2004 (9) TMI 385 - SC - Companies Law

Managing director's fraudulent allotment set aside; oppressed shareholders need not sell; broader review under Section 10F upheld

The SC upheld the HC, dismissing the appeals and affirming that the managing director perpetrated fraud and oppression by manipulating records and ... Claims to the right to control and manage the company - Opportunity to work - allotment of additional shares - meeting of the Board of Directors of the company - act of oppression on his part towards the then majority shareholders - manipulation of records of the company - fiduciary capacity within which the Directors - legal position of Directors of companies registered under the Companies Act - Jurisdiction of High Court under section 10F - Juristic person - held that:- Nothing has been shown as to how the amount of Rs. 6,86,500 was utilised. It appears that Ramanujam who was managing the affairs of the company single handedly, realized that the company had turned around and the Hotel property had appreciated in terms of its market value. He started working on a strategy to get controlling shares in the company. It was in furtherance of this objective that Ramanujam managed to show the entry regarding advance against shares in the Balance Sheet as on 31st March, 1994. For this amount, he allotted equity shares to himself to gain control of the company. In these facts it is difficult for us to appreciate that the additional funds were required by the company. In our view the finding of the High Court that no funds were needed by the company is fully justified. The only purpose was to allot additional shares in the company to himself to gain control of the company and to achieve this objective, the books of the company appear to have been manipulated. The High Court was right in holding that the entire manipulation of records of the company by Ramanujam was an act of fraud on his part. The acts of directors in a private limited company are required to be tested on a much finer scale in order to rule out any misuse of power for personal gains or ulterior motives. Non-applicability of section 81 of the Companies Act in case of private limited companies casts a heavier burden on its directors. Private limit ed companies are normally closely held, i.e., the share capital is held within members of a family or within a close knit group of friends. This brings in considerations akin to those applied in cases of partnership where the partners owe a duty to act with utmost good faith towards each other. Non-applicability of section 81 of the Act to private companies does not mean that the directors have absolute freedom in the matter of management of affairs of the company. In the present case Article 4(iii) of the Articles of Association prohibits any invitation to the public for subscription of shares or debentures of the company. The intention from this appears to be that the share capital of the company remains within a close knit group. Therefore, if the directors fail to act in the manner prescribed above they can in the sense indicated by us earlier be held liable for breach of trust for misapplying funds of the company and for misappropriating its assets. 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 be set aside. The facts of the case do not pose any difficulty particularly for the reason that the Managing Director has neither placed on record anything to justify issue of further share capital nor it has been shown that proper procedure was followed in allotting the additional share capital. Conclusion is inevitable that neither the allotment of additional shares in favour of Ramanujam was bona fide nor it was in the interest of the company nor a proper and legal procedure was followed to make the allotment. The motive for the allotment was mala fide, the only motive being to gain control of the company. Therefore, in our view, the entire allotment of shares to Ramanujam has to be set aside. Even the Company Law Board found that the allotment of additional shares by Ramanujam to himself was an act of oppression on his part. The Company Law Board drew this conclusion solely for the reason that no offer had been made 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. 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. FERA stands repealed and the statute brought in force by way of replacement of FERA, i.e., the Foreign Exchange Management Act (FEMA), does not contain any such re quirement. 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. Scope of power of High Court in appeal under section 10F of the Companies Act - The Board has not gone into real issues which were germane for the decision of the controversy involved in the case. The High Court has rightly gone into the depth of the matter. As already stated the controversy in the case revolved around alleged allotment of additional shares in favour of Ramanujam and whether the allotment of additional shares was an act of oppression on his part. On the issue of oppression the finding of the Company Law Board was in favour of Prathapan, i.e., his impugned act was held to be an act of oppression. The said finding has been maintained by the High Court although it has given stronger reasons for the same. We find no merit in the argument that the High Court exceeded its jurisdiction under section 10F of the Companies Act while deciding the appeal. In our view, the High Court was fully justified in granting the relief of setting aside the impugned allotments of additional shares in favour of Ramanujam. The approach of the Company Law Board was totally erroneous in as much as after having found that there was oppression on the part of Ramanujam, he was still allowed to take advantage of his own wrong in as much as he was given the option to buy Prathapan’s shares and that too not for a proper price. In our view the Company Law Board was wrong in allowing purchase of shares of Prathapan and his wife by Ramanujam. Such an order amounts to rewarding the wrong doer and penalizing the oppressed party. In the circumstances of this case asking the oppressed to sell his shares to the oppressor not only fails to redress the wrong done to the oppressed, it also results in heavy monetary loss to him. The relief granted by the High Court was a proper relief in the facts of the case. All the appeals are accordingly dismissed with costs. Issues Involved:1. Validity of allotment of equity shares of the Company in favor of Ramanujam.2. Effect of not obtaining permission of the Reserve Bank of India under the Foreign Exchange Regulation Act (FERA) by Prathapan regarding transfer of shares.3. Scope of power of the High Court in an appeal under section 10F of the Companies Act.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-wise Detailed Analysis:Issue 1: Validity of Allotment of Equity SharesThe main issue revolves around the allotment of 6865 equity shares to Ramanujam in a meeting of the Board of Directors alleged to have been held on 24th October 1994, and further 9800 equity shares on 26th March 1997. Prathapan challenged these allotments as acts of oppression. The following questions were considered:(a) Existence of Board Meeting on 24th October 1994:- The appellants presented a photocopy of the minutes of the alleged meeting, showing Suresh Babu's presence. However, Suresh Babu denied attending any Board meetings, and there was no evidence of a notice convening the meeting as required by Article 36 of the Articles of Association.- The absence of a log book for recording directors' attendance further invalidated the claim of a meeting. The court concluded that the alleged meeting did not take place, making the allotment of shares unauthorized and invalid.(b) Validity of the Meeting:- Given that no meeting took place, the question of its validity does not arise. Suresh Babu's absence would have rendered any such meeting invalid.(c) Necessity of Raising Share Capital:- The balance sheets up to 31st March 1993 showed no substantial investments. The sudden appearance of Rs. 6,86,500 in the balance sheet for the year ending 31st March 1994 was unexplained. The court found no evidence of a need for additional funds, concluding that the allotment was a strategy by Ramanujam to gain control of the company.(d) Bona Fide Act in the Interest of the Company:- Directors owe a fiduciary duty to issue shares for a proper purpose. The court found that the allotment of shares to Ramanujam was not bona fide and was solely for his personal gain, constituting an act of oppression.The court referenced several precedents, including Regal (Hastings) Ltd. v. Gulliver and Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd., emphasizing that directors must act in good faith and for the benefit of the company. The court concluded that the allotment of shares to Ramanujam was fraudulent and should be set aside.Issue 2: Effect of Not Obtaining RBI Permission under FERAThe court held that permission from the Reserve Bank of India under FERA could be obtained ex post facto, as established in LIC of India v. Escorts Ltd.. The subsequent repeal of FERA and its replacement by FEMA, which does not require such permission, further supported this view.Regarding locus standi, the court cited Rajahmundry Electric Supply Corpn. Ltd. v. A. Nageshwara Rao and other cases, concluding that the validity of a petition is judged based on the facts at the time of its presentation. Since Prathapan and his wife were registered shareholders at the time of filing the petition, they had the requisite locus standi.Issue 3: Scope of Power of High Court in Appeal under Section 10F of the Companies ActSection 10F allows appeals on questions of law. The court held that if a finding of fact is perverse and based on no evidence, it can be set aside in appeal. The High Court's decision to delve deeper into the matter was justified, given the Company Law Board's cursory treatment of the issues.Issue 4: ReliefThe court emphasized that relief depends on the facts of each case. Given the manifestly wrongful actions of Ramanujam, the only appropriate relief was to undo the advantage he gained through manipulation and fraud. The High Court's decision to set aside the allotment of shares to Ramanujam was upheld, as it was the proper relief in the circumstances.Conclusion:The Supreme Court dismissed the appeals, upheld the High Court's judgment, and ordered the setting aside of the allotment of additional shares to Ramanujam. The court emphasized that allowing Ramanujam to buy Prathapan's shares would reward the wrongdoer and penalize the oppressed party. The relief granted by the High Court was deemed appropriate and justified.