ALLOTMENT OF SHARES BY NOT FOLLOWING DUE PROCESS OF LAW WOULD AMOUNT TO OPPRESSION AND MISMANAGEMENT

 Allotment of shares

Allotment of shares refers to allocating shares to the shareholders who have applied for them. When a company issues new shares, it invites applications from the public or existing shareholders. Once the company receives the applications, it processes them and decides on the allotment of shares. The allotment process involves assigning a specific number of shares to each shareholder based on the number of shares they have applied for and available for allotment. Once the shares are allotted, the shareholders become the company owners to the extent of the shares allotted to them.

Process for allotment

The process for allotment of shares is in the following way-

• Announcing the issue details;
• Inviting applications;
• Processing the applications;
• Preparation of the allotment list;
• Issue of share certificates or demat statements.

If the above process is not followed then the entire process may be declared illegal and void.

Further issue of share capital

In the company wants to issue further share capital, the company is to require to increase the authorised capital, if required. The Memorandum of Association (‘MOA’ for short) and Articles of Association (‘AOA’ for short) shall also be amended in accordance with the provisions of the Companies Act, 1956 (‘Act’ for short). Section 31 of the Act provides that special resolution is required to alter the articles. Section 94(1) of the Companies Act, 1956, mandates that a company can alter its share capital only if expressly authorized by its AOA.

Issue

The issue to be discussed in this article is as to whether the allotment of shares is not in accordance with the provisions of the Act would amount to oppression and mismanagement with reference to a deciding case law.

Oppression and mismanagement

The terms ‘oppression’ and ‘mismanagement’ are not defined either in the Act or in the Companies Act, 2013. The court of law defines is conduct that involves a visible departure from the standards of fair dealing and a violation of conditions that require fair – especially with regard to the right of shareholders. The term ‘mismanagement’ can be described as conducting company affairs in a prejudicial, dishonest or inept manner. 

Any member of the company who has a grievance that the affairs of the company are being conducted in an oppressive manner or any material change has taken place which is not in the interest of its members then he has a right to apply to the Tribunal. The Tribunal may cancel the allotment of new shares if they are not in compliance with the provisions of the Act and reasonable opportunities are given to the stakeholders.

Case law

The National Company Law Appellate Tribunal in Axis Nirman and Industries Ltd. And Axis Overseas Ltd. Versus M/s Hotel Birsa Pvt. Ltd., Adbhut Vincom Private Ltd., Salini Soy, Mr. Sunil Toshniwal and Mr. Amit Sarda, Kolkata - 2025 (10) TMI 916 - NATIONAL COMPANY LAW APPELLATE TRIBUNAL PRINCIPAL BENCH, NEW DELHI (LB), cancelled the issue of shares and the conduct of the promoters amount to oppression and mismanagement.

In the above said case, Hotel Birsa Private Limited (‘Company’ for reference) is running hotels, restaurant and other related business. The authorised share capital of the company is Rs.4.25 crores. The company increased its authorised capital from Rs.4.25 crores to Rs.10 crores in the extra ordinary general meeting held on 18.02.2010. Subsequently the issued and subscribed share capital was raised from Rs.4.25 crores to Rs.6.35 crores.

The promoters of the company approached the Axis Nirman Industries Limited, the appellant herein for the urgent requirement of Rs.11 crores for making payment to HUDCO to prevent the company’s account from being classified as Non-Performing Asset and to revive the stalled hotel project. The Company assured the appellants that they complied with the formalities under the Companies Act in this regard. The appellants were also assured for good returns on their investments with the Company.

The appellants agreed to invest in the company and subscribed 90000 equity shares at a face value of Rs.100/-. The appellant, thus, made investments in the company to the tune of Rs.90 lakhs on 19.03.2010. The appellant No. 2 invested 120000 equity shares in the company @ Rs.100/- per share totalling to RS.1.2 crores. The company used these funds for clearing its debts and other operational requirements. The company allotted shares to both appellants according to their investments.

Adbhut Vincom Private Limited, the respondent No.2, holding 49% shares of the company felt that its stake in the company would be diluted on the investments of the appellants. Therefore, the said respondent filed  a petition No. 370 of 2010, before the National Company Law Tribunal (‘NCLT’ for short). In the said petition, the respondent No. 2 made allegations against the appellants-

• The respondent No. 3 and respondent No.4 had allegedly mismanaged the company’s affairs and manipulated its capital structure without proper approvals.
• The shares allotted to the appellants were claimed to have been issued in violation of statutory provisions.
• The resolutions increasing the authorized share capital and subsequent share allotments were challenged as being non-compliant with the Act.

The appellants also filed an application before the NCLT under Section 241 and 242 of the Act alleging oppression and mismanagement by the respondents and misused Rs.2.10 crores invested by the appellants and failure to protect the interests and rights of the appellants as shareholders.

The appellants received a notice on 05.11.2016 for the conduct of Annual General Meeting on 30.12.2016. The appellants challenged the said notice that it was not possible to hold Annual General Meeting for 2015-16 since the Annual General Meeting for 2014-15 was not conducted and the notice contained procedural irregularities. The NCLT held that the resolutions for the increase of the authorised capital and subsequent allotment of shares to the appellants violated the provisions of the Companies Act. The 2,10,000 shares allotted to the appellant are invalid. The NCLT further directed the company to refund the said amount to the appellants.

Being aggrieved against the order of the Tribunal the appellants filed an appeal before the National Company Law Appellate Tribunal. The appellants submitted the following before NCLAT-

• Despite being a substantial stakeholder, the respondent No.2 exhibited no interest in supporting the company during its financial difficulties. Instead, it executed a Memorandum of Understanding on 29.09.2009 to sell its entire shareholding of 2,08,250 shares, representing 49% equity, to one Libra Retailers Private Limited for which it received an advance of Rs. 1 crore.

• On 16.02.2010 the income tax department conducted a raid in the premises of the respondent No. 2 due to which the shares could not be transferred to Libra Retailers.
• The respondent No.2 requested the company to issue duplicate shares but the same was rejected by the company as it would contravene the provisions of the Act.
• After this the respondent No.2 did not participate in the Board meeting.
• The company issued notice to all stakeholders under certificate of posting, which is a valid mode of serving notices, for the conduct of Extra-ordinary General Meeting (‘EoGM’ for short) for the increase of authorised capital etc. The respondent No. 2 did not attend the meeting despite the receipt of notice.
• In the EoGM held on 18.02.2010 in Ranchi the AOA on was amended so that the company could issue further shares.
• In the Board meeting subsequently held at Kolkata on 19.02.2010, the urgent need of Rs.90 lakhs was discussed.
• The offer for new shares were offered to the existing shareholders. The notice in this regard was sent to all existing shareholders under the Certificate of posting. In the offer letter it was mentioned that failure to respond by 11.03.2010 would be treated as rejection of offer.
• The respondent No.2 did not respond to this offer and also did not attend the next board meeting held on 19.03.2010.
• In the Board meeting held on 19.03.2010 it was resolved to allot 90000 shares to the first appellant.
• In the Board meeting held on 14.04.2010 it was resolved to allot 120000 shares @ Rs.100/- per share to the second appellant.
• The allotment of shares to the appellants was lawful, proper, and carried out following statutory requirements
• The petition filed by the respondent No. 2 seeking to cancel the share allotment, was an afterthought aimed at regaining control over the company after it was revived through the appellants’ investments.
• The NCLT erred in cancelling the allotments based on its findings that service through certificate of posting were invalid.  

The respondent No. 2 submitted the following before NCLAT-

• The NCLT, after an in-depth analysis of facts, evidence, and statutory provisions, concluded that the actions of the appellants were oppressive, illegal, and intended to dilute the shareholding and management rights of the Respondent.
• The order effectively annulled all impugned resolutions, including those relating to the alteration of the AOA and MOA; increase in authorized share capital; increase in paid up capital; and the subsequent allotments of 90,000 and 1,20,000 shares to the appellants.
• The AOA of the company did not contain any provision permitting increasing of authorised capital.
• Section 94(1) of the Act, mandates that a company can alter its share capital only if expressly authorized by its AOA. The failure to amend the AOA prior to altering the MOA renders the entire process invalid.
• The notice issued for the EoGM did not propose any such amendment to the AOA, and no special resolution was passed as required under Section 31 of the Act.
• The notice for EoGM did not mention any proposal to amend the AOA, which was a legal precondition for such changes. Moreover, the resolutions passed were ordinary resolutions, despite the requirement for special resolutions for these changes under the Act.
• The burden of proving proper service lies with the sender, which the appellants failed to discharge. No dispatch register, postal receipts, or other corroborative evidence was produced.
• The issuances were in clear violation of Section 81 of the Act, which mandates that further shares must first be offered to existing shareholders on a pro-rata basis. The respondent was entitled to a proportionate offer of these shares but was deliberately denied this right.
• The offer letters for these issuances did not include renunciation rights, a mandatory requirement under Section 81(1)(c) and these offer letters were allegedly served via certificate of posting, which lacks credibility.

The respondent asserted that the appellants failed to demonstrate how the Rs.2.10 crores raised through these issuances were utilized in the interest of the company. The sole intent was to dilute the respondent’s shareholding from 49% to 32.75% and consolidate control over the company in favour of the appellants. The respondent further contended that issuing shares with the sole motive of diluting a shareholder’s stake constitutes oppression. The minutes of the EoGM were fabricated to include a resolution amending the AOA by special resolution. This alteration was a clear afterthought to cover up the procedural defects.

The respondent No. 3 submitted the following before the NCLAT-

• She was the promoter and Director of the company holding 51% of the shareholding of the company.
• The appellant challenged the impugned order of NCLT on the frivolous and illegal grounds and therefore the appeal is liable to be dismissed with hefty cost.
• The respondent No.3 is the only had the right to challenge the order of NCLT. Since the same has not been challenged the order of NCLT attained finality and the present appeal is non-est.
• The appellants are not directly affected by the impugned order.
• A derivative action cannot be taken by the appellants to file the instant appeal, being against the law of the land.
• The appellants are a third party and has no right to challenge the impugned order passed by the NCLT, which was passed against the majority shareholder, without any rightful authority to do so and the same only being done for an ulterior motive.

In view of the above she prayed for the dismissal of the appeal.

The NCLAT heard the submissions of all parties, examined the voluminous records and also gone through the written submissions of the parties. The NCLAT observed the following-

• The current dispute arose when the Respondent No. 2 filed Company Petition No. 370 of 2010 before the NCLT.
• In the said petition it was challenged the increase in authorized share capital and the allotment of 2,10,000 shares to the appellants, claiming the actions taken were without statutory compliance.
• The NCLT in its impugned order decided in favour of the respondent No.2 by cancelling the share allotments to the appellants and directed to refund the entire amount paid by the appellants.
• The NCLT ordered the forced sale of Respondent No. 2’s shares to Libra Retailer Private Limited, which was presented as a resolution to the ongoing dispute.
• Against the above said order of the NCLT, the respondent No.2 filed an appeal before NCLAT which decided in favour of respondent No. 2 and set aside the order of NCLT holding that it was beyond the jurisdiction of the NCLT.
• The appellants filed an appeal in CA (AT)No. 175 of 2017 against the order of NCLT cancelling the allotment of shares to them. The NCLAT dismissed the appeal.
• The appellant filed an appeal before the Supreme Court against the order of NCLAT.
• The Supreme Court remanded the matter back to NCLAT holding that the NCLAT had failed to properly examine the validity of the share cancellations and disposed of their case without a reasoned adjudication.

On remand the NCLAT first took the matter of the locus of the appellant to challenge the impugned order as contested by the respondent No. 3. The NCLAT rejected the contentions of the respondent No.3 since the Supreme Court remanded the matter to decide the case on merits. The NCLAT considered the following issues to be decided in the present appeal-

1. Whether the amendment to AOA and MOA of the company have been carried out in accordance with the provisions of Act?
2. Whether the fresh issue of shares after the alleged increase in authorized share capital of the company has been done in accordance with relevant provisions of Act?
3. Whether these actions on the part of the appellants, respondents No.1 & No.3 vis-à-vis respondent No.2 can be termed as Oppression and Mismanagement under Sections 397, 398 and 399 of the Act?

The NCLAT examined the issues No. 1 and No. 2 together since they were interlinked

The NCLAT analysed the provisions of-

• Section 16 – Alteration of the memorandum.
• Section 17 – Special resolution and confirmation by CLB required for alteration of memorandum.
• Section 31 of the Act - alteration of articles by a special resolution.
• Section 81 – Further issue of share capital
• Section 94(1) of the Act.

From the reading of the above provisions, the NCLAT observed that it is clear that the companies requiring increase in authorised share capital require an enabling provision in the AOA. In case such an enabling clause is not there in the AOA, the AOA has to be amended. Such an amendment requires a special resolution to be passed by members of the Company in the EoGM as prescribed by Section 31 (1) of the Act.

The NCLAT observed that in the notice issued by the Company for increasing the authorised capital by means of ordinary resolution.  The notice prescribes ordinary resolution instead of the special resolution required to the increase in authorised share capital. The NCLAT observed that on the same day another notice was issued for the conduct of EoGM for the alteration of AOA by passing special resolution.  The said notice has been disputed by respondent No. 2 claiming that the same has been created by the appellants and respondent No.3 when they discovered that MOA cannot be amended without amending enabling clauses of AoA. From the above the NCLAT observed the following-

• Two sets of notices have been issued on the same day i.e. 18.01.2010 having two sets of agenda.
• The first notice for EoGM is issued or given for two items both of which are proposed as ordinary resolution.
• For Agenda Item No.2 in the first notice relating to amendment of MOA thereby proposing to raise the authorised capital of the company is covered under Section 17 of the Act, which provides for special resolution.
• The explanatory statement for Agenda Item No.2 also refers to approval for increase in authorised capital of the company under Section 17 of the Act.
• There is no mention of amendment to Articles of Association of the company in the aforesaid EoGM notice.
• The second notice allegedly issued on the same day has agenda items Nos 3 (A) and 3 (B) for amending the Articles of Association of the company.

The NCLAT observed that in the first notice for EoGM issued on 18.01.2010 there is no such agenda for amendment of AoA. The same has been proposed through another notice which has been issued on the same day.  The notice for the same has been sent through ‘under Certificate of Posting’ to the three members viz. Mr. Prem Rajesh Soy, Mrs. Shalini Soy (Respondent No.3) and M/s Adbhut Vincom (Respondent No.2).

The NCLAT analysed the minutes of the meeting. The NCLAT observed that the minutes do not reflect agenda wise discussion. the appellants and Respondent No.3 when they realise that they could not have increased the authorised share capital without amending the AOA they created the second set of documents including minutes of the EoGM. The respondent No.2 is 49% shareholder of the respondent No.1 before the increase in share capital and no special resolution could have been passed without his presence in the meeting. Therefore, it was absolutely essential that notice for any special resolution to be taken up by the members of the company is received by the  respondent No.2.

The NCLAT found that the mode of intimation of notice of EoGM or Board meeting by the company has been through ‘certificate of posting’. Only a receipt of Certificate of Posting issued by the postal department cannot be relied upon as a conclusive proof that the notices have been received by the respondent No.2. No other mode of communication has been attempted to serve such notices. In absence of any other piece of evidence to substantiate the claim of notices being served, it can be concluded that the appellants and respondent No.1 were in default.

The NCLAT observed that consequent upon the EoGM on 18.02.2010 at Ranchi, a board meeting of the company was called in Kolkata on the very same day at 3.00 P.M. If the aforesaid board meeting was held on the 18.02.2010, then it was a physical impossibility to reach Kolkata at 3.00 P.M. after conducting the EoGM at 11.00 A.M on the same day at Ranchi. The notice for the Board meeting could have been issued only after EoGM had approved the changes to AOA and MOA, as the decision to issue further shares was dependent on changes to AOA and MOA.  This clearly shows the intention of appellants and respondent Nos.1 & 3 to keep Respondent No.2 out of decision-making process at every stage in violation of provisions of the Act, even though he held 49% of the shares of the company and no special resolution could have been passed without his consent.

It appears that the Prem Rajesh Soy (Deceased Promoter/ Director), and respondent No.3 were in a hurry to allot the shares to the appellant, due to which such right was not provided to the shareholders of the company. The Articles of Associations of the company have no such enabling clause under which renunciation right of existing shareholders could be waived. This is an express violation of provision of Section 81 (1) (c) of the Act. Therefore, the NCLAT held that the amendments to AOA and MOA and subsequent issue of fresh share capital have not been done in accordance with provision of Act.

Then NCLAT considered the third issue as to whether the actions of the appellants, respondent No.1, and respondent No. 3 constitute Oppression and Mismanagement under Sections 397, 398, and 399 of the Act? The actions of the appellants and respondent No. 3 clearly show a deliberate attempt to adversely affect the rights of respondent No. 2. This was done by-

• increasing the company’s authorized share capital from Rs.4.25 crore to Rs.10 crore without first changing the AOA;
• issuing 2,10,000 shares only to the appellants, which reduced respondent No. 2’s stake from 49% to 32.75%;
• failing to follow Section 81 of the Act, which requires new shares to be first offered to existing shareholders, and also giving a right of renunciation to existing shareholders; and
• multiple procedural violations, including issuing two conflicting EoGM notices, backdating resolutions, and failing to properly notify Respondent No. 2. These actions show that the share allotment was not conducted in a fair and legal manner.

The very fact that two different notices were issued on the same date raises serious doubts authenticity of the second notice. It strongly suggests that the appellants and respondent No. 3 realized their violation of various provisions of the Act and tried to fix it afterward. Such actions amount to mismanagement under Section 398.Section 81 of the Act, requires that new shares must first be offered to existing shareholders in proportion to their current holdings. The company claims it sent a rights issue notice to Respondent No. 2 by Under Postal Certificate. However, there is no proof that Respondent No. 2 actually received it.

The appellants are seeking interest on the Rs. 2.1 crore they paid for the cancelled shares. However, since the allotments have been declared illegal by NCLT, they cannot claim compensation for an invalid transaction.

Considering all these factors which include legal and procedural lacuna-

• in increasing the authorised and paid-up share capital; unfair share allotment;
• failure to notify respondent No. 2 properly;
•  denial of renunciation rights; and manipulation of corporate records,

the NCLAT held that the actions of the appellants and respondent No. 3 amount to both oppression and mismanagement under Sections 397 and 398 of the Act. The company’s decision-making process was neither fair nor legal, and it was clearly designed to reduce respondent No. 2’s stake and control.

The NCLAT dismissed the appeal and directed the respondent No.1 to refund the amount of Rs.2.1 crore paid by the appellants without interest.