2014 (7) TMI 224 - Board - Companies Law

Oppression and mismanagement in the affairs of the Respondent Company - diversion of the rights issue funds - refund of the capital contribution made in the firm from the firm s account to the company account - Held that - Admittedly, the scheme of rights issue was brought for the purpose of discharging the liabilities of the Company and to improve its net-worth. There is nothing on record to show that the liabilities of the Company stands discharge or its net-worth has improved by making investment/utilization of the rights fund by the then Directors. Therefore, the fund received under the rights issue has not been invested for the purpose for which it was meant. - it is also not disputed that the other object of the letter of offer which inter alia states that besides the present rights issue, the company also needs to redeem its existing preference shares having nominal value of ₹ 50 lakhs for which the company proposes to reissue the said shares to the existing shareholders in future has not been complied with. Major subscribers to the rights issue wrote a letter to the then Directors to maintain status quo in respect of all immovable and movable assets of the company, yet they did not pay any heed to it. It is pertinent to note here that earlier directors knowing fully well that they are being removed from the Board of Directors constituted their own partnership firm and diverted the entire rights issue funds of the shareholders. It is, also undisputed fact that son of the one of the erstwhile Director is also a partner in the partnership firm which supports the case of the Petitioners that the diversion of the funds of the company has been solely for the personal gains of the erstwhile Directors. Answering Respondents have not even given any data to show that the company is getting the profits, if any, earned by the said partnership firm in which the investment has been made. It will not be out of place to mention here that the Ld. Counsel appearing for the Answering Respondents, upon a query raised by the Board, had answered that the total annual return on the said investment in the partnership firm is approx. 6% p.a which in my considered view, is absolutely inadequate. Therefore, in the absence of any material on record and in direct contravention of the purpose and object for which the scheme of rights issue was issued, making investment by the erstwhile Directors of the Company in the partnership firm-in-dispute is patently mala fide. - Decided in favour of petitioner.

Issues Involved:
1. Allegations of oppression and mismanagement under Sections 397-398 read with Section 402 of the Companies Act.
2. Legality of the rights issue and the Board of Directors' (BOD) resolution.
3. Diversion of rights issue funds and the responsibility of the then directors.
4. Investment in the partnership firm M/s Genesis Financials.
5. Compliance with the purpose of the rights issue.
6. Bona fide actions of the erstwhile directors.

Detailed Analysis:

Allegations of Oppression and Mismanagement:
The Petitioners filed a Company Petition alleging acts of oppression and mismanagement in the affairs of the Respondent Company. They sought reliefs including the declaration of the rights issue and the BOD resolution as illegal, and the suspension of the current BOD from taking further actions without convening a General Body Meeting.

Legality of the Rights Issue and BOD Resolution:
The Petitioners challenged the legality of the letter of offer for the rights issue and the BOD resolution dated 11/04/2012. The initial order required the Respondent Company to show the procedural compliance for the rights issue. The Respondent Company appealed this order, leading to a consent order from the High Court, allowing the rights issue to proceed temporarily.

Diversion of Rights Issue Funds:
The Petitioners alleged that Rs. 1.45 crores collected under the rights issue were diverted to M/s Genesis Financials, a partnership firm involving the son of one of the erstwhile directors. They sought orders declaring this diversion illegal and directing prosecution against the then BOD for making false declarations.

Investment in M/s Genesis Financials:
The Respondents justified the investment in M/s Genesis Financials, claiming it was in the company's best interest and consistent with past practices. They argued that the business decisions of the BOD should not be interfered with under Sections 397 and 398 of the Act.

Compliance with the Purpose of the Rights Issue:
The Petitioners argued that the rights issue funds were neither used to discharge the company's liabilities nor to improve its net-worth, as stated in the application form for the rights issue. The court noted that the investment in the partnership firm did not comply with the stated purposes of the rights issue.

Bona Fide Actions of the Erstwhile Directors:
The court found that the erstwhile directors acted with mala fide intentions by diverting the rights issue funds to a partnership firm involving personal interests. The investment yielded only a 6% return, which was inadequate compared to a fixed deposit's potential return of 10% or more. The court concluded that the directors did not act bona fide.

Conclusion:
The court directed the Respondents to deposit the diverted funds in a nationalized bank in a fixed deposit scheme. The Respondents were warned of legal consequences for non-compliance. The court allowed the application, directing the restoration of the diverted funds to the company's account and ensuring that any future investment decisions comply with the stated purposes of the rights issue. The case was renotified for final arguments.

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