2019 (11) TMI 1465 - Tri - Companies Law

Oppression and mismanagement - illegal allotment of shares by converting their short-term loans into equity - rectification of register of members - restraint on respondents from taking up or passing any resolution on issue of unsecured FCD - Whether the Respondents in their capacity as Directors of the Company had failed in complying the fiduciary duty towards the shareholders? - HELD THAT - The company is merely discharging their contractual obligation of converting the loans into the equity shares to those four directors. This is in no way a violation of the fiduciary duties of the Directors - It does not lay down a law that fiduciary duty of a director to the company extends to a shareholder so as to entitle him to be informed of all the important decisions taken by the Board of Directors. Such a broad proposition of law, if understood to have been laid down in Dale and Carrington, would be inconsistent with the duty of a director vis-Rs.-vis the Company and the settled law that the statutory duty of a director is primarily to look after the interests of the company - there are no merit in the argument that Board of Directors have failed in their fiduciary duty by converting the loans of Directors into equity shares. Whether the conversion of loan into 1,70,060 equity shares in favour of four respondent directors herein was valid in law? - HELD THAT - T he said act of allotment of shares by conversion of unsecured loan to the four directors is an isolated act by the Board of Directors and not a continuous one. The judgement of NEEDLE INDUSTRIES (INDIA) LTD. VERSUS NEEDLE INDUSTRIES NEWEY (INDIA) HOLDING LTD. 1981 (5) TMI 89 - SUPREME COURT and SHANTI PRASAD JAIN VERSUS KALINGA TUBES LTD. 1965 (1) TMI 17 - SUPREME COURT inter alia reads 'that it has been held that the person complaining of oppression must show that they have been constrained to submit a conduct which lacks probity, conduct which is unfair to them and which cause prejudice to them in exercise of their legal and proprietary rights as shareholders. It was further held oppression should be a continuous act continuing till the date of filing the petition.' - the petitioner failed to prove the continuing oppressive acts conclusively and we cannot rely upon a single act of the directors as an oppressive act. Whether the preferential allotment proposed in Annual General Meeting amounts to oppression and mismanagement to the minority shareholders? - Whether the issue of oppression and/or mis-management on the part of the Respondents herein in running the affairs of the Company towards the Petitioners No. 1 2 have been proved? - HELD THAT - The purpose of the preferential allotment of 1,60,000 shares is for meeting the working capital requirements and bank loan repayment obligations and its expansion and future modernization. This in no way can be said to benefit the Directors and their friends/relatives. Further, the preferential allotment was also proposed as per Article 8 of the Articles of Association of 1st Respondent company. Also the petitioners in the instant petition were also the beneficiaries of the same Article 8, by which a mere holding of 15 shares by them in 2008 has got 22,015 shares - the petitioners cannot claim oppression and mismanagement as the preferential allotment was also being proposed under the same Article 8 of the Articles of Association. It is not acceptable when it suits you and keep quiet; and raise an issue when it does not suit you. The petitioner failed to prove the oppression and mismanagement on part of the respondents herein in running the affairs of the company towards them as claimed by them by the points mentioned as facts for consideration - petition dismissed.

Summary

Issues Involved:
1. Compliance with fiduciary duty by Directors.
2. Validity of the conversion of loans into equity shares.
3. Allegations of oppression and mismanagement related to preferential share allotment.
4. Proof of continuous oppressive acts by the Respondents.

Detailed Analysis:

Point (i): Compliance with Fiduciary Duty by Directors:

38. FIDUCIARY DUTY: Chapter IX of the Indian Trusts Act provides for certain obligations in the nature of trusts. By reason of Section 88 of the Indian Trusts Act, a person bound in fiduciary character is required to protect the interests of other persons but the heart and soul thereof is that as between two persons one is bound to protect the interests of the other and if the former availing of that relationship makes a pecuniary gain for himself; Section 88 would be attracted. What is sought to be prevented by a person holding such fiduciary benefit is unjust enrichment or unjust benefit derived from another which is against conscience that he should keep. When a person makes a pecuniary gain by reason of a transaction, the cestui qui trust created thereunder must be restored back.

39. The issue to be considered in the instant petition is the purported breach of trust on the part of Respondents 2 to 10, who are the Directors of the 1st Respondent Company, pertaining to conversion of loan to 1,70,060 equity shares.

40. To arrive at a conclusion on the first point of consideration, we have relied on the following case laws/judgements:

Sangram Singh Gaekwad vs. Santadevi Gaewad (2005) 11 SCC 374,

"….A Director of a Company indisputably stands in a fiduciary capacity vis-avis the Company. He must act for the paramount interest of the company. He does not have any statutory duty to perform so far as individual shareholders are concerned subject of course to any special arrangement which may be entered into or a special circumstance that may arise in a particular case. Each case, thus, is required to be considered having regard to the fact situation obtaining therein and having regard to the existence of any special arrangement or special circumstance."

The aforementioned principles of law found favour with the Court in Needle Industries (India) Ltd. and Others Vs. Needle Industries Newey (India) Holding Ltd. and Others [ (1981) 3 SCC 333] wherein it was held:

"Where directors of a company seek, by entering into an agreement to issue new shares, to prevent a majority shareholder from exercising control of the company, they will not be held to have failed in fiduciary duty to the company if they act in good faith in what they believe, on reasonable grounds, to be the interests of the company. If the directors&39; primary purpose is to act in the interests of the company, they are acting in good faith even though they also benefit as a result."

"If the shares are issued in the larger interest of the company, the decision to issue shares cannot be struck down on the ground that it has incidentally benefited the Directors in their capacity as shareholders."

41. After going through the above case laws regarding the first point of consideration, we came to a conclusion that in the instant case, the Directors of the Respondent company has acted in the best interest of the company. Given the fact that for the first time, in 62 years of existence, the 1st respondent company suffered a massive loss of ? 66.33 lakhs, which completely eroded the net worth of the Company. To tide over this precarious situation, the Board of Directors have gone ahead and taken a decision to modernize their plant at Thrissur Unit for ? 312 Lakhs. Out of which they mobilized ? 110 lakhs from Canara Bank and balance ? 202 Lakhs, by way of loans from the Directors.

42. We have also gone through the Loan Agreement submitted as Annexure R VIA, VIB, VIC to the petition and the clause 5 clearly stipulates that in the event of non-payment of interest, the company have to convert the loan into shares. We are of the view that the company is merely discharging their contractual obligation of converting the loans into the equity shares to those four directors. This is in no way a violation of the fiduciary duties of the Directors.

43. We are firmly of the view of taking into consideration the financial health of the 1st respondent company during that period, the acts of the directors can be justified as taken in the best interest of the respondent company.

The above conclusion is also substantiated in the judgement of M/s. Harinagar Sugar Mills Ltd. Vs. Shyam Sunder Jhunjhunwala & Others [ (1962) 2 SCR 339].

44. The counsel for the petitioner had mentioned the judgement in Dale and Carrington (Supra) in support of his averments as observed by the Hon&39;ble Supreme Court in Sangramsinh P. Gaekwad (Supra), that the rationale in Dale and Carrington (supra), thus, must be understood to have been rendered in the fact situation obtaining in that case. It does not lay down a law that fiduciary duty of a director to the company extends to a shareholder so as to entitle him to be informed of all the important decisions taken by the Board of Directors. Such a broad proposition of law, if understood to have been laid down in Dale and Carrington, would be inconsistent with the duty of a director vis-Rs.-vis the Company and the settled law that the statutory duty of a director is primarily to look after the interests of the company.

45. We therefore find no merit in the argument that Board of Directors have failed in their fiduciary duty by converting the loans of Directors into equity shares.

Point (ii): Validity of the Conversion of Loans into Equity Shares:

46. To arrive at a definitive conclusion whether the conversion of loan into equity shares in favour of four respondent directors herein was valid in law, we have gone through the following leading case laws/judgements:

47. While dealing with an application under Section 210 of the English Act (which is similar to Section 397 of the Companies Act, 1956), ROXBURGH, J., put it succinctly that "the purpose of Section 210 of the English Act, is not so much to rake up the past as to redeem the future". When the case went on appeal to the court of Appeal in In Re, H.R. Harmer Ltd {1958 (3) All.E.R. 689} Jenkins, L.J., also pointed out that "the phrase &39;the affairs of the company are being conducted&39; suggest prima facie, a continuing process and is wide enough to cover oppression by anyone who is taking part in the conduct of the affairs of the company".

48. The decision In Re, H.R. Harmer along with two other English decisions in Elder&39;s case and Meyer&39;s case, were quoted with approval in one of the earliest decisions of the Supreme Court in Shanti Prasad Jain vs. Kalinga Tubes Ltd {1965 (35) Com. Case 351}. It was held in the said decision as follows:-

"There must be continuous acts on the part of the majority shareholders, continuing up to the date of petition, showing that the affairs of the company were being conducted in a manner oppressive to some part of the members."

In Needle Industries (India) Ltd vs. Needle Industries Newey (India) Holding Ltd { 1981 (3) SCC 333}, the Hon&39;ble Supreme Court held that "…an isolated act, which is contrary to law, may not necessarily and by itself support the inference that the law was violated with a mala fide intention or that such violation was burdensome, harsh and wrongful. It was also pointed out that a series of illegal acts following upon one another can, in the context, lead justifiably to the conclusion that they are part of the same transaction, of which, the object is to cause or commit the oppression of persons against whom those acts are directed."

49. After going through the above case laws and points which are taken for consideration in the instant petition, we have come to the conclusion that the said act of allotment of shares by conversion of unsecured loan to the four directors is an isolated act by the Board of Directors and not a continuous one. The judgement of Needle Industries (India) Ltd vs. Needle Industries Newey (India) Holding Ltd (Supra) and Shanti Prasad Jain vs. Kalinga Tubes Ltd (Supra) inter alia reads &39;that it has been held that the person complaining of oppression must show that they have been constrained to submit a conduct which lacks probity, conduct which is unfair to them and which cause prejudice to them in exercise of their legal and proprietary rights as shareholders. It was further held oppression should be a continuous act continuing till the date of filing the petition.&39;

50. In the instant case, the petitioner failed to prove the continuing oppressive acts conclusively and we cannot rely upon a single act of the directors as an oppressive act, as per the aforementioned judgements of Hon&39;ble Supreme Court.

Point (iii) & (iv): Allegations of Oppression and Mismanagement:

51. As regards the third point, the resolution passed on Agenda item No.6 in Annual General Meeting held on 26.09.2014, i.e., regarding the preferential issue of shares, on which the Hon&39;ble Company Law Tribunal, Chennai has passed an interim Order is also for furtherance of the best interest of the respondent company and not to gain any pecuniary benefit by the existing Board of Directors. The purpose of the preferential allotment of 1,60,000 shares is for meeting the working capital requirements and bank loan repayment obligations and its expansion and future modernization. This in no way can be said to benefit the Directors and their friends/relatives. Further, the preferential allotment was also proposed as per Article 8 of the Articles of Association of 1st Respondent company. We also observed that the petitioners in the instant petition were also the beneficiaries of the same Article 8, by which a mere holding of 15 shares by them in 2008 has got 22,015 shares. As such now, the petitioners cannot claim oppression and mismanagement as the preferential allotment was also being proposed under the same Article 8 of the Articles of Association. It is not acceptable when it suits you and keep quiet; and raise an issue when it does not suit you.

52. Accordingly, we reject the contentions of the petitioners that the above preferential allotment was in violation of the Companies Act.

53. We therefore, of the view that the above facts clearly establish that the petitioner failed to prove the oppression and mismanagement on part of the respondents herein in running the affairs of the company towards them as claimed by them by the points mentioned as facts for consideration by us.

Conclusion:

54. This Bench, on hearing both the parties at length and after perusing the whole case records, the following are the final findings/observations and Orders:

i. We have not found any merit in the averments made by the petitioner as the purported act of allotment of shares to the four Directors by converting their short-term loan with accrued interest into equity shares as this is done as per the Board Resolution