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In common law, a company is a “legal person” or “legal entity” separate from, and capable of surviving beyond the lives of its members. In simple words a corporation is a group of individuals, acting in accordance with the decisions of the majority of its members.
According to section 47 of the Companies Act of 2013, all equity shareholders of a company have voting rights. It is because they are in charge of assets, they appear to have authority. A special resolution must be approved by a majority of 3/4 of the total shareholders. Minorities are left with little choice but to follow them. The basic principle governing the management of a company’s affairs is that the courts will not, in general, intervene in matters of internal administration at the request of a shareholder; and that the courts will not interfere with the management of a company by its directors as long as they are acting within the powers conferred on them. The majority power rule has been in application since 1843 English Law Precedent of Foss v. Harbottle.
The rule highlights that because a corporation is a legal entity, the action is vested in the corporation and cannot be filed by a single shareholder. When a corporation can file a lawsuit on its own behalf to recover property from its directors or officers, or from anybody else, that corporation is the proper plaintiff and the sole suitable plaintiff. Another benefit of the rule is that if every individual shareholder could sue someone who had harmed the corporation due to a violation of duty, there would be as many lawsuits as there are shareholders. There would be no end to the legal proceedings, and a huge amount of time and money would be wasted.
However, the application of these strict principles appeared to be incredibly harsh and inequitable for minority shareholders, as despite having a substantive right, they were still barred from seeking justice under the rule and were forced to accept the majority’s wrongdoings because they controlled the company and minority members had no say due to their small numbers. It is because the minority is unprotected under the rule, exceptions have emerged and statutory safeguards have been enacted to provide some protection for the minority. One of the earliest leading judgments in India dealing with the exception of misconduct and mismanagement by the directors leading to filing of application for winding up of the company is Rajahmundry Electric Supply Corporation Ltd. v. Nageswara Rao and Ors.
Facts of the Case
- The Case was brought before the honourable Supreme Court as an appeal in the form of Special Leave Petition. This appeal stems from the plea for an order that the Rajahmundry Electric Supply Corporation Ltd. be wound up under section 162, clauses (v) and (vi) of the Indian Companies Act, 1913.
- The action was taken under section 153-C of the companies Act, 1913 which deals with the appointment of administrator upon mis-management of the affairs of the company. 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 and authorising them to take the necessary actions for recovering the amounts due, paying the debts and for convening a meeting of the shareholders for the purpose of ascertaining their wishes whether the administration should continue, or whether a new Board of Directors should be constituted for the management of the Company.
- The Company’s affairs were being grossly mismanaged, that large sums were owed to the Government for charges for electric energy supplied by them, that the directors had misappropriated the Company’s funds, and that the directorate, which had the majority in voting strength, was “riding roughshod” over the shareholders’ rights.
Arguments of both the Parties
- The appellant contested it on the grounds that the Vice Chairman of the company was responsible for the Company’s mismanagement, that he had been removed from the board of directors, and that steps were being taken to hold him accountable, and that there was thus no basis for passing an order under section 162, or for taking action against under section 153-C.
- They further claimed that the application, insofar as it was filed under section 153-C, was not maintainable since there was no proof that the applicant had acquired the required number of shareholder consents as required by section 153-C sub-clause (3)(a)(i). That provision says that a member can only ask for relief if he has acquired the written permission of at least one hundred or one-tenth of the company’s members, whichever is less. They alleged that 13 of the 80 people who signed the consent form for the application were not shareholders at all, and that two people signed twice. It was also claimed that 13 of the people who had given their consent to the application’s filing had afterwards revoked their consent.
- The next argument was that the charges in the application were insufficient to sustain a winding up order under section 162, and hence no action under section 153-C could be taken.
- It was also argued that the words “just and equitable” in clause (vi) of section 162 must be construed ejusdem generis with the matters mentioned in clauses I to (v), that mere misconduct of the directors was not a basis for a winding up order, and that it was a matter of internal management for which recourse to the other remedies provided in the Act must be avoided.
- The appellant contends that an order for winding up under section 162 could not be made since all of the charges in the application amounted to director misconduct and there was no proof that the Company was unable to pay its debts.
- It was also argued that appointing administrators in supersession of the board of directors and giving them power to administer the company constituted an imposition on the company’s internal management.
- The respondent argued that they had consent from 80 people and according to the application could be filed. They further contended that mismanagement is a valid ground under just and equitable clause of section 162 and thus, the charges are maintainable under both the provisions of the Act. They also cited authorities to prove that “just and equitable” should not be construed as ejusdem generis with other clauses of the section.
Issues Involved in the case
The following question of law were involved in the case:
- Whether the charges under section 162 (winding up) and section 153-C(appointment of administrator) violated the established principle that the courts would not interfere in the internal management of the company, as long as the members are acting within the powers vested in them by law?
Summary of the Case and Judgment
The court was of the opinion that the number of members who had given agreement to the establishment of the application was 65, excluding the names of the 13 people who are said to be non-members and the two who are said to have signed twice. The Company has 603 members, according to the information provided. As a result, if 65 members consented to the application in writing, the criteria would be satisfied. The validity of a petition must be determined on the facts as they existed at the time of its presentation, and a petition that was legitimate at the time of its presentation cannot be rendered unmaintainable by circumstances that occurred after it was presented, unless the statute expressly states otherwise thus, the contention of the appellant that 13 members withdrew their consent later was rejected by the court.
The court agreed with the appellant that there was no evidence that the Company was unable to pay the amount and was commercially insolvent thus, the winding up cannot be claimed under section 162(v). However, they affirmed that the words ‘just and equitable’ in the enactment specifying the grounds for winding up by the court are not to be read as being ejusdem generis with the preceding words of the enactment. They further added that On the ‘just and equitable’ criteria, applications for winding up must be based on a justifiable lack of trust in the conduct and management of the company’s operations. However, this lack of trust must be based on the directors’ actions, not in their personal lives or affairs, but in the company’s operations. The court relied on the cumulative facts that the vice chairman was responsible for the mis-management and the company owed huge debt to the Government further, the affairs of the Company where in a state of confusion and embarrassment, it was necessary to take action under section 153-C.
The Court reaffirmed that they will not, in general, intervene at the request of shareholders in questions of internal administration, and will not interfere with a company’s management by its directors, so long as they are working within the powers placed on them by the Articles of Association.But this rule can by its very nature apply only when the company is a running concern, and it is sought to interfere with its affairs as a running concern. They added that when an application to wind up a company is filed, the goal is to put an end to the company’s existence by terminating its management in accordance with the Articles of Association and vesting it in the court. In that case, the rule that the court should not intervene in matters of internal management has no application.
Analysis of the judgment in the light of current legal regime in India
The judgment in the initial days of the development of jurisprudence for company law paved a way for the voice of the minority shareholders and the right of the shareholders to approach the court in case of mis-management.
In the judgment of the Supreme Court in LIC v. Escorts Ltd, the following rights of a shareholders were highlighted
(i) to elect directors and thus to participate in management through them;
(ii) to vote on resolutions at meetings of the company;
(iii) to enjoy the profits of the company in the shape of dividends;
(iv) to apply to the court for relief against oppression;
(v) to apply for relief against mismanagement;
(vi) to apply for winding up;
(vii) to share in the surplus on winding up.
The method or practise of managing ineptly, incompetently, or dishonestly is referred to as mismanagement. It should be emphasised, however, that the term is not defined in the Companies Act, and it is up to the court to decide on the facts of the case.
The term “conduct of the company‘s affairs” had been defined in “Law and Practice Relating to Oppression & Mismanagement – Minority Shareholder’s Remedies” by Dr. K. R. Chandratre, Bharat Law House, New Delhi, 2009 as under:
“The term conduct of the company‘s affairs is not synonymous with the conduct of the company‘s business nor the conduct of the management. The word affairs, is wider than both those terms, and illustratively includes– appointment and removal of directors and auditors; appointment and removal of executives; convening and conduct of board meetings and general meetings; voting rights; circulation of members‘ requisitioned resolutions; requisition for convening general meetings; non-compliance with articles of association of the company, any other agreement or document; accounts; dividends; transmission and transfer of shares; issue, allotment and redemption of shares or other securities; variation of class rights; legal and non-legal rights of shareholders; maintenance and inspection of statutory records; financial matters; conduct of business and operations of the company; incorporation and conversion of the company; subsidiaries and associate companies or companies controlled by those who are controlling the respondent company; sale or disposal of the company‘s business or assets; restructuring of the company business, etc.”
Current Legal Position under the Companies Act, 2013
Whenever there is mismanagement of the affairs of a company which is prejudicial to the public interest or to the interest of the company and its members an application can be filed under section 241 of the companies Act, 2013 by a member of a company or by the central Government. Further section 242 deals with the power of the tribunal if an application is filed under section 241. It states that If the tribunal found that the affairs of the company is being conducted in a manner prejudicial to the interests of the company / its members/ to public interest and if wind up is unfairly prejudice to such member /members and the facts would justify that it is just and equitable to wind up the company, the Tribunal may make such order as it thinks fit.
Under section 271(e) the Tribunal may also order the winding up of a company if it believes that it is just and equitable to do so. It is a separate ground for a winding up order, and it is not essential for the circumstances to be analogous to those that justify an order on one of the six other particular grounds already discussed under the section for a case to be made out under it. In the case of Gadadhar Dixit v. Utkal Flour Mills (P.) Ltd, the court held that the Tribunal must give fair weight to the interests of the company, its employees, creditors, and shareholders, as well as the general public, when exercising its power on this ground. When other remedies are ineffective in protecting the company’s general interests, relief based on the just and equitable clause is used as a last resort.
The case reflects that 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. It is also highlighted that the aim of such provisions under law is to safeguard the interest of the investors. The case also sets grounds for the exception to the majority rule in India.