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TMI Blog2004 (9) TMI 385X X X X Extracts X X X X X X X X Extracts X X X X ..... ffer with the finding of the High Court. No merit in the contention that the petition under sections 397/398 of the Companies Act, filed by the Prathapan and his wife before the Company Law Board was not maintainable. No merit in the argument that the High Court exceeded its jurisdiction under section 10F of the Companies Act while deciding the appeal. The relief granted by the High Court was a proper relief in the facts of the case. - CIVIL APPEAL NOS. 5915 TO 5918 OF 2002 - - - Dated:- 13-9-2004 - MRS. RUMA PAL AND ARUN KUMAR, JJ. Dushyant A. Dave, Krishnan Venugopal, K.S. Venugopal, E.B. Shaji, Nikhil Goel, Prasad Vijay Kumar, A. Venugopal and A.D. Sikri for the Appellant. S. Ganesh, Joseph Kodianthapa, Ajay K. Jain, Saji Kurup, Deepak Prakash and M.P. Vinod for the Respondent. JUDGMENT Arun Kumar, J. - P.K. Ramanujam, appellant 2 and P.K. Prathapan and his wife Pushpa Prathapan, respondents 1 and 2 are the contesting parties in this litigation. Appellant 1 is the company in which they are all shareholders and the litigation is about its control and management. Both parties are making claims to the right to control and manage the company. Br ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be paid in cash to the vendors out of which Rs. 5 lakhs (Rupees five lakhs) were re ceived from Prathapan and a sum of Rs. 50,000 (Rupees Fifty Thousand) was invested by Muralidharan, brother of Prathapan. The rest of the amount came from other respondents. There was no financial contribu-tion by Ramanujam. Initially Ramanujam and his wife Draupathy were the Directors of the company. However, in December, 1988 Draupathy was dropped as director and in her place Muralidharan, brother of Prathapan and Suresh Babu, brother of Prathapan s wife, were taken as Directors of the Company. 5000 (five thousand) equity shares worth Rupees five lakhs were allotted in the name of Smt. Kalyani Kochuraman, mother of Prathapan against the investment of Rupees Five Lakhs. These 5000 equity shares were subsequently transferred in the name of Prathapan and his wife, 2500 (two thousand five hundred) each, subject to the transferees obtaining requisite permission of the Reserve Bank of India under the Foreign Exchange Regulation Act (FERA). The transfer of shares in the name of Prathapan and his wife Pushpa was duly recorded in the Register of Members maintained by the company. Thus Prathapan and his w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e year 1998 Prathapan is said to have come to India to consider acquiring another Hotel for expanding the business of the company. At that time he is said to have discovered certain startling facts about the company. The most important fact which is at the centre of the controversy in this case is that the company s authorised capital was increased from Rs. 15 lakhs to Rs. 25 lakhs and thereafter to Rs. 35 lakhs without the knowledge of Prathapan, a principal shareholder of the company. Further in an alleged meeting of the Board of Directors of the company said to have been held on 24th October, 1994, chaired by Ramanujam, the Board of Directors of the company is said to have been informed about a sum of Rs. 6,86,500 (Rupees six lakhs eighty six thousand five hundred only) standing to the credit of Ramanujam in the books of the company. He made a proposal for allotment of shares in lieu of that amount in his favour. As per the case of Ramanujam the Board allotted 6,865 equity shares of Rs. 100 each in the said meeting in his favour. According to Prathapan he was never made aware of the increase in authorised share capital of the Company and the alleged allotment of additional equit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d before the Company Law Board for rectification of the Register of Members so as to delete the entries recording of transfer of shares in favour of Prathapan and his wife. This was on the ground that they had failed to obtain permission of the Reserve Bank of India under the Foreign Ex change Regulation Act regarding transfer of shares in their favour. 9. In the proceedings in the petition under sections 397 and 398 of the Companies Act, locus standi of Prathapan and his wife to file the petition was challenged. This issue was decided by the Company Law Board against Ramanujam. The petition for rectification of Register of members was dismissed. However, Prathapan was aggrieved about the relief granted by the Company Law Board. In spite of the finding on oppression being in his favour, he was asked to sell his shares and leave the company. Ramanujam was aggrieved of the finding of oppression against him and of the dismissal of the application for rectification of Register of Members. Both parties approached the High Court of Kerala against the judgment of the Company Law Board. The High Court maintained the judgment of the Company Law Board so far as the rejection of petitio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Exchange Regulation Act (FERA) by Prathapan regarding transfer of shares in his and his wife s favour ? Did Prathapan and his wife Pushpa have no locus standi to file the petition under sections 397 and 398 of the Companies Act before the Company Law Board ? Issue 3. Scope of power of the High Court in an appeal under section 10F of the Companies Act; Issue 4. Relief to be granted to a majority shareholder who by an act of oppression on the part of management of the company is converted into a minority shareholder. Issue 1. Validity of allotment of equity shares 11. This is the main issue which arises for consideration in this case. As already noted Ramanujam who was the Managing Director of the company got allotted 6865 equity shares to himself in a meeting of the Board of Directors of the company alleged to have been held on 24th October, 1994. Again on 26th March, 1997 he managed to get allotted further 9800 equity shares to himself. Prathapan has challenged these allotments of shares in favour of Ramanujam as acts of oppression on the part of Ramanujam, the Chairman and Managing Director of the company for which he filed a petition under sections 397 and 398 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... absolute discretion allot such number of shares as they think proper..." Article 38 requires that the Directors present at the Board Meeting shall write their names and sign in a book specially kept for the purpose. Article 4( iii ) prohibits any invitation to the public to subscribe for any shares or debentures of the company. The above provisions of the Articles of Association show that the Board of Directors have an absolute discretion in the matter of allotment of shares. But this pre-supposes that such a decision has to be taken by the Board of Directors. The decision is taken by the Board of Directors only in meetings of the Bo- ard and not elsewhere. Ramanujam, the Managing Director cannot take a decision on his own to allot shares to himself. If Suresh Babu was present in the meeting, as is the case of Ramanujam, he must have signed a book specially kept for recording presence of the Directors at the Board Meeting in terms of article 38. Ramanujam should have been the first person to produce such a book to show the presence of Suresh Babu at the alleged Board meeting said to have been held on 24th October, 1994, specially when Suresh Babu was denying his presence at the me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... On the relevant date Suresh Babu was the only other Director of the Company. He denies having attended any meeting of the Board of Directors of the company. There is nothing to rebut this stand of Suresh Babu. In his absence no valid meeting of the Board of Directors could be held. ( c )For considering this point let us assume that a meeting of the Board of Directors of the company did take place as alleged by Ramanujam. First question that arises is whether the company required additional funds for which the shares were issued. We have already referred to Balance Sheets of the company, copies whereof have been placed on record. Till 31st March, 1993 the Balance Sheets did not show any investment of substantial amounts of money in the company. It is the Balance Sheet for the year ending 31st March, 1994 which for the first time shows an advance of Rs. 6,86,500 towards share capital pending allotment. Nothing has been placed on record to show that during the financial year 1993-94, i.e., 1st April, 1993 to 31st March, 1994 suddenly need had arisen for a substantial investment. The company was running a hotel, the property whereof was owned by the company. No particular reason f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also trustees for the shareholders of the company. To the extent the power of the Directors are delineated in the Memorandum and Articles of Association of the company, the Directors are bound to act accordingly. As agents of the company they must act within the scope of their authority and must disclose that they are acting on behalf of the company. The fiduciary capacity within which the Directors have to act enjoins upon them a duty to act on behalf of a company with utmost good faith, utmost care and skill and due diligence and in the interest of the company they represent. They have a duty to make full and honest disclosure to the shareholders regarding all important matters relating to the company. It follows that in the matter of issue of additional shares, the directors owe a fiduciary duty to issue shares for a proper purpose. This duty is owed by them to the shareholders of the company. Therefore, even though section 81 of the Companies Act which contains certain requirements in the matter of issue of further share capital by a company does not apply to private limited companies, the directors in a private limited company are expected to make a disclosure to the sharehol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... without informing other shareholders about it and without offering them to any other shareholder, the action was totally mala fide and the sole object of Ramanujam in this was to gain control of the company by becoming a majority shareholder. This was clearly an act of oppression on the part of Ramanujam towards the other shareholder who has been reduced to a minority shareholder as a result of this act. Such allotments of shares have to be set aside. 11.4 On the role of Directors, the law is well settled. The position has been the subject-matter of various decisions. Some of them are: In Regal (Hastings) Ltd. v. Gulliver 1942 (1) All. ER 379 Lord Russell of Killowen observed as under: "Directors of a limited company are the creatures of a statute and occupy a position peculiar to themselves. In some respects they resemble trustees, in others they do not. In some respects they resemble agents, in others they do not. In some respects they resemble managing partners in others they do not. The said judgment quotes from Principles of Equity by Lord Kames. In one sentence the entire concept is conveyed. The sentence runs Equity prohibits a trustee from making any profit b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an improper motive, the issue is liable to be set aside and it is immaterial that the issue is made in a bona fide belief that it is in the interest of the company...." (p. 339) In Needle Industries (India) Ltd. s case ( supra ) the Board of Directors had resolved to issue 16000 equity shares of Rs. 100 each to be offered as rights shares to the existing shareholders in proportion to the shares held by them. The offer was to be made by a notice specifying the number of shares to which each shareholder was entitled to. The notice further said, in case the offer was not accepted within 16 days from the date on which it was made, it was to be deemed to have been declined by the concerned shareholder. The Holding Company held 18990 shares and it was entitled to 9495 rights shares. The Holding Company could not avail its right to exercise the option for purchase of rights shares offered to it. As a result the whole of the Rights Issue consisting of 16000 shares was allotted to the Indian shareholders. The Holding Company filed a petition under sections 397 and 398 of the Companies Act, 1956 in the High Court. The Single Judge held in favour of the Holding Company that it had suf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ol over the affairs of the company, the same cannot be upheld. 11.6 Courts in the Commonwealth countries including England and Australia have emphasized that the duty of the Directors does not stop at to act bona fide requirement. They have evolved a doctrine called the proper purpose doctrine regarding the duties of company directors. In Hogg s case ( supra ), explicit recognition was given to the proper purpose test over and above the traditional bona fide test. In this case the director had allotted shares with special voting rights to the trustees of a scheme set up or the benefit of company employees with the primary purpose of avoiding a takeover bid. Buckley, J. found as a fact that the directors had acted in subjective good faith. They had indeed honestly believed that their actions were in best interests of the company. Despite this it was observed: "...an essential element of the scheme, and indeed its primary purpose, was to ensure control of the company by the directors and those whom they could confidently regard as their supporters." As such, he concluded that the allotment was liable to be set aside as a consequence of the exercise of the power for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lan with other directors to convert petitioner Barooah into a minority and to obtain full and exclusive control and management of the affairs of the company. In a petition filed under sections 397 and 398 of the Companies Act, 1956, acts of Khaund were found to be by way of oppression and mismanagement within the meaning of sections 397 and 398 of the Companies Act. Allotment of 100 equity shares by the company to Khaund at a meeting of the Board of Directors said to have been held on 14th January, 1971 was held to be illegal. The Board of Directors of the company was superseded and a special officer was appointed to carry on management of the company with the advice of Barooah, Khaund and a representative of labour union. There were several other directions issued by the court which are not necessary to be mentioned here. The Division Bench considered in detail the relevant legal position. Without using the phrase proper purpose doctrine the principle enunciated therein, was applied. The following observations of Justice A.N. Sen are reproduced: "It is well settled that the directors may exercise their powers bona fide and in the interest of the company. If the directors e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r relief against the act of oppression complained of by him, and, on the other hand, may add to his suffering and griev ance and cause him greater hardship. Such an order will not further the ends of justice and indeed the cause of justice may be defeated." On the question of issue of fresh share capital, it was held to be illegal to issue shares to only one shareholder. This was held to be a violation of common law right of every shareholder. Common Law recognized a pre-emptive right of a shareholder to participate in further issue of shares however. In India in view of section 81 of the Companies Act, such a right cannot be found for sure. However, the test to be applied in such cases which requires the court to examine as to whether the shares were issued bona fide and for the benefit of the company, would import such considerations in case of private limited companies under the Indian Law. Existence of right to issue shares to one director may technically be there, but the question whether the right has been exercised bona fide and in the interests of the company has to be considered in facts of each case and if it is found that it is not so, such allotment is liable to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the majority shareholders regarding issue of further share capital. The High Court accepted the finding of oppression. However, it placed it on a much broader base by taking into consideration various other factors. The High Court s finding is based on a much stronger footing. In fact, the High Court has gone on to conclude that Ramanujam has played a fraud on the minority shareholders by manipulating the allotment of shares in his favour. We find no reason to differ with the finding of the High Court. Issue 2 12. This brings us to the issue regarding locus standi of Pratha pan and Prathapan s family to maintain the petition under sections 397 and 398 of the Companies Act and their failure to obtain permission of the Reserve Bank of India as per section 29 of the Foreign Exchange Regulation Act. So far as the question of permission of the Reserve Bank of India under FERA is concerned the same can be obtained ex post facto . This stands concluded by judgment of this Court in LIC of India v. Escorts Ltd. [1986] 1 SCC 264. The statute does not provide any time limit for obtaining the permission. We cannot lose sight of the subsequent development in this connection. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... behalf which, in fact, led Ramanujam to file a petition for rectification of the Register of Members as a counter blast to the petition filed by Prathapan under section 397/398 of the Companies Act. It is not open to Ramanujam now to raise the question of FERA violation, more particularly in view of his having recorded the transfer of shares in the name of Prathapan and his wife Pushpa in the records of the Company. This also answers the objection regarding locus standi of Prathapan and his wife to file the section 397/398 petition before the company Law Board. Since they were registered as shareholders of the company on the date of filing of the petition and they held the requisite number of shares in the company, they could maintain the petition. 12.3 We, therefore, find no merit in the contention that the petition under sections 397/398 of the Companies Act, filed by the Prathapan and his wife before the Company Law Board was not maintainable. Issue 3 : Scope of power of High Court in appeal under section 10F of the Companies Act 13. We have now to deal with the question of scope of appeal filed under section 10F of the Companies Act by Prathapan in the High Court. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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