Issue of public interest in a petition under section 397/398 of Companies Act, 1956?

It is known that resolving the disputes between or among the shareholders in a closely held company is very difficult in the absence of any settlement between or among the parties. Now a day, based on the practice of entertaining petitions under section 397/398 of the Companies Act, 1956 without looking into sheer technicalities, a shareholder/s who is qualified to approach Company Law Board under section 399 of the Companies Act, 1956 and who has a grievance with the other shareholders prefers to file a Petition under section 397/398 of the Companies Act, 1956. It is known that as adjudicating a company dispute requires specialization and also a traditional Civil Court may not speedily dispose a Company dispute and may not go beyond the brief. In view of the difficulties in approaching the traditional Civil Court though a Civil Court can be approached at times in respect of the grievances in the Company, many prefer to approach the Company Law Board.

Normally, in most of the Petitions under section 397/398 of the Companies Act, 1956, the parties talk about their interests and rights in the Company and it is really rare to talk about public interest in the Company. But, in view of the clear reference to public interest under section 397/398 of the Companies Act, 1956, it is the responsibility of the Company Law Board to look into many other considerations pertaining to the Company and also the public interest. This is the complication with a petition under section 397/398 of the Companies Act, 1956. The parties before the Board may effective conceal certain things and disclose the things based on their convenience. However, in view of the law and the responsibility conferred on the Company Law Board as conferred on the Company Court while dealing with a winding-up petition, the Company Law Board do every effort to ascertain all issues pertaining to the Company; not only the creditors, assets and liabilities of the Company.

Dealing with the issue of public interest under section 397/398 of the Companies Act, 1956 and the requirement on the part of the Company Law Board to look into many issues while entertaining a petition under section 397/398 of the Companies Act, 1956, the Hon’ble High Court of Bombay in Bhalchandra Dharmajee Vs. Alcock, Ashdown and Co.Ltd reported in 1972 (42) CC 190 was pleased to observe as follows:

“(6) After the amendment of sections 397 and 398 of the Companies Act by sections 10 and 11 of the Companies (Amendment) Act (LIII of 1963), it would appear that the affairs of the company have to be conducted not only in the best interest of its members for their profit but also in a manner which is not prejudicial to public interest. The element of public interest enters into the management of the companies after 1963. The modern corporation has become the accepted instrument of social policy, because it affects a large part of the economic life of the community. It has become an instrument for the improvement of the economic standards of the people and for economic growth of the nation. Society depends for some of its needs on corporate enterprise. It has therefore an interest in its stability and efficiency as an economic institution. The element of public interest also arises from the responsibility for ensuring a minimum wage to the numerous employees in the corporate sector. It is necessary to see that people who put their labour and lives into a concern get fair wages, continuity of employment and a recognition of their right to their jobs where they have trained themselves to highly skilled and specialised work. In deciding whether the court should wind up a company or change its management the court must take into consideration not only the interest of the shareholders and creditors but also public interest in the shape of the need of the community and the interest of the employees. This, in my opinion, is the requirement of section 397 and 398 of the Companies Act. This country has been spending vast sums of money in promoting new industries in public and private sectors in the interest of the economic progress of the country and improvement of living standards. In face of this, it would appear to be improper to destroy a company which has worked for nearly 87 years and has acquired experience and expertise in manufacture and supply of structurals and in boat building and ship repairing. At the same time the company cannot be kept alive so as to incur further liabilities and to diminish the dividend payable in case of winding up to the existing creditors or the shareholders. Their interests also have not to be sacrificed. It is therefore necessary that pending the hearing and final disposal of these petitions, an arrangement ought to be made for the collection, realisation, preservation and maintenance of those assets of the company which are in the possession of the company. It is also necessary that an investigation ought to be made into the affairs of the company to find out if it is possible to resuscitate the company. It is only after such investigation that one can come to a conclusion as to whether the company ought to be wound up or whether it ought to be kept alive. In view of this position, I think the best order to make is to appoint a special officer to collect, realise, preserve and maintain the assets of the company and also to make the necessary investigation referred to hereinabove.”

Note: the views expressed are my personal and I am aware of various aspects of the issue.

Is it possible to lay a hard and fast rule on the Powers of Company Law Board under section 397/398 of Companies Act, 1956?

It is known to the corporate professionals that there are so many complications in getting the disputes resolved among shareholders in the Company. The disputes among the shareholders or the groups tend to come in closely held companies as the largely held Public Limited Companies should follow SEBI (DIP) regulations while allotting shares and as SEBI and the Stock Exchange monitors various issues in respect of Listed Public Companies. When the trust is lost between or among the groups in a Company, then, each group tries to take control over the Company or the affairs of the Company by resorting to certain acts. The law governing the protection of the rights of the shareholders is very complicated despite the protection given to the shareholders against oppression and mismanagement under section 397/398 of Companies Act, 1956. When there is oppression or mismanagement in a Company, the aggrieved group can approach the Civil Court at times, Company Law Board in most of the cases and can even approach the High Court seeking winding-up of the Company. There are complications in getting the corporate disputes resolved through Civil Court and as such there is a specific bar on Civil Courts’ Jurisdiction in respect of Company cases under the proposed Companies Bill. Again, when the Company is a going concern, the High Court may not favour winding-up a Company and as such the remedy provided under section 397/398 of the Companies Act, 1956 is important for the aggrieved shareholders or the aggrieved group against oppression and mismanagement. There are concerns that the remedy provided by the Company Law Board is not effective and there are also concerns that the remedy before the Board under section 397/398 of the Companies Act, 1956 is getting misused.

If we keep the other broader issues apart, the powers of the Company Law Board under section 397/398 of the Companies Act, 1956 were the subject matter of discussion among the corporate and the corporate professionals dealing with issue very frequently. There are so many precedents on section 397/398 of the Act and also on the powers of the Company Law Board. If we keep the express limitation on the powers of the Company Law Board under section 402 apart, even otherwise, the powers of the Company Law Board were the subject matter of discussion in many appeals and even before the Hon’ble Supreme Court of India. It is true that the precedents laid-down by the Constitutional Courts to be interpreted in right spirit and the settled practice are to be adhered to. Despite so many guidelines from the Constitutional Courts on the proceedings before the Company Law Board under section 397/398 of the Companies Act, 1956, there exist complications and the Board may have to deal with variety of situations in each case before it. Many are in dilemma as to the scope of section 397/398 of the Companies Act, 1956 and also the powers of the Company Law Board. There are judgments where the Courts held that the Company Law Board can not exercise the powers which are not expressly conferred on it and there are judgments supporting the argument of elaborate powers of the Company Law Board under section 397/398 of the Companies Act, 1956.

In my personal opinion, the observation of Hon’ble Supreme Court of India in M.S.D.C. Radharamanan Vs. M.S.D. Chandrasekara Raja & Another reported in 2008 (6) SCC 750: 2008 AIR (SC) 1738: 2008 (5) SCR 182: 2008 (3) SCALE 650: 2008 (4) KCCR 299 (SN), is the correct legal position and the approach on the issue of the powers of the Company Law Board under section 397/398 of the Companies Act, 1956 and the reference in the judgment referred above is extracted hereunder:

“19. The provisions of the Act vis-a-vis the jurisdiction of the Company Law Board must be considered having regard to the complex situation(s) which may arise in the cases before it. No hard and fast rule can be laid down. There cannot be any doubt whatsoever that the acts of omission and commission on the part of a member of a company should be qua the management of the company, but it is difficult to accept the proposition that the just and equitable test, which should be held to be applicable in a case for winding up of a company, is totally outside the purview of SECTION 397 of the Act. The function of a Company Law Board in such matters is first to see as to how the interest of the company vis-a-vis its shareholders can be safeguarded. The Company Law Board must also make an endeavour to find out as to whether an order of winding up will serve the interest of the company or subvert the same. Further, if an application is filed under Section 433 of the Act or SECTION 397 and/or 398 thereof, an order of winding up may be passed, but as noticed hereinbefore, the Company Law Board in a winding up application may refuse to do so, if any other remedy is available. The Company Law Board may not shut its doors only on sheer technicality even if it is found as of fact that unless the jurisdiction under Section 402 of the Act is exercised, there will be a complete mismanagement in regard to the affairs of the company.

20. Sections 397 and 398 of the Act empower the Company Law Board to remove oppression and mismanagement. If the consequences of refusal to exercise jurisdiction would lead to a total chaos or mismanagement of the company, would still the Company Law Board be powerless to pass appropriate orders is the question. If a literal interpretation to the provisions of SECTION 397 or 398 is taken recourse to, may be that would be the consequence. But jurisdiction of the Company Law Board having been couched in wide terms and as diverse reliefs can be granted by it to keep the company functioning; is it not desirable to pass an order which for all intent and purport would be beneficial to the company itself and the majority of the members? A court of law can hardly satisfy all the litigants before it. This, however, by itself would not mean that the Company Law Board would refuse to exercise its jurisdiction, although the statute confers such a power on it.”

As such, there can not be any hard and fast rule on the powers of Company Law Board under section 397/398 and section 402 of the Companies Act, 1956 while certain limitations and settled principles are necessary to be followed.

Note: the views expressed are my personal.

Protection to majority's corporal rights?

We have been seeing tremendous corporate growth in India in the recent past and it can be attributed to the liberalization policy, growth of service sector and computerization/simplification of corporate filing through MCA scheme etc. The advantage of incorporating a company and do business is its liability factor. The liability of a member/shareholder for the losses sustained by the Company is limited to the extent of his shareholding and exception can be invoked by lifting the corporate veil. Again, the scope of expansion of business is so much when a company is incorporated rather a partnership firm or a proprietorship concern. Everybody knows this. Despite many advantages in forming a company and doing business, we will see some difficulties in the course of management and the disputes between the majority and the minority shareholders in a company. Fairness in functioning and unbiased management is the underlying principle of company law. Its true that the majority can do many things in a company through AGM, Board resolutions and extraordinary general body meetings. But, the majority or the managerial personnel are not supposed to misuse their position and authority in the company in order to oppress the minority or a group. Some companies are promoted by businessmen and technocrats with a clear intention to have a complete say in the management of the company. These people will form either a private limited company or a closely held public limited company. The difference between the private limited company and the public limited company is, on principles, as follows:

1. The transfer of shares is restricted in private limited companies.
2. The private limited company will be having lot of discretion in prescribing the regulations governing the company.
3. The public limited company can not restrict the transfer of shares normally.
4. The Companies Act itself will deal with many regulations when it comes to the functioning of public limited company.
5. When it comes listed public limited company, the company should follow the SEBI regulations and it needs to comply with the listing agreement entered into with the concerned stock exchanges.
6. The private company can not solicit shares from public like public limited companies.
7. More care is taken by the state in the form of prescribing laws and regulations when it comes to public limited companies and the disclosure requirements are also more in their financial statements.

I have just explained very few differences between the private limited companies and public limited companies. Thus, the intention, normally, behind forming a private limited company or a closely held public company is to have a control over its affairs and management. But, in the course of their management and expansion, there can be difference of opinion between the majority and the minority in a company. As the company is run by professionals called directors and as human mind is so complicated, there is every scope for the differences between or among the shareholders or the differences between the majority and the minority. As per the scheme of company law, fairness and unbiased attitude towards the members is emphasized. Despite the settled company law principles, we see the differences and litigation between majority and minority. The majority may try to oppress the minority and can resort to mismanagement in the company. At times, the minority may oppress the majority using their authority.

Addressing the issue of minority rights and their protection, the Companies Act, 1956 provides a remedy or preventive remedy. Members who are qualified under section 399 of the Act, can approach the Company Law Board seeking such measures under section 397/398 against the majority and in the interests of the Company and in order to put an end to the matters complained of, the Company Law Board can pass such orders including interim measures.

The scheme of section 397/398 of the Act is primarily meant to enable the minority to approach the Board against the misdeeds of majority. It doesn't deal with the issue as to what happens when a majority is oppressed by minority. It may happen at times and the minority can misuse their authority and even try to dilute the shareholding of the majority. All these things are very very complicated. The object behind not mentioning about the rights of the majority in a company, may be, that the majority can not be oppressed as it can do anything through board resolutions, AGM and extraordinary general body meetings. But, practically, it may happen where majority is oppressed by minority and these are the complications of company law or company related issues.

The issue I want to dealwith is with regard to the rights of the majority to question the oppression and mismanagement committed by the minority. Can the majority approach the Company Law Board under section 397/398 of the Companies Act. Yes, it’s true that, at times, it is very difficult to construe the words "minority" and "majority" for the said purpose. But, in a clear case, can majority approach the Board under section 397/398 of the Companies Act alleging some oppression and mismanagement by the minority. Its an interesting question and in my opinion, even the majority can approach the Company Law Board under section 397 and 398 of the Companies Act. The issue is not that much simple, but, I do feel that nothing happens if the majority questions the misdeeds of the minority in the Company under section 397/398 of the Act if such an approach to the Board is otherwise qualified as mandated in the section and the plethora of judgments delivered by various courts and especially the Apex Court.

Dealing with the issue referred to, the High Court of Kerala, in Dr.V.Sebastian and others VS. City Hospital P.Ltd. and others, (1985) 57 Com Cases 453, was pleased to observe/refer that “sections 397 and 398 of the Companies Act, 1956, are intended primarily to protect minority interests. In ordinary cases, the majority will be able to protect itself by controlling the directors at general body meetings. But where the majority is prevented from doing so, despite the clear indication in the articles that majority rule based on the right to demand poll should operate as a correcting influence, the majority becomes an artificial minority entitled to claim protection under ss.397 and 398”. Again, on the same issue, the Company Law Board, in K.N.Bhargava and others Vs. Trackparts of India Limited and others, (2000) 2 Com LJ 275 (CLB), was pleased to observe that “section 399 of the Companies Act, 1956, vests with the shareholders the right to move the Company Law Board in case of oppression under section 397 and in case of mismanagement under section 398. Oppression could be either by the majority against the minority or vice versa and as such it is immaterial as to who is in management while case of mismanagement, it may be relevant. However, when two groups are in management and disputes arise between the two groups, if the same could not be resolved in the domestic forum, then, there can not be any bar in the aggrieved group approaching the Company Law Board even if it is in the management along with other group. In the present case, admittedly, there tare two groups of shareholders directors and one group has approached us with grievances of oppression and mismanagement on the part of the other group. Therefore, as a general proposition, it can not be laid down that the shareholders in management can not file a petition under section 397/398”.

It is really an interesting issue in company law in India and I do strongly feel that nothing will happen if the majority approaches the Company Law Board against the minority questioning the oppression and mismanagement under section 397/398 of the Companies Act, 1956.

Mismanagement of Company Properties – Company Law in India – A Case Study

Company Law is very interesting and complicated. A shareholder having a substantial stake in the Company should be very careful as to how the Company functions and as to whether there is any chance for oppression and mismanagement. A substantial shareholder in a Company should always have an eye on the functioning of the Company and should keep track of all the transactions or the business. It is advisable for a shareholder having substantial interest in a Company to have a say in company transactions and try to have an influence in the management or the Board too.

A substantial shareholder in a largely held Public Company or a Listed Public company need not worry much about his interest in the Company. Because, listed Public Companies are largely held and will have a wide participation of various investors. Again, the market regulator SEBI prescribes so many regulations for the good functioning of a listed Public Company. There are many disclosure requirements, effective grievance redressel, adherence to corporate governance in view of the compulsory listing agreement to be entered into and many other issues.

But, in closely held Public Companies and Private companies, there tend to be frequent internal quarrels; and oppression and mismanagement. Even majority in a Company may be thrown out by the minority and we see many cases before the Company Law Board where the majority approaches the Company Law Board seeking redressel under section 397/398 of the Companies Act, 1956.

Even the founder of Apple Computers, Steve Jobs has been thrown out literally in his own words though he could come-back to Apple again through his another Company NEXT. It’s a reality that a substantial shareholder in a Company may be in trouble if he fails to keep a close watch on the Company transactions and as to how the company functions.

In India, we see many oppression and mismanagement cases in Private Limited Companies and closely held Public Companies and I would like to give a case study as follows:

CASE:

“A” is a Private Limited Company in India with very good track record in making profits. “A” is being managed by “B” and “B” is a majority group. “C” is a person with substantial shareholding in the Company and he has not involved in the day-to-day affairs of the Company for some time as he was in abroad. When “C” has come to India and wanted to take part in day-to-day affairs of the Company, he could not do that due to the influence of “B” in the Company. “C” has found out so many irregularities in Company. As the “C” is coming to know all about the Company, its transactions and its irregularities, “B” wanted to harm the “C” by diverting the funds of the Company and by resorting to mismanagement. “B” has, opposite to its objects, entered into a Joint Venture Agreement with a builder to develop all and important immovable properties of the Company. “B” has undervalued the Company’s properties and entered into an agreement and “C” could not take part in any of the transactions of the Company. “C” knows that the entire transaction is illegal and it damages his interest in the Company. “C” could do anything except approaching the Company Law Board seeking various remedial measures and especially setting aside the Joint-venture agreement with the Builder.

Though, “C” has asked for an interim injunction restraining the builder from carrying out the developmental activities, he could not get the interim injunction as desired and as a result the developmental activity has been proceeding. The main Company Petition is pending before the Board. The perusal of the averments in the Company Petition and the evidence before it makes everyone clear that “B” is at fault and “C” deserves a remedy.

But, “C” is in dilemma as to when the main Company Petition gets disposed of and what happens if the “B” and the Builders creates some Third Party interest. Again, “C” has come to know the limitation on the powers of the Company Law Board under section 402 of the Act in setting-aside the transactions.

The interest of “C” is substantial in “A” Company and he could not venture ignoring his interest in the Company.

ANALYSIS:

1. “C” could have convinced the Board and could have got the interim injunction.

2. There was no application questioning the maintainability of the application before the Board on the ground that under section 402, the prayer as prayed by “C” is not maintainable. But, “B” can raise the issue of maintainability of the prayer sought by the “C” any time.

3. It is also likely that the Board can finally say that it can not pass an order setting aside the Joint-Venture Agreement entered into between “B” and the Builder.

4. As many applications are being filed, the case is getting delayed.

5. If a third party interest is created by “B” and the Builder, then, “C” may not even see the disposal of his case in his life time.

6. “C” is confused as to the alternatives for getting an effective and speedy redressel.

What the Case Highlights?

1. The case highlights the problem being faced by corporates in getting speedy and effective redressel.

2. The case highlights the complications in Company Law.

3. The case highlights the importance of knowledge and technicalities of Company Law for the people at management or the substantial shareholders who are none other than the investors.

Mismanagement in family companies - a case study - Company Law in India

I have earlier written some articles dealing the issue of oppression and mismanagement under section 397/398 of Companies Act, 1956. I am of the opinion that the company law is very very complicated world wide in view of its complicated structure, scheme and various stake holders. Management of any company will be seriously considering two issues viz., winding-up proceedings and proceedings under section 397/398 of the Act against the Company. Both the winding-up proceedings and the proceedings under section 397/398 of the Act are very very complicated as those proceedings can bring the very functioning to halt. Its a challenging task even for the concerned adjudicatory forum to deal with those matters. For example, a winding-up petition can be filed by a creditor against the company with the help of deeming provision after sending the statutory notice containing a demand for return of debt money, but, merely because the company do not consider the statutory notice, the adjudicatory forum may not wind-up the company unless other issues are considered. Company Law is a nice subject to study and dealing with company issues are always challenging and also interesting. There are many interesting areas in Company Law and many to be explored.
Touching the practical issues, I want to present one of those complicated areas under section 397/398 of the Act and especially the issue of mismanagement in closely held companies or the family companies in the form of a case study.
Case:
There was a closely held company floated by all family members. All the family members own shares in the Company. The family has active participation in other companies too. In the company as referred to, few members are actively involved in day-to-day management of the company and few other members are not involved in day-to-day management. While this is the case, one of the family members who are qualified to approach the Company Law Board under section 399 of the Companies Act, 1956, approaches the Company Law Board alleging some mismanagement in the Company. The applicant before the Board refers to many irregularities and especially the action of the majority in selling the company properties for throw away price. The majority has taken a stand denying the allegation that the properties of the company are sold for a throw away price and also specifically alleges that the applicant before the CLB did not participate in the day-to-day affairs of the Company. The Board has given an exit option to the applicant rather looking into the issue of irregularities.
The issues for consideration in the above case are like:
1. Will the majority be allowed to contend that they are privileged in the company as they run the company and participate in the day- to-day affairs of the company?
2. How to deal with the issue of undervaluation of company properties in the given case?
3. Whether the applicant before the Board be forced to exercise exist option on the ground that he did not participate in the day-to-day affairs of the Company.
Study of case and the issues:
With regard to the first issue, barring the rights provided under the Companies Act, 1956, the majority can never contend that it is privileged as it is involved in day-to-day affairs of the Company. It is same even in family companies as company is a company irrespective of its shareholding pattern or kind. The Act deal with the issue of incorporation and functioning of the company and in a family companies, the understanding and the regulations contained in the Articles matters more. But, no where it is provided in the Act that the a person or a group which is taking care of the day-to-day affairs of the Company is privileged over the minority keeping the provisions of the Act apart. A shareholder is a shareholder and he has every right to question the misdeeds in the company and he need not participate in day-to-day affairs of the company thinking that the directors are expected to act fairly in the interest of all the shareholders. As such, in my opinion, the issue of non-participation in the affairs of the company or its functioning can not be given significance under company law.
The second issue is very very complicated. Some companies over values its properties and procures loan. Few other companies under values the company properties in order to get away from paying taxes to the Government. The overvaluation may not create much problem to the shareholders and the creditors are duty bound to inquire and looking into the issue of overvaluation when the company approaches them for a loan. But, the issue of undervaluation is very very dangerous. The problem with the undervaluation is that most of the money goes unaccounted. The minority may allege that the valuable properties of the company are sold for a throw away price and the majority may show the guideline value at the area. It is very very complicated issue to deal with. Because, once the properties are sold, then, the purchasers' interests are also to be considered. The issue of Board's power in setting aside the deeds to be looked into so carefully. Its one of the very complicated areas under section 397/398. The applicant before the Board who alleges oppression and mismanagement in the company should be able to prove that the properties are sold for a throw away price and for that he should resort to the enquiry as is being done by the Rent Control Courts while fixing the fair rent. What I feel is that the second issue as referred to above is always complicated.
With regard to the third issue, though the Board is empowered with many powers in the interests of the Company and as provided under section 397/398 of the Act, I don't think that it is right to force the applicant to exercise exist option on the ground that the applicant did not participate in the day-to-day affairs of the Company.
Note:
1. I am aware of various complications in Company Law and especially in applications under section 397/398 of the Act.
2. I have only expressed my opinion on the subject and I will be very happy to know the things not known and If somebody highlights the mistakes in my opinion above with reasons I will be very happy.