Prevention of Oppression and Mismanagement

A company in a broad sense is a group of persons who have come together or who have contributed money for some common purpose and have incorporated themselves into distinct legal entity. Company is the amalgamation of two distinct words- “com” and “pain”, the former meaning with/together and the later meaning “bread”. [1] The whole scheme of the Companies Act, 1956 is to ensure proper conduct of the affairs of the company in public interest and preservation of image of country in public interest.

Majority rule is hallmark of democracy. It equally applies to corporate democracy and is not free from pitfalls and abuse. Corporate democracy is more vulnerable to it because it is reckoned with the number of shares and not with number of individuals involved. The rule of majority [2] has been made applicable to the management of the affairs of the company. The members pass resolution on various subjects either by simple or three-fourth majority. Once resolution is passed by majority it is binding on all members. As a resultant corollary, court will not ordinarily intervene to protect the minority interest affected by resolution. However there are exceptions to this rule- Prevention of Oppression and mismanagement being one such ground.

With a view to check abuse of majority power, the Companies Act contains special provisions for Prevention of Oppression and Mismanagement. Chapter VI of the Companies Act deals with this. The chapter is in two parts- Part ‘A’ deals with Powers of Company Law Board (Sec 397-407) and Part ‘B’ deals with Powers of Central Government (Sec 408-409). By 1988 Amendment power under Sec409 are transferred to CLB. Further powers of Central Government are exercisable only if directed by the CLB. There can also be a composite petition under Sec 397/398 and under Sec 433(f) [winding up of company for just and equitable reasons] for relief against oppression and mismanagement. This was valid when the jurisdiction for both was exercisable by court. Presently, jurisdiction under section 397/398 the CLB can order winding up. With the amendment of 2002, powers of the CLB and of court are transferred to Tribunal. Tribunal is yet to be established. Upon its establishment, it may hold good to say that powers under sec 397/398 and under sec 433(f) are exercisable by the Tribunal.

The requisite number of members to make an application before the Tribunal is [3] :

In case of Company having share capital: 100 members or 1/10th of total number of its members, whichever is less or member/s holding not less that 1/10th issued capital. The applicants should have paid all calls and other sum due on their shares.

In case of Company not having a share capital: not less than 1/5th of total number of the members. In case of joint shareholding they will be counted as only one member.

Ch- I PREVENTION OF OPPRESSION

The meaning of the term “oppression” as explained by Lord Cooper in the Scottish case of Elder v. Elder & Watson Ltd. [4] , was cited with approval by Wanchoo J. of the Supreme Court of India in Shanti Prasad Jain v. Kalinga Tubes [5] . He said that the conduct complained of should, at least, involve a visible departure from the standards of their dealing, and violations of conditions of fair play on which every shareholder who entrusts his money to Company is entitled to rely. The complaining member must show that he is suffering from oppression in his capacity as a member and not in any other capacity.

To constitute oppression, persons concerned with the management of the company’s affairs must in connection therewith be guilty of fraud, misfeasance or misconduct towards the members. It does not include mere domestic disputes between directors and members or lack of confidence between one set of members and others. [6]

It was observed in Rao (V.M) v. Rajeswari Ramakrishnan [7] :

That the oppression complained off must affect a person in his capacity or character as a member of the company; harsh or unfair treatment in other capacity, e.g., as a director or a creditor is outside the purview of the section.

There must be continuous acts constituting oppression up to the date of the petition.

The events have to be considered not in isolation but as a part of a continuous story.

It must be shown as a preliminary to the application of section 397 that there is just and equitable ground for winding up the company.

The conduct complained of can be said to be “oppression” only when it could be said that it is burdensome harsh and wrongful; oppression involves at least an element of lack of probity and fair dealing to a member in matters of his proprietary right as a shareholder. [8]

There are preliminary conditions which must be satisfied to entitle a shareholder to relief under S397:

The company’s affairs are being conducted in a manner

Prejudicial to public interest or oppressive to any member/s

Which would make it just and equitable to wind up the company, but,

Winding up would unfairly prejudice such member/s [9]

It is not necessary to establish any personal prejudice for any relief under the section. [10] Tribunal has been given the powers to impose upon the parties whatever solution the Tribunal considers just and equitable.

Circumstances which amount to oppression

Looking at the judicial pronouncements a few acts which amount to oppression are listed below:

Attempt to force new and more risky objects upon an unwilling minority may in circumstances amount to oppression. This can be best illustrated with the case of Hindustan Coop Insurance Society Ltd, Re. [11] Here, a life insurance business of a company was acquired by Life Insurance Corporation in1956 on payment of compensation. Directors, who had majority voting powers, refused to distribute this amount among share holders. Rather, they passed a special resolution changing the objects of the company and use compensation money for new objects. This was held to be an oppression. Here the majority forced the minority shareholders to invest money in different kind of business against their will. [12]

An attempt to deprive a member of his ordinary membership rights is “oppression”, as in the case of Mohan Lal Chandumall v. Punjab Co. Ltd [13] . In the instant case, a public company doing forward contract business amended its articles of association under statutory directions, so as to deprive its non-trading members their right to vote, to call meetings, to elect directors and receive dividends. Court held that “the company in doing so trampled upon valuable rights of such members by unjust exercise of its authority and power, and this amounted to oppression within Section 377.

Suppressing notices of meetings to some of the members amounts to oppression. Casual omission may not be oppression, but systematic elimination of notices to some of the members is serious deprivation of their most important right. [14]

Continuous refusal by company to register shares with an ulterior motive of retaining control over the affairs of the company. Though the refusal once by the company may not be oppressive, but a continuous refusal by the company to register the shares with an ulterior motive of retaining the control over the affairs of the company where CLB will have to grant relief under Sec 397.- Kumar Exporters (P) Ltd v. Naini Oxygen and Acetylene Gas Ltd.

Failure to distribute the amount of compensation received on nationalization of business of company among members, where requires to be distributed. Hindustan Co-op Insurance Society Ltd, In re [15] – Here, the insurance business of the company was nationalized and compensation was received. The directors did not call any AGM. After three years the board resolved to call a GM and pass a resolution to continue the company and carry on other businesses authorized by memorandum with compensation money received. Sec 39 of the Life Insurance Act envisaged distribution of compensation to shareholders and dissolution of the company. The court held that the resolution and persistent conduct of the respondent in the affairs of the company shows that they never intended to distribute the compensation money amongst the shareholders, who were entitled thereto. This conduct was held to be oppressive to the company and the applicant’s minority shareholding company.

Other instances of oppression may include- issue of further shares benefiting a section of the shareholders; registration of transfers in violation of articles; irregularity in allotment and transfer of shares; denial of inspection of books to shareholder etc.

There is nothing to limit equity shareholdings only. Applicants may be partly or wholly preference share holders too. Any member or members having obtained the consent in writing of requisite number of members may apply. Right to apply is not confined to oppressed minority alone even oppressed majority can apply. [16]

Ch- II PREVENTION OF MISMANAGEMENT [S 398]

Section 398 provides for relief in cases of mismanagement. All the provisions are common with Section 397 except [17] :

The burden of satisfying Tribunal that Company shall be wound up is not in Sec 398.

The word “likely” is used in Sec398 (1) (b). So this section can be invoked not only when there is mis-management but also when it is likely that affairs of company will be conducted prejudicial to public interest or interest of Company on account of material change in management or control of Company.

So, Sec397 is only curative, whereas Sec 398 is both curative and also preventive. Under Sec400, Tribunal shall give notice of every application made to it under Sec397 & 398 to Central Government and shall take into consideration the representations if any made by Government, before passing a final order. [18]

Sec 398(1) (a) will not only take into account acts or conduct of company leading to mismanagement but also non- conduct of the affairs of the company which leads to prejudice caused to the company.

Instances of Mismanagement

A very clear illustration of mismanagement under Section 398 appears in Rajahmundary Electric Corporation v. Nageshwara Rao [19] . Here, a petition was brought against a company by certain shareholders on the ground of mismanagement by directors. Court found that vice-chairman grossly mismanaged the affairs of the company and had drawn considerable amounts for his personal purposes, the shareholders outside the group of chairman were powerless to set matters right. This was held to be sufficient evidence of mismanagement. The court accordingly appointed two administrators for management of company for period of 6 months vesting in them all the powers of the directorate.

Where the managing directors of the Company continued in office after expiry of their terms, without a meeting being held to re-appoint them prior to making fresh application to Central Government under Sec 269, the continuation of office under these conditions was held to be mismanagement.- Sishu Ranjan v. Bholanath Paper House [20]

Where bank account was operated by unauthorized person. Kuldip Singh Dhillon v. Paragon Utility Financers Ltd. In this case, a certified copy of a resolution had been sent to the bank authorizing certain persons to operate the account. No such resolution was found recorded in the minutes book; rather the resolutions passed on the particular date and recorded in the minutes book; rather the resolutions passed on the particular date and recorded in the minutes book were different.

Sale of assets at low price and without compliance with the Act- One of the estates of a tea and rubber plantation company was sold by the direction at a low price to another tea plantation company without complying with the requirements of sec 293(1) which demands approval by shareholders and without giving adequate under Sec 173 and relevant information, giving delivery of possession before general body meeting and accepting consideration in instalment. It was held that all these acts constituted mismanagement of affairs and sale was set aside. The Board of directors and the purchasers were held liable for the company’s losses and were required to submit an account of the income of the estate from the date of delivery of possession to the date of its actual return to the company- Malayalam Plantations Ltd., Re [21]

Violation of statutory provisions and those of articles- Transferring shares without first offering them to the existing members in accordance with their rights under the articles, holding meetings without sending notice to members; issue of shares for consideration other than cash not represented by corresponding assets and burdening the company with additional rental by shifting the company’s office- Akbarali Kalveri v. Konkan Chemicals Ltd. [22]

Other instances include Gross neglect of interest of the company by sale of its only assets and total inattention thereafter to the affairs of the company [23] ; Violation of conditions of company’s memorandum etc.

The famous Satyam fiasco is a very good example of mismanagement of funds of the company and fraudulent accounting, where the Chairman of Satyam Computer Services- Ramalinga Raju in his letter to the Board of Directors confessed to India’s biggest corporate fraud worth Rs 7,000 crore on the company. [24]

Effect of Arbitration Clause [25] – Provisions in the Articles of Association of a company for reference of disputes between Company and director, or between directors or between members cannot oust the jurisdiction of the Court to try petition by member for winding up or petition against oppression and mismanagement.

Partnership- The Supreme Court has laid down that a relief cannot be granted under S 397 and 398 on the analogy of principles applicable partnership and the application of this has to be confined to rare cases for invoking the jurisdiction under S.433 for ordering winding up of small private company. [26]

Banking- A banking company can be wound up only under Part III of Banking Regulation Act and not under the just and equitable clause in Sec 433(f). Consequently no application is maintainable under sec 397 in respect of banking company. [27]

Ch- III RELIEFS AVAILABLE

The reliefs available to the oppressed and the share holders can be divided into Preventive and punitive as follows:

Preventive and corrective measures [28]

Sec 397 and 398 give wide powers to the CLB to make any order with a view to bring to an end the matters complained of or to prevent the matter complained of or apprehended. Section 402 provides for specific kinds of orders that can be passed. Few of them are as follows:

Regulation of conduct of affairs

Purchase of shares of members by other members/ company

Consequential reduction on capital

Termination or modification of contract with managing director, manager or director

Termination of contract/ arrangement with other parties.

Therefore it can be seen that buyback of shares and consequent reduction in capital can take place without recourse to any other provisions of the Act. Emphasis under the above sections is on preventing or curing the ills and not punishing the misdeeds. The powers can be exercised without limitations of other provisions of the Act, Memorandum or Articles of Association. In the case of Needle Industries (India) v. Needle Industries Newey Holding Ltd. [29] , the SC passed an order to make complete justice even after holding that there was no oppression and minority was required to buy majority shares. [30]

Under Sec 408, the Central Government can appoint additional directors/ directors on board of the company if so directed by CLB. The Central government also has powers to issue directions to directors appointed by it and call for the report from them about the affairs of the company. It is more or less a takeover of the management. Under proviso to section 408(1) the CLB has exclusive power to direct the amendment of articles providing for proportionate representation for appointment of directors.

Under Sec 409, CLB has power to direct that no resolution or action having effect of change in board of directors shall be given effect unless confirmed by CLB.

Punitive Measures

Sec 406 provides that provisions of sections 539 to 544 of the Act, as modified vide Schedule XI, are applicable to the proceedings under sections 397/398. These are the provisions providing for penalties and liabilities for falsification of books, frauds and damages etc. but these provisions are rarely invoked. [31]

Section 542 deals with Fraudulent trading. In the winding up of proceedings, if it appears that certain persons have carried on business of company with intent to defraud creditors of the company or any other persons, or for any fraudulent purpose, shall be personally responsible without any limitation of liability, for all or any of the debts or other liabilities of company as Tribunal may direct. Application under 542 applies for application made under Sec 397 and 398. [32]

Sec 397-402, 408-409 are discussed above. Sec 403 provides for interim orders by CLB, sec 404 provides for effect of alteration of memorandum and articles of association by order of CLB and Sec 405 provides for addition of respondents.

CONCLUSION

Apart from the general powers under Sec 397 and 398, the Tribunal has specific powers to pass any order providing for [33] :

The regulation of affairs of company in the future.

Purchase of shares or interest of any members of the company by other members or company itself.

In case of purchase of shares by company, the consequent reduction of share capital. (refer Sec 77)

The termination setting aside or modifications of any agreement between company and following persons:

Managing Director, Manager or any Director

Any other persons not mentioned above. In case of any other persons notice shall be given to party concerned. Further, no agreement with any other person shall be modified except after obtaining consent of the party.

Setting aside of any transfer, delivery of goods, payment, execution or other act relating to property made or done by company or against company within three months before date of application.

The Tribunal shall set aside the above acts provided they will be deemed to be fraudulent preference if done by an individual before he is adjudged an insolvent.

Before Sec 397 & 398 an aggrieved person had ust one remedy- to apply for winding up under ‘just and equitable’ clause of sec 433(f). However now, Sec 397 & 398 are intended to avoid winding up of company and keep it going while at the same time relieving the minority shareholders from acts of oppression & mis management. Relief under these sections is perhaps a better alternative to the winding up.

Companies Bill, 2009

Chapter XVI of the Companies Bill, 2009 talks about Prevention of Oppression and Mismanagement starting form Clause 212- 217. Clause 212 (1)of the Bill has provided that if

a) company affairs are being conducted in a manner prejudicial to public interest or member of company; or

b)there is some material change brought about, not in the interests of, any creditors, debenture holders or any class of shareholders of the company, or has taken place in the management or control of the company, by alteration in the Board of Directors, manager, or in the ownership of the company’s shares, or in any other manner, and such change, will result in the affairs of the company being conducted in a manner prejudicial to its interests or its members or any class of members, then any member of the may apply to the Tribunal, provided such member has a right to apply under section 215 for an order.

Clause 212(2) of the Bill also empowers Central Government to apply to the Tribunal for an order if it thinks that affairs of the company are being conducted in manner prejudicial to public interest.

Powers of the Tribunal originally under Sec 402 of the Act is provided in Clause 213 of the Bil, widening the ambit and conferring more powers to the Tribunal.

Sec 407 of the Act dealing with ‘Consequences of Termination or modification of certain agreements’; has been replaced with Clause 214 of the Bill

Sec 399 of the Act dealing with Right to apply under Sec 397 (oppression) and Sec 398 (mismanagement) and has been replaced by Clause 215 of the Bill which talks about right to apply under Clause 212.

Clause 216 has introduced a provision for class action which was not available in the previous Act in the Chapter of prevention of Oppression and Mismanagement. It provides : Any one or more members or one or more creditors or any class of creditors may, if they are of the opinion that the management or control of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or creditors, can file an application before the Tribunal on behalf of the members and creditors.