Removal of Directors and the litigation?

We all know the role of the Directors in any Company and Board is collectively involved in the day-to-day affairs of the Company. Through segregation and delegation depending upon the size of the Company, the plan, the regulations in the Articles, the directors in-fact run the Company subject to the provisions of the Companies Act, 1956 and excepting few decisions which should only be taken by the shareholders at the Annual General Body Meeting (AGM) or Extraordinary General Body Meeting (EAGM). Subject to the limitations in the provisions of the Companies Act, 1956, the regulations in the Articles of the Company and the SEBI guidelines and regulations, normally, a Director either holds substantial number of shares in the Company or he represents a group of shareholders and the practice is also referred to as “Corporate Democracy”. In view of the role and the powers of the Directors or the Board collectively, a decision taken for removal of a Director leads to so much litigation very often. The problems with the removal of Directors will often come in Private Companies, closely held Public Companies or the family companies as is referred very often. The litigation surrounding removal of directors too is very complicated to dealwith if the removal is strongly opposed by the Director or by the group which he represents. In my opinion, normally, the issue of removal of Director is agitated either before the Civil Court or before the Company Law Board under section 397/398 of the Companies Act, 1956. There can be lot of things prompting the AGM to remove a director and in most of the cases; it reflects infighting among the shareholders or the shareholder groups. In my opinion, even if one approaches the Registrar of Companies (ROC) explaining as to how the removal is procedurally incorrect, the Registrar concerned may insist the Director who has been removed to approach the Court or the competent authority and get an order that the removal is illegal. Thus, an aggrieved Director may be forced to approach the Civil Court asking for a declaration that a particular resolution of AGM in which he has been removed is illegal. In view of the fact that there is no specific bar on the Civil Court in entertaining these kinds of corporate litigation, the Civil Court is forced to entertain the litigation and should give finding though it is criticized very often that the Civil Court lacks expertise in deciding corporate disputes. But, in my opinion, a Civil Court may not be able to look at the motives, issues of oppression etc. in a Civil Suit challenging the removal of a Director. A Civil Court may look at the procedural issues in removing the Director and may lay a special consideration on the regulations in the Articles of the Company governing removal of Directors and on the provisions of the Companies Act, 1956 dealing with the appointment and removal of Directors. Without going into the merits and demerits in the judgement taken in the AGM, the Civil Court can give a finding that the removal is illegal if there exists a procedural lapse and may say that the removal is valid if there is no procedural lapse. But, this is not the case when a Director removed or the one group of shareholders approaches the Company Law Board under section 397/398 of the Companies Act, 1956 alleging oppression and mismanagement and challenging his removal from directorship. There are two important issues when a Director or the concerned group approaches the Company Law Board challenging his removal as a Director as follows:

1. The Director or the group questioning the issue of removal should be qualified under section 399 of the Companies Act, 1956 if they want to move a petition before the Company Law Board under section 397/398 of the Companies Act, 1956.

2. Secondly, there should be oppression and mismanagement for filing a petition under section 397/398 of the Companies Act, 1956. There are so many judgements explaining as to how to construe the words “oppression” and “mismanagement” used under section 397/398 of the Companies Act, 1956. In the beginning, the words are construed so strictly and it is considered as an extraordinary remedy. If we go by the judgements on section 397/398 of the Companies Act, 1956 in the past, then, the oppression as alleged should be ‘harsh’ and ‘burdensome’. Again, there should be series of acts constituting oppression and mismanagement. That was legal position in the past. However, in the recent judgements it is held that the Company Law Board can pass any order under section 397/398 or section 402 of the Companies Act, 1956 even if the oppression and mismanagement is not established or proved. That means, the Company Law Board can very well say that, infact, there is no oppression and mismanagement, still, an order or direction can be passed and it is justified. Now, scope of section 397/398 of the Companies Act, 1956 is literally changed and technicalities are ignored.

The above two issues are important when it comes to approaching the Company Law Board under section 397/398 of the Companies Act, 1956. Unlike the Civil Court which can only look into the procedural irregularity in removing a Director, the Company Law Board can look into various issues and its decision or direction need not be based on the procedural irregularities only and its order is normally directed to put an end to the matters complained of or in order to regulate the future affairs of the Company. The Company Law Board may not decide to interfere with the removal of a Director even if it finds some procedural lapse, and at the same, it may say that the removal is not correct even if it is done in accordance with the provisions of the Companies Act, 1956. This is a very complicated issue to understand and to dealwith. Again, if one approaches the Civil Court challenging the removal of a Director, then, the scope of granting other relief and giving directions or interim directions to the Company from time to time may be less, but, it is not the case with the powers of the Company Law Board under section 397/398 of the Companies Act, 1956. There should not be any major disputes between or among the shareholders in the Company, but, if there is a dispute and the shareholders come to the Court or the Company Law Board, then, there can be so many complications in the course.

Note: the views expressed are my personal, a view point and I am aware of various connected issues on the subject.

Drafting Articles of Association?

Section 26 to 32 of the Companies Act, 1956 specifically deals with the issue of Articles of Association. Section 26 of the Companies Act, 1956 is as follows:

“Section 26. There may be in the case of public company limited by shares and there shall in the case of an unlimited company or a company limited by guarantee or a private company limited by shares, be registered with the memorandum, articles of association signed by the subscribers of the memorandum, prescribing regulations for the Company.”

Thus, while it is a requirement for the Private Limited Companies to have an Articles of Association, it is an option when it comes to Public Limited Companies. The detailed provisions of the Companies Act, 1956 regulates the Public Limited Companies while liberty is given to the Private Limited Companies to have their own regulations on many issues or aspects. Normally, a care is taken while preparing articles of association of a Public Limited Company in view of their exposure, stakes and professional guidance.

The schedules to the Companies Act, 1956 provides model Articles of Association which can be adopted by different kind of companies. I do strongly feel that preparation of Articles of Association is a difficult exercise unless the model articles are adopted or only very few changes are made to the model articles to the extent provided under the Companies Act, 1956.

I want to express my view on preparation of Articles of Association of Private Limited Companies as Public Limited Companies normally are very careful and takes a good professional advice on everything from the beginning.

It is the settled company law principle that Articles can not override the provisions of the Act. Again, certain privileges under the Companies Act, 1956 are available only when those are backed by the Articles of Association. Though, we use the word ‘preparation’, I feel that the professionals advising the Company or involved in incorporation of a Company normally may only do few additions or alternations to the model Articles of Association provided in the Act itself. But, when the promoters want to have their own say on the Company’s regulation, two preliminary things should be in mind while preparing Articles of Association of a Private Limited Company and those are:

1. It is not correct to delete the regulations contained in the model articles of association without considering its impact and in view of the fact that many provisions of the Act can be availed only when those are backed by the Articles of Association.
2. While incorporating a regulation which is not there in the model articles provided, one should be very careful about the provisions of the Companies Act, 1956 and no provision should go against the provisions of the Act.

I have seen interesting regulations in the Articles of Association of a Private Limited Company which can not sustain at all in view of the express bar under the Act. Private Limited Companies or the closely held companies may, at times, enter into interesting arrangements in the course of their business and they take the provisions of the Company Law so easily. In practice, even the professionals advising the companies, will go by the wish of the managerial personnel of the Company or the Company and they may not insist on the Companies to be in strict compliance of the provisions of the Act or the Company Law.

It is settled legal principle that any act which is against the Memorandum and Articles, and which is against the provisions of the Act are void and those are normally referred to as “ultra vires”.

Though, there is a principle of “doctrine of constructive notice”, we can not expect the third parties to probe into the Company with which they are entering a business transaction and it is not possible practically in many cases. Only Public Financial Institutions or the Financial Institutions may be in a position to probe company’s internal regulations and other things when the Company approaches them for a loan. Barring that, in many cases, a third party may not be able to look at the company’s internal regulations and other internal issues and also we are aware of “doctrine of indoor management” etc, though it operates in a different situation.

Company Law is very complicated and interesting. Any laxity on the part of the promoters or the professionals advising the Company, can lead to lot of complications or difficulties.

Assuming a case that the promoters or the majority in a Company has no intention at all to impeach the rights of the other or cause any loss or damage; even in those cases, the procedural irregularity may cause so many problems to the Company when a dispute arises.

The complications can be like:

1. Can we say that an act which is against the provisions of the Act or the regulations is legal?
2. Can we get all the business deals of a Company set-aside on the ground that there exist a simple procedural irregularity or the business deals are entered into ignoring the regulations of the Company?
3. Where is the effective mechanism to find-out as to whether the Company functions in accordance with the provisions of the Act or not?
4. How to get a company corrected when it is proceeding with an untenable regulation in its Articles?

I have just listed few complications that we can see with the laxity on the part of the promoters while getting the regulations prepared or ensuring that the Company functions in accordance with the provisions of the Act. I can definitely say that the non-compliance of the provisions of the Act, would lead to numerous complications.

A creditor or a shareholder can not sustain a winding-up petition against a Private Limited Company showing that the company contains a regulation and functions based on the regulation which is clearly against the express provisions of the Act. It is difficult really. Section 397/398 of the Companies Act, 1956 are not meant for ensuring that the Company functions in accordance with the regulations thought the Company Law Board is conferred with extraordinary powers while entertaining an application under section 397/398 of the Act. There will be lot of problems when some one approach the Civil Court seeking a declaration that a regulation contained in the Articles of a Company is void or the transaction entered into in violation of the regulations in the Articles are void.

In view of numerous complications with incorrect drafting of Articles of Association, I would like to mention few points which can be considered while preparing an Articles of Association of a Company or getting a Private Limited Company incorporated.

1. It is to be remembered that though we use the word “preparation of articles” while getting a company incorporated, it is actually an adoption even when the promoters insist for few changes in the model articles provided in the Act.
2. It is advisable to convince the promoters not to insist for additions, changes, alternations or deletions in the model articles provided in the Act.
3. Promoters are to be convinced that the Articles can be altered easily.
4. It is to be remembered that the additions, changes or alternations in the model articles provided requires careful scrutiny of the provisions of the Act.
5. Unless it is necessary to have a new regulation in the Articles of Association or a new regulation is must for promoting the Company, it is better not to resort to additions, alternations, changes etc. in the model Articles provided in the Act.

Note:
1. I have focused only on the preparation of Articles of a Private Limited Company.
2. I have not detailed all provisions dealing with the Articles of Association under the Act.
3. I have not discussed many company law concepts surrounding the issue.
4. I am aware of the vastness of the subject.