1936 (9) TMI 17 - HC - Companies Law

Directors must act in company's best interest, not secure own debts preferentially. Upholding fair treatment in insolvency.

Thakur Das Versus Ramgulam Singh

The plaintiff's appeals were allowed, and the suit was dismissed with costs throughout. The court held that directors of an insolvent company should not ... Winding up – Overriding preferential payments and Directors - Power of Issues Involved:1. Enforceability of a simple mortgage.2. Priority of mortgages.3. Fraudulent preference and duties of directors.4. Rights of an auction-purchaser.Issue-wise Detailed Analysis:1. Enforceability of a Simple Mortgage:The appeals were against the preliminary and final decrees granted by the Subordinate Judge in a suit to enforce a simple mortgage. The Vishvakarma Mills Ltd. borrowed Rs. 75,000 from the Government under the Bihar and Orissa State Aid to Industries Act, 1923, and executed a deed of mortgage of all its assets in favour of the Government. However, the Government neglected to register this mortgage. The Company paid the instalments for March 1926 and March 1927, but failed to pay the third instalment due in March 1928. Consequently, the Government had the Company execute a promissory note for Rs. 60,000. The Company was in financial difficulties, and the Government's loan did not seem to be a judicious investment.2. Priority of Mortgages:The plaintiff, a shareholder and Director of the Company, guaranteed the loan by the Bihar Bank and was sued in that capacity. On 4th March 1928, a Directors' meeting authorized an agreement where the plaintiff would pay the next instalment of Rs. 5,000 to the Imperial Bank and the loan due to the Bank of Bihar, in return for a mortgage in his favour. The mortgage bond executed on 20th May 1928 stated that the plaintiff's mortgage was a second mortgage, with the Government's mortgage as the first. However, it was clear that the original mortgage was defective due to non-registration, and the promissory note to the Government was executed. Despite this, the plaintiff's mortgage was considered secondary to the Government's debt.3. Fraudulent Preference and Duties of Directors:The plaintiff's actions were scrutinized under the lens of fraudulent preference. The plaintiff, as a Director, had a duty to see to the necessary registration of documents. He was aware of the non-registration and the Company's financial distress. Despite agreeing to pay off the Bank of Bihar's claim, he did not do so, and the mortgage was not executed until much later. The plaintiff either knew the Government could not sue on their mortgage or intended the Government's debt to take priority. This situation was likened to a contract between a trustee and his cestui que trust, where the trustee, by discharging a small portion of the debt, became a secured creditor against the unsecured Government debt, preventing equitable payment to creditors. The case of The Gaslight Improvement Co. v. Terrell was cited, emphasizing that directors, as trustees, must apply all assets for the benefit of creditors and not secure their own debts preferentially.4. Rights of an Auction-Purchaser:The Bihar Bank applied for a compulsory winding-up order, and the Government proceeded under the Public Demands Recovery Act, selling the Company's assets to the 2nd defendant, Thakur Das. The plaintiff sued to enforce his mortgage, claiming about Rs. 7,500. The suit was stayed against the Company but proceeded against Thakur Das, with the Subordinate Judge granting a decree against the 2nd defendant. The plaintiff argued that the Government had not sued on their mortgage but proceeded under the Public Demands Recovery Act, meaning no priority of mortgages arose. However, it was determined that the 2nd defendant, as the auction-purchaser, stood in the shoes of the judgment-debtor (the Company) and was entitled to the same equities and estoppels. The plaintiff, as a director, could not insist that his mortgage debt take precedence over the Government's debt. The judgment emphasized that directors of an insolvent company should not be allowed the privileged position of a secured creditor by discharging a small portion of the company's debt.Conclusion:The appeals were allowed, and the plaintiff's suit was dismissed with costs throughout, as it was not right for the directors of an insolvent company about to go into liquidation to secure their own debts preferentially. The judgment reinforced the principle that directors must act in the best interest of the company and its creditors, and not secure their own debts at the expense of other creditors.