1956 is not effective. There are several issues to say as to why the remedy available to the shareholders under section 397/398 of the Companies Act, 1956 is not effective. Execution of orders passed by the Company Law Board under section 397/398 of the Companies Act, 1956 is always complex and many times, the parties defy the orders and defend their actions in the course of the proceeding. While the shareholders mention urgency while seeking some interim measures or the disposal of the Company Petition under section 397/398 of the Companies Act, 1956, the Company Law Board often emphasizes the ‘principle of natural justice’ and will also say that the disposal of Company Petition will be done priority-wise. Apart from these usual issues, there are several complicated issues under section 397/398 of the Companies Act, 1956. Now, the issue of maintainability of the petition, at the initial stage, is not encouraged. Earlier, there were several cases where the question of maintainability and dismissal of Company Petition on technical grounds went up to Supreme Court. Another complicated area under section 397/398 of the Companies Act, 1956 is about the powers of Company Law Board to decide the validity of certain actions and the remedial measures. There are several cases where the majority can make the Company a shell Company slowly and through various deeds and it is to deny the benefit to the minority shareholders. This is a very complex issue to deal with under section 397/398 of the Companies Act, 1956. If the Company Law Board is not effective in providing the remedial measures to the minority shareholders and it can only provide protective measures, the minority shareholders can only approach the Civil Court seeking remedial measures and the Civil Court lacks the expertise in dealing with these issues. Again, if the shareholders seek preventive measures and the limited remedial measures under section 397/398 of the Companies Act, 1956; and also approach the Civil Court seeking remedial measures against the Company like cancellation of agreements or contracts etc., then, the issue of ‘simultaneous proceedings’ would normally be pleaded by the majority. Like-wise, several issues are there as to why corporates or the shareholders usually term the proceedings under section 397/398 of the Companies Act, 1956 ineffective. As there is so much emphasis on ‘Corporate Governance’ which intended to safeguard the interests of the shareholders and public, there should be due emphasis in providing an effective remedy to the shareholders under section 397/398 of the Companies Act, 1956 as otherwise; the proceedings before the ‘National Company Law Tribunal’ under the proposed ‘new Companies Act’, will also be ‘ineffective’.

As there is no effective alternative, as the winding-up proceedings are discouraged normally if the Company is a going concern and in view of the stakes involved, there is no option for the minority shareholders in most of the cases except to approach the Company Law Board when there is ‘oppression’ and ‘mismanagement’ in the Company.

The interesting issue under section 397/398 of the Companies Act, 1956 is about dealing with subsidiary companies. It is true that the ‘holding company’ and ‘subsidiary company’ are two distinct legal personalities. It is also true that the ‘subsidiary company’ may not have frequent business transactions with the holding company or vise versa and the holding company may only comply with the regulations by providing with the particulars of the subsidiary companies in its financial statements or may comply with the regulations of Stock Exchanges or the SEBI regulations if the Company is a Listed Company. It is also true that that the subsidiary companies have close and frequent business transactions with the holding company or vise versa apart from the apparent investment and the control over the management. When the companies are closely held and when the holding company constitutes subsidiary companies with a specific objective, then, there tend to the frequent business or commercial dealings between or among the companies leaving allegations of diversion in many cases. It is a reality and it happens. If there are diversion of funds or unfair advantage by the holding company to the subsidiary companies and if the minority in the holding company wants to challenge such a mis-management, then, the minority shareholders may not directly question the mis-deeds in the subsidiary companies though an investigation can be sought under section 235 of the Companies Act, 1956. In strict senso, the shareholders of the holding company can not ask for all measures under section 397/398 of the Companies Act, 1956 against the subsidiary companies. This is a very complex issue and it is unfair and illogical to lay a principle that the shareholders of the holding company should wait for years before a main company petition asking for investigation decided and then, expecting the Central Government to step-in to investigate into the affairs and suggest the measures to be taken. It should depend upon the facts and circumstances of the case and logic should also be seen in these cases rather applying the sections of the Companies Act, 1956 technically. Despite the restricted wording under section 402 of the Companies Act, 1956 in deciding the validity of the transactions entered into between the Company and the outsiders, the Company Law Board is looking into those issues by adhering to the ‘principles of natural justice’ and by listening to all the parties concerned. If the logic applied that the shareholders of the Company can also ask the relief against a particular company under section 397/398 of the Companies Act, 1956, then, literally, there will not be any relief to the minority shareholders in the Company and they will be forced to approach Civil Court seeking appropriate remedy and a Civil Proceeding will take several years.

In view of the functioning of Civil Courts in this country, in view of stakes involved, in view of difficulties with simultaneous proceedings and in view of the tendency of discouraging the Civil Courts to deal with the Company disputes as is being specially mentioned in the new Companies Bill, the scope of section 397/398 of the Companies Act, 1956 and the powers of the Company Law Board can not be restrictive. It is true that the Company Petitions with vague allegations under section 397/398 of the Companies Act, 1956 can not be encouraged and at the same time, when there is a strong case of ‘oppression’ and ‘mis-management’, the Company Law Board or the National Company Law Tribunal in future should be in a position to provide remedy to the aggrieved shareholders.

Interpreting the provisions so strictly about proceeding against the subsidiaries, the Madras High Court, in Amalgamations Limited (Now Amalgamations (P) Ltd) & Others Vs. Shankar Sundaram & Others CDJ 2011 MHC 4938, was pleased to observe as follows:

“39. In fact, the Company Law Board relied upon the decision reported in Hungfordcase and rightly arrived at a conclusion that it will be improper and illegal to join subsidiaries in the company application on facts and circumstance of the case. But the Company Law Board has held that the main company petition under section 397 of the Act is not demurable or objectionable in the absence of subsidiary companies and their directors and share holders and in approprate case, they would come under the expression affairs of the company meaning the affairs of the holding company" Further, it was also held that "Therefore, when a person is not a member of a company, his alleging oppression and invoking the provisions of section 397 against that company does not arise. Therefore, a shareholder of a holding company cannot complaint of oppression by a subsidiary in which he is not a member as there is no legal relation between him and the subsidiary company."

40. Therefore, the proposition of law that the affairs of the company would mean the affairs of the subsidiaries also cannot be accepted as it creates a legal fiction to treat the members of the holding company as members of the subsidiary company. This section can be implemented only in so far as Section 235 of the Act invoking Section 214 (2) of the Act and not for section 397 and 398 of the Act. When the intention of the legislature is clear to include only one company simplicitor, we cannot put our own words into that. In fact, for this proposition also, the learned Senior Counsel relied on the decision reported in (Vijay Narayan Thatte and others vs. State of Maharashtra and others (2009) 9 SCC 92 wherein the Honourable Supreme Court held that when a plain gramatical meaning of law and literal rule of interpretation is very clear and when there is a conflict between law and equity, law as such must prevail.

41. The company Law Board has rightly held that "Thus, notwithstanding our findings that the affairs of a company do not include the affairs of its subsidiaries, we find that the petitioner has not has not even prima facie established that the inclusion of the subsidiaries either as necessary or proper parties to adjudicate his allegations against the holding company. Therefore, we are of the view that the prayer of the respondent subsidiaries and their directors to delete their names from the array of parties should be granted."

48. The Company Law Board has rightly concluded that the company petition is essentially a petition against the holding company. Therefore the Company Law Board found that without even going into the merits of the case and ordering investigation into the affairs of the holding company, the Court cannot definitely order for investigation into the affairs of the subsidiary companies. In fact, if it is found, after hearing the petition that the order of investigation can be made into the affairs of the holding company, then the provisions of Section 239 would come into play and it is for the inspectors, to be appointed by the Central Government, to decide as to whether the business of the subsidiary also required to be investigated. In fact, this has been held by the Division Bench of this Court in the decision reported in (MicromeriticsEngineers Pvt Ltd., and others vs. S. Munusamy) 2004 122 Company Cases 150 also, which is mentioned supra. Therefore, we hold that the Company Law Board has rightly stated that there need not be any direction and gave liberty to the respondent in case the respondent desires that there should be a direction for investigation into the affairs of any of the subsidiary company, it is always open to him to file separate applications in terms of Section 214 (2) read with Section 235 of the Act. When this safeguard was given by the company Law Board, it is not open for the respondent, at this stage, to contend that because the company application filed by him is a combined application, it has to be taken up together along with the main company petition when he has not complied with Section 399 (4) of the Act.

49. In any view of the matter, as we have found that the respondent has not even made any allegations against the subsidiary company or claimed any relief against most of the subsidiary companies in the main company petition and as per the decisions of the Honourable Supreme Court mentioned supra, the subsidiary companies cannot be included in the Company Petition. Hence, the order passed by the learned single Judge, setting aside the order of the Company Law Board deleting the subsidiary companies from the array of parties, is not correct. Inasmuch as the subsidiary company cannot be made as a party to the company petition, we are inclined to allow LPA Nos. 129 and 131 of 2002.”

In the above case, the issue was deletion of names of the subsidiaries in a petition under section 397/398 of the Companies Act, 1956. If, on fact, there is no prima facie allegation of diversion etc. against the subsidiaries, then, there can be justification in ordering the deletion of the names of the subsidiaries in a petition under section 397/398 of the Companies Act, 1956. The Company Law Board has dealt with the issue both on facts and on law. While dealing with the issue legally, the Company Law Board has highlighted the difference between section 397/398 and the provisions of investigation under section 235 of the Act. In fact, cumulative proceedings before the Board are encouraged and it is very usual to seek relief under section 397/398 and also under section 235 of the Act etc. However, in the above case, a restrictive scope is given to section 397/398 of the Companies Act, 1956 and it may not be correct. If such an interpretation is drawn where there is prima facie illegality in transactions between holding company and the subsidiary company, then, there will not be any effective remedy to the minority shareholders under section 397/398 of the Companies Act, 1956 and the in fact, the section becomes meaningless.

It all depends upon the facts and circumstances of the case; however, giving a restrictive meaning to section 397/398 of the Companies Act, 1956 is not in the interests of the minority shareholders. It is also equally true that the frivolous litigation misusing section 397/398 of the Companies Act, 1956 is to be discouraged at the initial stage itself considering the market dynamics and the impact.

Note: the views expressed are my personal.