Smt. Pushpa Katoch vs Manu Maharani Hotels Ltd. And Ors

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Introduction

The concept of majority rule has been applied to the management of corporate affairs. Resolutions on numerous subjects are passed by a simple majority or a three-fourths majority of the members. When a resolution is passed with the required majority, it becomes binding on all company members. As a result, the court will not usually intervene to safeguard the minority interest impacted by the resolution, because when a person joins the company, he or she implicitly agrees to submit to the majority’s decision. Thus, if a company is wronged, the company is the legal entity with its own personality, and it can only file a lawsuit against the perpetrator; shareholders (members) do not have the right to do so individually. This rule has been in application since the leading english judgment of Foss v. Harbottle. 

Prevention of Oppression and Mismanagement: an exception to the majority rule. 

This rule is subject to exceptions under the law. One such exception is prevention of oppression and mismanagement. A member who believes the company’s operations are being conducted in a way that is oppressive to some members, including himself, or against the public interest, may file a petition with the Tribunal under section 241 of the Companies Act, 2013. The Delhi High Court ruled in O.P. Gupta v. Shiv General Finance (P.) Ltd. that a member’s right to move to the court under section 397 [now Section 241] was a statutory right that could not be hindered by an arbitration clause in a company’s articles of association.

Requirements for filing against oppression. 

The Companies Act provides for a minimum number of members who must sign the application under section 241. If the company has a share capital, the application must be signed by at least 100 members or one-tenth of the total number of members, whichever is lower, or any member or members owning one-tenth of the company’s issued share capital. If the company is without share capital, the application has to be signed by one-fifth of the total number of its members. However, the Tribunal may, on application, allow any member or members to sue “if in its opinion circumstances exist which make it just and equitable to do so.” 

 In the case of Kuttanad Rubber Co. Ltd. v. K.T. Ittiyavirah the Kerala High Court held that terms of sub-section (3) of section 399 [now Section 244(2)] , when a petition was moved with the consent in writing of some of the shareholders, such a petition was on behalf of and for the benefit of all of them, namely, the petitioners and the consenting shareholders.

Powers of the tribunal

Under Section 242(1) the Tribunal is empowered to make any order as it may think fit to with a view to end the matters complained off in Section 241. Before passing an order the Tribunal needs to satisfy itself that:

(a) the company’s affairs have been or are being conducted in a manner prejudicial or oppressive to any member or members or prejudicial to public interest or in a manner prejudicial to the interests of the company; and 

(b) to wind up the company would unfairly prejudice such member or members, but that otherwise the facts would justify the making of a winding-up order on the ground that it was just and equitable that the company should be wound up.

Judicial Precedents on the acts that constitute oppression

The honourable Supreme Court of India in the case of Shanti Prasad Jain v Kalinga Tubes Ltd. held that: 

“The essence of the matter appears to be that the conduct complained of should at the very least involve a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to the company is entitled to rely. The complaining shareholder must be under a burden which is unjust or harsh or tyrannical”.

In the Re: Hindustan Cooperative Insurance Society Ltd, the court observed that it is oppression when the majority exercised their authority wrongfully, in a manner burdensome, harsh and wrongful or they attempted to force the minority shareholders to invest their money in a different kind of business against their will.

Similarly, an attempt to deprive a member of his ordinary membership rights is an “oppression” as held in the case of Mohan Lai Chandumall v Punjab Co Ltd.  The company Law Board, in the case of Ashok Kumar Oswal v. Panchsheel Textiles Mfg., observed that a single action of allotment of shares can amount to oppression.

Minor acts of mismanagement, however, are not to be regarded as oppression. As far as possible shareholders should try to resolve their differences by mutual readjustment. Moreover, the courts will not allow these special remedies to become a vexatious source of litigation as observed in Lalita Rajya Lakshmi v. Indian Motor Co.

The Delhi High Court in the case of Pushpa Katoch v. Manu Maharani Hotels Ltd., held that in a public company, sale of shares of the existing directors without offering them to the promoting director of the company cannot be said to be an act of oppression. This article analyses the case in detail. 

Facts of the Case

1. This case was brought before the Delhi High Court as an appeal against the order of the Company Law Board. 
2. The three respondents are the appellant’s real sisters. These four sisters formed the company M/s. Manu Maharani Hotels Ltd., and the respondents transferred their stake in the company to an outsider somewhere in the year 2000.
3. A Memorandum of Family Agreement was reached between the parties on the 4th of May 1999, according to which all four sisters agreed that if any sister wanted to sell her portion, she would first offer it to the other sisters. It was argued that the parties fully comprehended and acted on the implications and significance of this family settlement. 
4. The Board of Directors had likewise made a decision to this effect at its meeting on March 16, 1994. The four sisters were the absolute shareholders of all the shares of the company, formed with the goal of converting family property into a hotel and running the same jointly with mutually unanimous consent/decisions, according to the minutes of the aforementioned meeting.
5. Two respondent sisters wrote letter dated 17th October 1997 to the appellant and her sister Mrs. Saroj Jamwal, offering to sell their shares at Rs. 14.50 per share.
6. Following that, at a Board meeting on November 6, 1998, it was decided that two of the company’s promoter directors would sell their shares to the other two promoter directors, with a request for some time to complete the deal.Appellant however, couldn’t arrange the funds owing to her personal issues. 
7. Respondents then sold their shares to outsiders without informing the appellant, and the appellant only learned of this after reading a notice posted in the hotel’s lobby on February 12, 2000, informing the staff that the company’s administration had changed hands.
8. The appellant objected to her sisters’ actions and filed a petition with the Company Law Board under Sections 397 and 398 of the Companies Act,1957 citing different reasons. The primary source of complaint was the transfer of shares to outsiders, as a result of which the company’s management changed hands and three new directors were appointed in a Board meeting on February 10, 2000.

Order of the Company Law Board against which the appeal is preferred

1. As its company’s Articles of Association contain no provision relating to pre-emption rights, the respondents had the freedom to transfer their shares to outsiders. According to the Articles, the corporation cannot even refuse to register a transfer of shares unless certain conditions are met. As a result, selling shares without first offering them to the appellant could not be constituted as oppression. 
2. The Company Law Board found validity in the appellant’s accusation that the corporation had broken the law by issuing additional shares on a preferential basis, affecting the appellant’s rights and reducing her holdings, and so it was considered to be an act of oppression.
3. The induction of three new directors at the Board meeting on February 10, 2000 was ruled to be illegal since the appellant had not received notice of the meeting.
4. The appellant will remain a director as long as she owns 14.7 percent of the company’s stock and will not be forced to retire by rotation.
5. Since the issue of additional shares reduced her percentage shareholding below 14.7 percent, that percentage would be restored if she accepted additional shares to be offered to her, which offer should be made within one month of receipt of the impugned order, and the appellant would be free to accept this offer within three months of the date of the offer by remitting necessary funds.
6. If she does not accept the offer within the specified time frame, the direction in this regard will be terminated.
7. She should be offered proportionate shares as and when new shares are issued.
8. As long as the appellant is a director, notices of Board meetings, along with the agenda, should be provided to her by registered post with seven days notice.

Arguments of the Parties

1. The appellant relied upon the aforementioned minutes and Memorandum of Family Settlement and contended the appellant had a right of pre-emption which was breached and violated by offering the shares to outsiders.
2. They also asserted that the property on which the hotel was established by the four sisters was a family property and the company was incorporated with the intention that the control thereof remains within the family. Accordingly, all four promoters were given equal management power. The four sisters were given 60 percent of the shares in equal portions, while the financial institutions were given 40 percent of the shares.
3. The respondent contended that the articles of the association of the company didn’t contain any provision relating to the preemption right. They however, mandated the management of the company to accept registration of transfer which could be refused on specific grounds mentioned therein which were not attracted. 
4. They also added that the two respondents had approached the appellant earlier who didn’t accept their offer for 3 years. Since the company was suffering from losses, the other respondent also decided to sell her shares. 

Issues involved in the case

The following issue was involved in the case: 

1. Whether the sale of shares outside the family by the respondents was in breach of the family arrangement or well within the articles of the company? 

Judgment of the case

The court in the case was of the opinion that Company Law Board has acted in a fair manner as they agreed with the order of the Company Law Board and held that sale of shares without offering the same to the appellant cannot be considered to be an act of oppression. To be viewed as oppressive, an act must be either burdensome or wrongful, or it must involve a lack of probity and fair dealing with a shareholder in questions of his or her proprietary right. Such a right might be derived from the Companies Act or the Articles, or it may be imputed on equitable grounds in specific situations.

The Court observed that because the company is a public limited company, there should be no restrictions on a shareholder’s right to transfer his or her shares under section 111A of the Companies Act, 1957 which applies to the company. As a result, the petitioner has no statutory right to claim the shares for herself.In the same way, the petitioner has no right to seek transfer of the respondent sisters’ shares because there are no provisions in the Articles affording a shareholder a pre-emptive right. The shares are so transferable like any other movable property, whether under the Companies Act or the Transfer of Property Act. The only restrictions on the transfer of a company’s shares are those set forth in its Articles, if any. As a result, any restriction not specified in the Articles is not binding on the corporation or the shareholders. The court further highlighted that if there was such a provision in the Article of Association, it would have been ultra vires the provisions of the Companies Act, as no company can provide in the Article of Association any matter which offends the specific provision of an act. 

It was also noted that after forming a public company, it was too late in the day to consider such an arrangement and record it in a Board meeting or a family settlement, both of which could not be legally binding. The Court recorded that the four sisters could at most be held to be morally bound by the family agreement. 

The court also held that the complaint about the induction of three new directors at the Board meeting on February 10, 2000 is also without merit. A recast of the Board was unavoidable after new management took over. The controlling group possessed the necessary authority and power to appoint its own board of directors.

Analysis of the Judgment in the light of Current Legal regime 

The articles of association are a crucial document for a company since it contains the rules, regulations, and bye-laws that govern the company’s internal administration and management. The articles are primarily for the company’s internal management. All the powers, rights and obligations of directors and other officials are described in the articles. In the articles of a private company, all the restrictions are also laid down. All the provisions regarding the shares are also mentioned under the articles of association. In a matter of internal conflict, it is usually the article of association that is referred to. 

Earlier in the Case of V.B. Rangaraja v. V.B. Gopalkrishnani, the court observed that the Articles of the Association are the regulations binding on the company and the shareholders. The shares are the movable property and their transfer is regulated by the Articles of the Association. The case also involved similar facts wherein the parties had entered into an oral agreement which restricted the members from transferring their shares outside the branch of the family they belonged to. The court observed that this agreement was not binding upon the shareholders.

Section 58 (2) of the Companies Act, 2013 provides that the securities or other interest of any member in a public company shall be ‘freely transferable’. Further, proviso to Section 58 (2) of the Act, states that any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as ‘contract’. 

The proviso to Section 58(2) of the Companies Act 2013 is consistent with the Bombay High Court’s decision in the case of Messer Holdings Limited vs Shyam Madanmohan Ruia & Others. According to the Bombay High Court, any contract or agreement between two or more people regarding the transfer of securities can be enforced like any other contract and does not obstruct the free transfer of securities.

As a result, any agreement reached by the shareholders in connection to the shares of a public corporation is lawful and enforceable as a ‘contract’ between the shareholders. If any public company is made a party to such a consensual arrangement/contract, the contract will be enforceable against the public company as a ‘contract’ under the proviso to Section 58(2). In case of breach of such a contract by any party, the aggrieved party may avail legal remedies as available in case of ‘breach of contract’ including specific performance of the contract under the Specific Relief Act, 1963.

Under the Companies Act 2013, the term “freely transferable” is not defined. However, Section 58(4) states that if a company refuses to register a share transfer without “adequate cause,” the transferee may file a complaint with the National Company Law Tribunal (“NCLT”), which will order the company to register the transfer in accordance with Section 58(4).

Conclusion 

The enforceability of contractual restrictions on the transfer of shares in Indian public limited corporations has been the topic of several Indian judicial judgements. The Indian legislature has also looked at this issue, leading to a revision in the applicable laws in the form of a proviso to section 58(2) of the Companies Act, 2013. After the decision of the division bench of Bombay High Courts in this regard, status-quo continues as the Supreme Court hasn’t got the opportunity to address the issue and at least for the time being and would have a persuasive value over the single judge decision of Delhi High Court. 

Currently, foreign investors interested in investing in Indian companies can, despite the requirement of free transferability of shares, enter into valid private agreements with other shareholders to limit the transfer of shares, regardless of whether such restrictions are incorporated in the Company’s byelaws.