Misapplication of rights-issue proceeds found; directors must restore diverted funds and proceeds to remain intact pending proper use.

Misapplication of rights-issue proceeds into a partnership firm was held contrary to the stated objects where claimants failed to show discharge of liabilities or improvement of net worth; the investment produced inadequate returns and lacked documentary justification of corporate benefit, so the directors who authorised the diversion were required to restore the funds and the company must keep such proceeds intact unless applied only to the rights-offer purposes.

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Issues: Whether the investment/diversion of funds raised under the rights issue into a partnership firm was mala fide and not for the bona fide purpose of the company, and whether the directors who caused such diversion are liable to restore the amount to the company.

Analysis: The Board examined the scheme of the rights issue and the stated objects in the letter of offer, including discharge of liabilities and improvement of net-worth. The record showed absence of evidence that liabilities were discharged or net-worth improved by the investment in the partnership firm. Major subscribers had requested status quo regarding company assets, which was ignored. The partnership firm included the son of an erstwhile director as partner and the respondents admitted the annual return on the investment was approximately 6% p.a., which the Board found inadequate compared to returns reasonably obtainable by alternate safe investment. The respondents failed to demonstrate how the company benefited from the investment or that the decision was bona fide; factual and documentary material supporting a legitimate corporate purpose was lacking. The Board therefore concluded that the diversion was contrary to the objects of the rights issue and amounted to mala fide action by the erstwhile directors.

Conclusion: The application is allowed; the Answering Respondents are directed to take appropriate steps to restore the amount raised under the rights issue into the company account and the present Board must keep such funds intact unless used only for the purposes enumerated in the rights issue letter of offer.

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