Company Law - Investigating the concept of Public Interest under mismanagement through case laws

Chapter 2: INTRODUCTION

Section 398 has no counterpart in the English Act. It was recommended by the Company Law committee to provide relief against mismanagement which can not otherwise be suitably dealt with under any provisions of the Act. In order to grant relief under this section, it is not necessary for the court that there are facts to justify the making of a winding up order. It is enough if the affairs of the company are conducted in a manner prejudicial to the interests of the company or to the public interest.

Cf. Richardson & Cruddas Ltd v Haridas Mundra , is the case where the court was inclined to interfere in the public interest, as the company was engaged in essential industries necessary for the implementation of the second five year plan for the country.

Section 398 has two facets. The first is the positive acts done by the management which results in prejudice being caused to company and secondly, even where no action at all is taken by the management, such non action results in prejudice being caused to the company. In other words, the expression “the affairs of the company are being conducted in a manner prejudicial to the interests of company” in s. 398 (1) (a) will take within its ambit the non conduct of the affairs of the company and which non conduct results in prejudice being caused to the company. The non conduct may arise for a variety of reasons including serious disputes amongst the Board of directors of the company which results in a complete deadlock or stalemate .

Chapter 3: THE MARCH OF LAW

In cases falling under section 398(1) (b), action can be taken to prevent even likelihood of injury in future either to the interests of the company or to public interest . The section comes into play when there is actual mismanagement or apprehension of mismanagement of affairs .

A conduct which is prejudicial in a financial sense to the company must also be preju-dicial to the interests of the shareholders .

Section 398 is a complete Code in itself. In exercising jurisdiction under this section the court can pass any order and lay down the procedure for imple¬menting its order. The court will continue to have the power till its orders are fully im¬plemented.

The words "such order as it (the CLB) thinks fit" would enable the CLB to pass orders to reframe, or insert a new article, which may be against the company's memorandum or other articles and even against the Companies Act, provided only that the order is necessary to put an end to the matters complained of .

When a party is charged with acts of mismanagement, misappropriation or improper conduct, full particulars of the acts complained of must be set out in the pleading and unless so set out, such charges should be ignored and no reli¬ance should be placed on them. Applying this legal requirement to petitions under Sections 397-398 in Clive Mills Co. Ltd., Re , the court said: "It is not only in the case of fraud, but in case of all other allegations relating to mismanage¬ment, misappropriation or other improper conduct with which a party is charged in appli¬cations under sections 397 and 398 of the Act, full particulars must be set out in order to enable the party charged to understand what he is charged with, and also to enable him to answer such charges. If vague and general charges are made without giving any particu¬lars or setting out any material facts, this court should ignore such charges and not pro¬ceed to investigate them. The party charged must be given the opportunity of answering the charges made against him, and this he cannot do unless he knows what he is charged with. General and vague allegations of misappropriation, misapplication of funds, mis¬management or other improper conduct in the management of the company's affairs do not justify this court in making any order on such allegations."

Similar observations are to be seen in Bengal Luxmi Cotton Mills Ltd., Re . These cases were followed in M.M. Dua v. Indian Dairy & Allied Services P. Ltd . where also there was a long list of charges and no particulars.

In Mohta Bros. (P.) Ltd. v. Calcutta Landing and Shipping Co. Ltd. , the Calcutta High Court observed "They (the case cited in the Judgment) are no authority for the proposition that even though a petitioner fails to make out a case for statutory relief by setting out material facts in the pleading, yet the court should grant relief to the petitioner by directing an investigation, in the hope that the report of the in¬vestigation might disclose materials for further orders against the company and in favour of the petitioner".

Where the allegation was that the Board of directors' resolution for appointment of the managing director was of fraudulent nature, but no material was furnished in support of the allegation of fraud, it was held that the alleged ground for the petition was not made out .

The powers under this section cannot be exercised against a person who has ceased to be a director at the date of the petition for compensation for tortuous acts committed in the past, even if the acts complained of constitute misfeasance under S. 543. The court (now CLB) is not concerned with past management except where the past 'projects itself as a continuing wrong and pervades the conduct of the company's affairs . Since in this case the relief sought was all against the respondent who was no longer in management or control of the company, they were all outside the scope of the section.

A composite petition under both sections 397 and 398 may be filed provided the reliefs claimed are not conflicting .

It is not unreasonable for a per¬son seeking relief against alleged unfair prejudice to include in his petition a prayer for winding up on the just and equitable ground. The petitioner can seek relief in the alterna¬tive .

In a case where there is no oppres¬sion but the affairs of the company are managed in a manner prejudicial to its interests, the court will interfere under this section .

In the case of Hungerford Investment Trust Ltd., Re v. Turner Morrison & Co. Ltd ., P.B. Mukherji, C.J., held that the court ought not to exercise the extraordinary and summary jurisdiction under Ss. 397 and 398 when an alternative rem¬edy has already been pursued. The court further held that mismanagement is like fraud, particulars of which must be clearly set out in a petition under this section. One kind of mismanagement cannot be pleaded and some other kind proved. It was further observed that serious and disputed questions of title and controversies which were already the subject of pending legal proceedings should not be adjudicated in a summary proceeding as envisaged by this section. If an action of the Directors is illegal or invalid, the com¬pany or the shareholders may take appropriate action in a court of law challenging the validity of such action but a petition under section 397 or this section is not an appropri¬ate remedy for the purpose.

Where the petition under sections 397 and 398 was filed after a petition under sections 408 and 409 and containing almost the same averments and prayer as the earlier petition, the petition under sections 397 and 398 was held not to be maintainable .

Conditions that prevent the proper functioning of the company, according to the provisions of the Indian Companies Act, the uncertainty as to the de jure character of the Board and difficulty of having the state of affairs rectified in the usual way, the patent fact that the company was being run by the Board in their own interest overriding the wishes and interest of the majority of share¬holders which inevitably involved the company in costly litigations were facts from which the court could conclude that the affairs of the company were being conducted in the interest of a group and certainly not in the interest of the company. These acts would bring the case within section 398 of the Companies Act. By reason of the change in management, the affairs of the company had been proved to have been conducted in a manner prejudicial to the interest of the company. To satisfy the requirements of section 398(b) it is enough to establish that there was a likelihood of the affairs of the company being conducted in a manner prejudicial to the interest of the company .

Where the Managing Directors of a company continued in office after their terms had expired, without a meeting being held to re-appoint them prior to making a fresh application to the Central Government under s. 269, the continuation in office under these conditions was held to be mismanagement within the purview of this section and s. 397 .

Though the busi¬ness of the company was flourishing, there was deadlock in management due to lack of faith between the two factions in the family. The court would have power in such cases to order winding up and appoint special officers to manage affairs, settle all liabilities and di¬vide the remaining assets between the two factions. So also infighting among the directors resulting in serious prejudice to the company constitutes mismanagement under section 398 .

In Subir Kumar Basu v. New Central Group Engg. P. Ltd , a valuer was replaced because of a vitiated report.

Where a set of properly appointed directors were not permitted to join or function as director, the court said that the complaint of such appointees could be regarded as a symptom of mismanagement and entertained a petition under s. 398 for providing appro-priate relief .

Where the directors were not taking any interest in the affairs of the company, the management failed in protecting the company's records causing prejudice to the company and the business was also seriously prejudiced because of the infighting among the directors and the company had started incurring losses, the court held that this was a fit case for orders under S. 398 .

Where the complaining shareholders alleged mismanagement by the directors and the latter contended that the complainants were not the shareholders of the company at all and while the directors did not produce even the register of members to substantiate their point, the complainants were able to establish their payments for shares and appointment as director, it was held that it would be appropriate to replace the present management with two of the complaining members .

One of the es¬tates of a tea and rubber plantation company was sold by the director at a low price to another tea plantation company without complying with the requirements of s. 293(1) which demands approval by shareholder and without giving adequate notice under sec¬tion 173 and relevant information giving delivery of possession before general body meeting and accepting consideration in installment. It was held that all these acts consti¬tuted mismanagement of affairs. The court set aside the sale. The Board of Directors and the purchaser 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 .

Where it was established that the sale of the company's assets was in gross neglect of the interest of the company and that the management was indifferent to the affairs of the company after the sale of assets, grant of relief under sections 397 and 398 was held to be proper .

Where the circumstances were such that the sale of the company's one unit undertaking would have resulted in its inevitable winding up, the Court said that it could direct under section 398, taking it to be a mismanagement of affairs, that the ordinary resolution for the sale be suspended till a special resolution for the purpose was passed .

Where the assets of the borrower company were disposed of by the lending institution to the brother-in-law of the manag¬ing director in a collusive sale and the member-directors of the company were not able to payout the buyer to recover back the assets, the Company Law Board ordered the man¬aging director to take steps to put the company on winding up or to have its name struck off the register. In the meantime the Lending Institution was instructed not to seek any recovery from the company and to release the directors from their personal guarantees .

In A Company, Re, ex p., Burr , Vinelott J stated:

"There can be no doubt that if the direc¬tors of a company continue to trade when the company is making losses and when it should have been apparent that there was no real prospect that the company would return to profitability, the court may draw the inference that the directors' decision was improp¬erly influenced by their desire to continue in office and in control of the company and to draw remuneration and other benefits for themselves and others connected with them. So also if the company is trading at a profit which yields a return which does not reflect the value of the assets employed and which would be available for distribution in a winding up, and if there is no real prospect that the profits will ever represent a reasonable return on the capital employed. If that inference is drawn, the court may conclude that the af¬fairs of the company are being conducted in a way which is unfairly prejudicial to the members or to members other than the directors and those who obtain such benefit. It cannot, therefore, be said that the petition on its face does not disclose any cause or ac¬tion. But it is not sufficient simply to allege that a company is making a loss or insuffi¬cient profits and that there is no real prospect that it will make a profit or a sufficient profit in the future. There must be some evidence which, if substantiated at the trial, could found the inference that the directors' decision to continue to trade was influenced by self-interest.”

Transferring shares without first offering them to the existing members in accordance with their rights under the arti¬cles, holding meetings without sending notice to members; issue of shares for a consid¬eration other than cash not represented by corresponding assets and burdening the com¬pany with additional rental by shifting the company's office have been held to be acts constituting mismanagement of affairs so as to attract the preventive jurisdiction of CLB under S. 398 .

Violation of the conditions of the company's memoran¬dum by those who are in charge of company's management may amount to mismanage¬ment .

A petition was filed by persons in charge of the management of a sick industrial com¬pany for relief against apprehensions of mismanagement in the future. The Company Law Board in Gorden Woodroffe & Co. Ltd. UK v. Gordon Woodroffe Ltd , directed the holding of the annual general meeting but only after giving sufficient time for completion of the revival proc¬ess. On appeal to the Madras High Court, it was found that there was no possibility of the completion of the revival process in the near future. But even so the court felt that corpo¬rate democracy must prevail. The shareholders had the right to constitute their Board of directors through election at the annual general meeting and they could hold the meeting at any time after following the prescribed procedure.

Allegations of abuse of fiduciary duties, conspiracy to defraud members by changing pattern of shareholding by misappropriation of company resources, allotment of shares to obtain majority support by a large scale fabrication of documents, all these, and there were many more allegations, were held to be sufficient to provide relief by superseding the Board of Directors by a committee of administrators to take charge of the company's affairs, to conduct its business and that of its subsidiaries .

Of the two directors of a small private company, one who was the managing director kept the other totally in the dark about the state of accounts and financial position of the company by not calling a meeting of the Board and of the shareholders and because of such conduct on the part of the members belonging to the group of the managing director, the company incurred losses and the theatre became closed because of non-renewal of license. This was held to be a sufficient symptom of mismanagement enabling the court [CLB] to order displacement of the managing director and handing over the management to the petitioning director .

The management of a family company must be carried on with utmost good faith and fair play. Any action on the part of direc¬tors in violation of this duty which affects the interests of family members could be reck¬oned in the circumstances as constituting mismanagement. It would be a grave act of op¬pression of family members if major decisions are taken without consulting all the family members and without including them in the agenda of the Board meeting. The Company Law Board ordered that the decisions taken at such Board meeting were null and void. No valid meeting ever took place. The appointment of five additional directors, the sale of a shop, the purchase of a house and some other matters were set aside. The managing director was directed to convene a general body meeting within six weeks to elect direc¬tors .

Where a company of four brothers was provided with funds by a bank for its business and three of the four brothers started using the money in breach of the agreement between them for the use of that money, it was held that the fourth brother had a legitimate ground for making a complaint of financial mismanagement under S. 398. The CLB ordered readjustments in the accounts so as to ensure that the funds in which the petitioner also had an interest were not utilized for any purpose extraneous to the company's business and the terms of the agreement between the members .

A petition for relief against mismanagement was based upon the allegations of diver¬sion of funds and malafide conduct. The specific allegations were about the appointment of the managing director and distribution of dividends. The Company Law Board found that both these acts were approved by the general body meeting. It did not interfere in the functioning of the corporate democracy. A rights issue cannot be restrained only on the ground that the aggrieved shareholder would not be able to subscribe for his proportion and, therefore, his voting power would be diluted. The Company Law Board observed that allegations of misapplication or siphoning of funds should be supported by details; otherwise they could not be examined properly, particularly where the accounts of the company have been audited by chartered accountants without any adverse comments .

In A Venkataramana v. AKR Minerals P. Ltd ., the allegations mainly related to illegal sale of company's land, raising of loans from banks and siphoning off funds of the company. But none of them was substantiated on facts.

The Madras High Court in its decision in Hari Kumar Rajah v. Sovereign Dairy In¬dustries Ltd ., has been of the view that the mere fact that the petitioner has not been able to show misappropriation of funds, does not mean that the respondents thereby become entitled to continue in office to the prejudice of other mem¬bers and company's interests. Relief should be allowed so that the petitioner does not have to approach other forums. In this case there were findings to the effect that directors were without qualification shares as required by the company's articles, illegal allotments of shares were made on selective basis, and failure in holding annual general meetings and laying before the meeting audited accounts, failure in filing annual returns and other routine documents. The court ordered that the present Board of directors be superseded and a receiver be appointed to take care of matters such as reconstituting the Board and holding meetings.

Where a petition is based upon misappro¬priation of funds or property, the recovery for which can be sought under sec. 543 by filing an application for misfeasance, it is not obligatory for the petitioner under section 397/398 to file a separate application. That section can be invoked where the allegations can sustain a prima facie view that the respondent is guilty of acts of misfeasance. A separate petition for restoration of property would be maintainable where it is shown that the person in pos¬session of the company's property has lost his right to possession by reason of the fact that he is no longer a majority shareholder of the company .

Bona fide decisions consistent with the company's memorandum and articles are not to be equated with mismanagement even if they turn out to be wrong in the circumstances or they cause temporary losses. The court will not permit the machinery created by the section to be used by the minority for compelling the majority to come to terms, where the company is honestly managed. The suspension of business for a short-while after presentation of the petition need not be an act of mismanagement .

Directors' bona fide decision not to declare dividend and to accumulate available prof¬its into reserves is not mismanagement. A director's constant effort in cornering the shares of the company is also not mismanagement in itself .

The change in the control and management of the company and the appointment of new directors as a result thereof cannot be questioned under this section, and the court will not interfere with the affairs of a company in a case where the act complained of is not ultra vires the company. The section is only concerned with acts prejudicial to the interests of a company, whether caused by conduct lawful or unlawful .

A member-director receiving some commis¬sion from the works which was closed by the decision of the other directors cannot raise a complaint under S. 398 .

Without more, the mere keeping of the moneys of the company in a term Deposit is not bad business practice or in any such mismanagement as would warrant interference under section 398 of the Companies Act. The single act of letting out the premises of the com-pany is not sufficient to attract this section. Allegations that properties of the company have been let out at low rents without any proof what higher rents were available as also an unsubstantiated allegation that premium amounts were misappropriated were held to be not sufficient in invoking the provisions against mismanagement .

Allegations of financial excesses and irregularities which were not substantiated by evidence were not regarded as sufficient either for an order of investigation or for any relief against mismanagement .

Where the directors of a company in financial difficulties arrange with the company's creditors that the creditors may become shareholders and directors instead of being creditors, this is not an act of mismanagement or oppression so far as the existing shareholders are concerned but done bona fide in the best interests of the company .

Removal of some of the directors from office which was found to be valid was held to be not a state of mismanagement of the company's affairs .

Removal of existing directors and appointment of new directors cannot be challenged in a petition under S. 398. It is only when the new directors misconduct the affairs of the company that it may be said they had been working to the prejudice of the company .

The removal of petitioners from their position as directors resulted in the stoppage of the project which was launched with their help. The project involved a huge amount of public money. The root cause was differences among promoters which were mainly due to errors in appraisal costs and unprofessional management of the project by promoters. The promoters were directed to identify new promoters to be tied to the project. The new promoters would buyout the petitioners' interest at mutually agreed price. Financial in-stitutions were asked to provide help in the process of changeover. The Company Law Board deprecated wasteful use of large sums of money .

In the case of Subhash Chand Agarwal v. Associated Limestone Ltd ., the company was not in the nature of a partnership because it was a public company and, therefore, partnership principles could not have been applied to order its winding up. More than half the capital of the company was held by a State Government undertaking so that the company was in the category of a Government company. An order for winding up of a government company on the just and equitable ground would be something for which there was no precedent. The CLB also found that the company was turning the comer and the accumulated losses were being wiped out. A petition filed by a member on the ground that the managing director of a public company has been removed would not find much respect unless it could be shown that the interest of the company would be prejudiced by the removal. This was something which the facts of the case did not reveal. The personal grievances of the member listed non-receipt of notices of meetings, non-filing of annual returns, failure to reply or comply with request letters for inspection, etc. These could be taken care of and remedied under other specific provisions of the Companies Act. They cannot be made a ground for winding up or for an order against oppression. Adverse observations by auditors are a part of the report to the shareholders. So long as such report is placed before the shareholders and they are given the opportunity to debate and discuss the matter in the internal forums of the company, the company cannot be accused of denial of opportunities or of mismanagement.

Termination of the services of a works manager who held only ten shares was not in itself an act of mismanagement .

The mere removal of a person from the office of secretary or medical specialist by a majority deci¬sion of the Board of directors, without anything more, is not a case of mismanagement. It must be shown that the removal had prejudicially affected the company's interest or the public interest .

Chapter 4: CONCLUSION

Section 398 provides for relief in cases of mismanagement. For a petition under this section to succeed, it must be established that the affairs of the company are being conducted in a manner prejudicial to the interest of the company or public interest, or that, by reason of any change in the management or control of the company, it is likely that the affairs of the company will be conducted in that manner. If the Tribunal is so convinced, it may, with a view to bringing to an end or preventing the matter complained of or apprehended, make such order as it thinks fit. A very clear illustration of mismanagement contemplated by the section is Rajahmundry Electric Supply Corpn v A. Nageshwara Rao .

A petition was brought against a company by certain shareholders or the ground of mismanagement by directors. The court found that the Vice Chairman grossly mismanaged the affairs of the company and had drawn considerable amounts for his personal purposes, that large amounts were owing to the Government for charges for supply of electricity, that machinery was in a state of disrepair, that the directorate had become greatly attenuated and "a powerful local junta was ruling the roost" and that the shareholders outside the group of the Chairman were powerless to set matters right. This was held to be sufficient evidence of mismanagement. The court accordingly appointed two administrators for the management of the company for a period of six months vesting in them all the powers of the directorate.

A similar management was provided to a company by the Calcutta High Court in Richardson & Cruddas Ltd v Haridas Mundra .

In Hemant D. Vakil v RDI Print and Publishing Ltd , it was held that where the group in power was conspiring to defraud members, mismanagement was held to be established.

There should be present and continuing mismanagement. The charges of mismanagement in the past, even if proved, are not enough to establish existing injury to the interest of the company or public interest . Where directors preferred objects of their liking and made a huge allotment of shares for a consideration other than cash, this was held to be a mismanagement of affairs . Misuse and misapplication of the company's finances by three brothers out of four who were operating the company was held sufficient to invite order of CLB for readjustment of accounts so as to prevent extraneous use of funds outside the company's business and the shareholders' agreement .

Proof of prejudice to the public interest or to the interests of the company is enough. The section enables the court to take into consideration outside interests affected by corporate operations. Thus, the Calcutta High Court refused to order the winding up of a grossly mismanaged company and appointed special officers to manage it because the company was engaged in special industries necessary for the implementation of the country's plans . Under S. 397 the power is of discretionary nature which enables the Company Law Board to make an order as it thinks fit with a view to bringing to an end the matters complained of, as distinct from the power granted under S. 398 which enables the Company Law Board to pass an order with a view to bringing to an end or preventing the matter complained of or apprehended .