Company Law Board & SARFAESI proceedings?

Company Law Board exercises very important functions under section 397/398 of the Companies Act, 1956 providing relief to the shareholders against ‘oppression and mis-management’ in the Company. When a group of shareholders are oppressed in any company or the company is mis-managed causing loss to the interests of the shareholders, shareholders very frequently exercise the option of approaching the Company Law Board under section 397/398 of the Companies Act, 1956 if they are qualified to do so under section 399. The shareholders have the option and can even approach the High Court seeking to wind-up the Company on ‘just and equitable cause’. In appropriate cases, the shareholders do approach even the Civil Courts seeking some relief against the Company though there always remains a confusion about the jurisdiction of Civil Court in dealing with the cases of ‘oppression and mis-management’ and also there is a strong belief that it is extremely difficult to get speedy relief from a Civil Court. In the cases of ‘oppression and mis-management’, the affected shareholders expect immediate relief in order to get their interests in the Company protected and this is the reason why the shareholders approach the Company Law Board under section 397/398 of the Companies Act, 1956 where the CLB is supposed to ignore technicalities and is supposed to ‘put an end to the matters complained of’.

In the process of adjudication under section 397/398 of the Companies Act, 1956 and where mis-management in the Company is alleged, the applicant shareholders can even make many other group companies or third parties etc., as parties to the petition and can be seeking to get certain transactions cancelled. This happens when the majority group in the Company or the directors in actual control of the Company, deal with the properties and funds of the company in an illegal manner and with the ultimate intention of siphoning off funds of the Company. These things are very frequently alleged in respect of ‘closely-held companies’ and rarely seen in-respect of ‘Listed Public Limited Companies’ in view of the shareholding-pattern and the authority of the SEBI to look into certain issues and the authority of the stock-exchanges where the shares are listed if it is a listed Company. 

In appropriate cases, the Company Law Board can be passing suitable orders under section 397/398 of the Companies Act read-with section 402 of the Act and these orders can affect even the third parties including Banks at times in my opinion.

Competency of Company Law Board to interfere with SARFAESI proceedings:

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) is meant to enable the Banks to speedily recover their ‘secured dues’ without approaching any Court or Tribunal and even when there exists a grievance to any person affected, he can only file an appeal under section 17 of SARFAESI Act, 2002. It is settled that when a Bank initiates proceedings against a Company under SARFAESI Act, 2002, the aggrieved party can give their objections to the Bank, can seek mandatory reply from the Bank under section 13 (3A) and if they are not satisfied at the reply given by the Bank, the aggrieved party can file an appeal under section 17 of the SARFAESI Act, 2002. There is a specific provision under section 34 of SARFAESI Act, 2002 that no Civil Court can interfere with SARFAESI proceedings and even the High Court exercises caution in interfering SARFAESI proceedings though there can never be a complete bar on the jurisdiction of High Court under section 226 and 227 of Constitution of India with regard to the proceedings initiated by Public Sector Banks or Banks. However, in view of the perceived failure of the Debt Recovery Tribunals in providing speedy and effective relief, High Courts can entertain challenge to the SARFAESI proceedings in appropriate cases as otherwise; there will not be any relief to the aggrieved even when the Bank proceeds illegally and unreasonably. Though, Civil Court’s jurisdiction is not completely barred in respect of SARFAESI proceedings in view of the scope established with Mardia Chemicals Case and other subsequent cases, it is highly difficult to convince any Civil Court and get the relief against the Bank. Again, aggrieved are often afraid to approach the Civil Courts in view of the lack of expertise on the part of Civil Courts in dealing with SARFAESI issues, the technicalities, the expenses and the delay involved.

As such, though section 34 of the SARFAESI Act, 2002 specifically deals with the jurisdiction of Civil Court, it is implied that no court or the forum can interfere with the proceedings initiated by the Bank under SARFAESI Act, 2002. This is established even when the liquidation proceedings are pending against a Company and the Bank will be proceeding against the ‘Secured Assets’ even when the liquidation proceedings are taking place against the Company.

Under these circumstances, it would be interesting to look into the jurisdiction of Company Law Board to pass any order or orders under section 397/398 of the Companies Act, 1956 affecting the proceedings initiated by the Bank against the Company. Two things are very important in this regard and those are as follows:

a.                           One is that the power of the Company Law Board to pass orders section 402 of the Companies Act, 1956 affecting the third party transactions and agreements.

b.                           Second is that the relief provided to the affected person under section 17 of the SARFAESI Act, 2002.

Though it is frequently referred that the Debt Recovery Tribunal can look into all issues under section 17 of the Companies Act, 1956, the Tribunal may not be able to effectively look into certain issues. For example, there is a precedent now that the rights of Tenants under the Tenancy Laws made by the State Governments will prevail over the rights of the Bank under SARFAESI Act, 1002; and if the Bank wants to get any tenant vacated from the premises; it has to mandatorily approach the Rent Control Tribunals. Same is the case, where the Bank can not claim the complete ownership of the ‘Secured Asset’ and these issues arise when the property mortgaged is a ‘Joint Family Property’ and the Bank was negligent in accepting the property as a security. In these cases, the appropriate authority to look into the rights of the members of a family in the property is the Civil Court and the Debt Recovery Tribunal may not be competent enough to look into partition and related property issues. These are the complications with which there was a precedent initially with regard to SARFAESI proceedings that the Debt Recovery Tribunal is supposed to only look into the fact as whether the Bank has followed the procedure under SARFAESI Act, 2002 or not. But, this precedent now has changed and the authority of the Debt Recovery Tribunal under section 17 of the Act is expanded at-least as a matter of principle irrespective of practical issues and difficulties.

Like-wise, a group of shareholders in a Company may allege mis-management in the Company and can oppose any proceedings initiated by the Bank against the Company under the provisions of SARFAESI Act, 2002. If it is established that the Bank is negligent and is also at fault while sanctioning the loan to the Company, the minority shareholders can definitely be opposing the proceedings initiated by the Bank against the Company. For example, if the Bank grants loan to the Company upon certain terms without bothering at the regulations under Companies Act, 1956 and without looking into the fact as to whether the people processed the loan transaction with the Company are authorized to do so or not, then, certainly, the minority shareholders would even be questioning the Bank and the Bank can not say that they are not supposed to look into any rules and regulations; and they will only look into the security provided. This argument may not be accepted always. There may be a contention here that even the minority shareholders or a shareholder of a Company can approach the Debt Recovery Tribunal under section 17 of the Companies Act, 1956 and as such, Company Law Board can do nothing with regard to the proceedings initiated by the Bank against the Company under SARFAESI Act, 2002. It is true that the shareholders can approach the Debt Recovery Tribunal under section 17 of the SARFAESI Act, 2002 according to me if they could establish that their interests in the Company are affected and the Bank is wrong in sanctioning the loan without looking into the required issues. However, the Debt Recovery Tribunal may not be competent enough to look into the corporate rights of the shareholders and the Company Law principles. The Debt Recovery Tribunal can say that the affected shareholders can only proceed against the Company or the management and they can approach the High Court seeking winding-up and can approach the Company Law Board alleging mis-management. The Debt Recovery Tribunal may be right in its contention and it’s a very complicated issue and I don’t think that these issues would arise frequently, but, there is a possibility.

The issues of Bank negligently sanctioning loans to the Company and the interests of the shareholders, is very important when the Bank intends to proceed against the Company beyond the security provided.  Even when the Company gives security, if it is wrongful on the face of it and if the minority group or the shareholders are affected because of it, then, the minority group or the shareholders can definitely be questioning even the loan transactions with the Bank. 

If any individual guarantees the repayment of loan given to the Company and individual properties were mortgaged, then, the mortgagor may have no option if he feels aggrieved, except to approach the Debt Recovery Tribunal or the High Court in appropriate cases seeking relief. The issue is when the Bank proceeds against the Company assets and the Company and the interests of the shareholders in the Company are affected. This is certainly a very complicated issue to deal-with.

Few important points to be noted:

1.     It can not be said that the Company Law Board can not pass orders under section 397. 398 and 402 of Companies Act affecting the SARFAESI proceedings initiated against the Company. 

2.     Even if there is a mis-management in the Company, if the Bank has taken due and reasonable care while sanctioning the loan to the Company, then, the CLB may hesitate to interfere with any SARFAESI proceedings initiated by the Bank against the Company.

3.     Though the Debt Recovery Tribunal can look into all objections under section 17 of the SARFAESI Act, 2002, it may not be competent enough to deal with the issues of ‘oppression & mis-management’ requiring expertise and there can be a clear link at times between the SARFAESI proceedings against the Company and the interests of the minority group as protected under Companies Act, 1956.

4.     Though every shareholder is entitled for certain rights in the Company and for the relief at times, it is certainly complicated to say that the shareholder/s not qualified to approach High Court seeking liquidation etc. and shareholders not qualified under section 397/398 of the Companies Act, 1956, can approach the Debt Recovery Tribunal under section 17 of the SARFAESI Act, 2002. It is important in the light of a single shareholder alleging that his interests in the Company are affected with the Bank proceeding against the Company.

5.     If the Bank’s sanction of loan to the Company is clear and independent of other issues in the Company, then, the allegations of mis-management in the Company may not affect the rights of the Bank in proceeding against the Company or the security provided.

6.     The Bank’s interests can in no way be affected by any orders of the Company Law Board when the loan sanctioned to the Company is guaranteed with the sufficient assets of individuals and the CLB in those cases, may hesitate to interfere with the SARFAESI proceedings initiated by the Bank.

7.     Except the issues of fraud, gross negligence and the interests of the minority group in the Company, no other issues can be raised against the Bank if Bank is involved in a proceeding under section 397, 398 and 402 of Companies Act, 1956.

8.     There are no established precedents so far on these issues, but, these issues are very significant and real with the routine commercial transactions between the Banks and Companies.

Note: the views expressed are my personal only. 

The difficulties in the process of company liquidation and needed reforms?

Winding-up – a brief:
The Companies Act, 1956 contain elaborate provisions as to when a Company is to be wound-up, the procedure for initiating winding-up proceedings, the role of the managerial personal if the company is wound-up by the Company Court and the liquidation process to be conducted by the Official Liquidator appointed by the Company Court. It is generally understood that the Company faces winding-up proceedings when its financial position is not good or it has become insolvent. In most of the cases it may be true that only insolvent companies are wound-up in accordance with the provisions of the Companies Act, 1956. But, it is also true that a Company may be wound-up due to the serious difference of opinion among the groups in the Company and it is on the ground “just and equitable”. But, when the company is not insolvent, then, the differences among the groups may normally lead to approaching Company Law Board under section 397/398 of the Companies Act, 1956. At the same time, a Company with valuable properties and the scope for expansion of business is wound-up at times. We see few cases where the winding-up proceedings are long fought in the Court by preferring appeals and convincing the court with some revival scheme. There are cases where the Company which has faced serious winding-up proceedings reviving well later.
Official Liquidator and his responsibilities:
I want to deal with the issue of Official Liquidator’s responsibilities in the conduct of liquidation process and inherent difficulties. Once official liquidator is appointed by the Company Court, then, in accordance with the provisions of the Companies Act, 1956, the official liquidator gets the information from the managerial personal and takes charge of all the properties of the Company. The Official Liquidator also entertains the claims from the creditors of the Company and the Liquidator himself adjudicates the claims and makes proportionate payments with the permission of Company Court. It is a complicated and risky process without any option. The office of the Official Liquidator is burdened with many liquidation proceedings and often the Court appoints an expert liquidator to ease the burden on the Official Liquidator attached to the High Courts. There is a provision in the proposed Companies’ bill for the appointment of company law experts or the experts as liquidators of the Company so as to speed-up the entire issue. It’s a good move actually as otherwise the shareholders of a Company or creditors of the Company may feel as if they are not supported by law and I have heard the expression of few of creditors of a Company in Liquidation and their enormous problems in the course. The office of the official liquidator is not computerized at present and even if the office is computerized fully, liquidation is a complicated exercise to be done and it is better to take experts as liquidators and these experts may be supported by the staff of the Official Liquidator attached to the concerned High Courts.
Normally, when the Company is wound-up and the Official Liquidator is appointed, then, the Official Liquidator will realize money out of the properties of the Company and discharges the liability of the Company to the workmen, creditors, secured creditors, tax and other payments to the government and other organizations. The Companies Act, 1956 contain detailed provisions as to how the payments are to be made by the Liquidator and also about preferential payments. We have many precedents on the issue of preferential payments and I don’t want to deal with those in detail.
Rules governing the payments during liquidation process:
Dealing with the issue of making payments during liquidation process, the Madras High Court, in In re Manasuba and Co. (P.) Ltd, (1973) 43 Com Cases 245, was pleased to observe that “section 529 of the Companies Act, among other things, provides that in the winding up of an insolvent company the same rules shall prevail and be observed with regard to the respective rights of secured and unsecured creditors as are in force for the time being under the law of insolvency with respect to the assets of persona adjudged insolvent. While exercising jurisdiction under section 529, the company court would observe the well established rules unless which regulate the affairs in insolvency proceedings and the tests which would apply for deciding whether a particular asset has vested in the official assignee for distribution among the general body of creditors would equally apply for determining whether the asset would vest in the official liquidator for distribution and payment of dividend pro rata without any claim for preferential payment. Normally, in the winding up of an insolvent company, just as in an insolvency, a secured creditor will be out of the scope of liquidation and he will be entitled to enforce the security and realise the same to obtain full satisfaction of the secured debt and it is only the surplus which will go into the hands of the official liquidator. It is settled law that were a fiduciary relationship is established between the company and a third party and money are paid by the third party to the company in a situation in which the company occupies a fiduciary relationship is established between the company and a third party and moneys are paid by the third party to the company in a situation in which the company occupies a fiduciary relationship, with an obligation to either use the money for a specified purpose or to retain or keep it with the company to meet certain contingencies, the said sum would be impressed with a fiduciary character and would not form part of the general assets of the company. Property thus held by an insolvent company in a fiduciary capacity, burdened with certain fiduciary obligations, is treated a property held in trust for a specific purpose under the insolvency laws. Such property or money held for a specific purpose is by law treated as clothed with a species of trust governed by the same principles and rules which apply to property held in express trust. Section 529 of the Companies Act of 1956, which has taken the place of section 229 of the fact of 1913, corresponds to section 317 of the English Act. In the matter of preferential payments and claims for priority resting upon a fiduciary relationship, the Companies Act of 1956, merely provides that the provisions of the bankruptcy law would be observed. Cases in England and in India have taken the uniform view that property deposited with the bankrupt for a specific purpose would come under the category of trust property and would not vest in the official assignee as bankrupt’s property either because there is a specific trust with regard to the same or because the property was entrusted to the bankrupt, the later being clothed with a fiduciary obligation with regard to the property. In order that the property may be exempted from vesting under the aforesaid provision, it is not necessary that an express trust should have been constituted and it is sufficient if the entrustment involves obligations on the bankrupt in the nature of a quasi or constructive trust”.
Secured Creditors and their steps:
The Companies Act, 1956 provides for a preferential payment to the secured creditor and for making a payment, their due is to be ascertained by the Official Liquidator normally. But, there can be a special law like Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, enabling the secured creditors or the Financial Institutions to proceed with their recovery process overriding other laws. In such a case, it becomes the responsibility of the Official Liquidator to represent the Company before the concerned forums like Debt Recovery Tribunal. We can not say that the Financial Institutions or especially public financial institutions are good and will not commit any illegalities or irregularities. We are seeing many cases where serious allegations are being made against the Public Financial Institutions too. Under such circumstances, the Official Liquidator, in the interest of the workmen and shareholders, should effectively represent the Company before the forums like Debt Recovery Tribunal. But, the Official Liquidator may be handicapped with the relevant information and facts to fight with the secured creditors in many cases. Other shareholders and creditors may not be normally allowed to represent the Company when the Official Liquidator is appointed. This is an interesting area to be looked into during the liquidation process. It is true that when the Official Liquidator or his office is efficient and listens to the other creditors and shareholders of the Company, then, the Official Liquidator may be able to effective discharge his responsibility before the Company Court and also before other forums like Debt Recovery Tribunals under special law. But, we can not ignore the practical difficulties, limitations and complications in the course.
Right of the Secured Creditors and Liquidator’s Responsibility:
It is seen that, in most of the cases, the banks or Public Financial Institution are the secured creditors. And, for realizing their claim, they will resort to special laws like Recovery of Debts due to Financial Institutions Act, 1993 and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Stating that the official liquidator is mandated to represent the workers in order to get their lawful stake from and out of the realization of the money, the High Court of Madras, in V.K.Seshasayee and another Vs. Official Liquidator, (2005) 127 Comp Case (Mad), was pleased to observe that “as a determination of the claim of the secured creditors before the Debt Recovery Tribunal was going on, it is was necessary for the official liquidator in the interest of the workmen to participate in the proceedings before the Tribunal. The official liquidator was to represent effectively in the proceedings before the Tribunal for distribution of the sale consideration to the secured creditors and workers and shareholders of the company”. Dealing with the scope of the issue, the Supreme Court of India, in Industrial Credit and Investment Corporation of India Vs. Srinivas Agencies, 1996 (5) JT 405: 1996 (4) SCC 165: 1996 (3) Supreme 40, was pleased to observe that “it may be pointed out that S. 529 and 529-A of the Act do contain provisions insofar as the priority of secured creditor's claim is concerned. Of course, the Company Court would not transfer the proceeding to it merely because of its convenience ignoring the difficulties which may have to be faced by the secured creditor, who may be at a place far away from the seat of the Company Court. The need to protect the company from unnecessary litigation and costs have, however, to be borne in mind by the Company Court.” Further, the court went on observing that “we are, therefore, of the view that the approach to be adopted in this regard by the company court does not deserve to be put in a strait-jacket formula. The discretion to be exercised in this regard has to depend on the facts and circumstances of each case. While exercising this power we have no doubt that the Company Court would also bear in mind the rationale behind the enactment of Recovery of Debts Due to the Banks and Financial Institutions Act, 1993, to which reference has been made above. We make the same observation regarding the terms which a Company Court should like to impose while granting leave. It need not be stated that the terms to be imposed have to be reasonable, which would, of course, vary from case to case. According to us, such an approach, would maintain the integrity of that secured creditor who had approached the Civil Court or desires to do so, and would take care of the interest of other secured creditors as well which the Company Court is duty-bound to do. The company court shall also appraise itself about the fact as to whether dues of workmen are outstanding; if so, extent of the same. It would be seen whether after the assets of the company are allowed to be used to satisfy the debt of the secured creditor, it would be possible to satisfy the workmen's dues pari passu.”
Conclusion:
Liquidation, being the responsibility of the Official Liquidator, is a risky process and needs expertise. Going by the experience, the Official Liquidator and their office attached to the High Courts, had their own difficulties or limitations in effectively completing the liquidation process. The new Companies Bill contains a provision for appointing experts as Liquidators and it is to be seen as to how the liquidation is done in future. It’s a very complicated area under Indian Company Law needing many reforms.
Note:
I just wanted to highlight the complications in liquidation process, the responsibilities of the Official Liquidator and needed reforms for effective completion of liquidation process before the Company is finally dissolved.