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Praful M. Patel vs Wonderweld Electrodes (P.) Ltd. on 18 September, 2001

Praful M. Patel vs Wonderweld Electrodes (P.) Ltd. on 18 September, 2001

Equivalent citations: 2003 115 CompCas 377 CLB

Bench: S Balasubramanian, C Das

ORDER Balasubramanlan, Vice-President

 

1. The main complaint of the petitioner in this petition filed under Section 397/398 of the Companies Act, 1956 ('the Act') in regard to the affairs of Wonderweld Electrodes (P.) Ltd. ('the Company') is that by clandestine preferential allotment of additional shares, the petitioner's group ('the petitioners') who was in majority has been reduced to minority. Accordingly, he has sought for cancellation of the allotment of those shares.

 

2. Shri Vidhya Shankar, the counsel, appearing for the petitioner submitted that this company was incorporated on 23-6-1988 to take over the business of an erstwhile partnership firm. In this partnership firm, there were three identifiable groups of partners. The proportion of profit-sharing was - petitioner's group 60 per cent, respondent's group 30 per cent and one Mr. Mahendra Manilal Patel 10 per cent. When the business of the partnership was taken over by the company, as provided in the memorandum of association of the company, shares were allotted to the three groups in the same proportion as that of profit-sharing in the partnership firm and, accordingly, the petitioner's group was allotted 60 per cent shares while the respondent's group 30 per cent shares and Mr. Mahendra Manilal Patel 10 per cent shares. Even though initially the petitioner's group had three directors on the Board of the company yet due to a demise of one from the petitioner's group and vacation of office by another, only one from the petitioner's group continued on the Board. However, the respondent's group continued to have majority directors. Even though there was no dispute between the partners for a long time, yet the company had, in the notice issued for the AGM scheduled on 5-9-1998 which was received from the auditor of the company by a fax on 1-9-1998, included an item for issue of right shares on the ground that for development of a business of the company, further funds were needed. One receipt of this fax from the auditor, the petitioner issued a fax message on 2-9-1998 (Exhibit P-8) seeking information as to in which Board Meeting the decision to convene the AGM was taken since the petitioner, being a director, had no knowledge of any Board Meeting in the absence of requisite notice. By another fax dated 4-9-1998 (Exhibit P-9) the petitioner requested the company not to proceed with the AGM. Instead of receiving a reply to the fax dated 4-9-1998, on the same date, the petitioner received a fax from the company stating that the petitioner had already vacated office as a director in terms of Section 283(1)(g) of the Act and, therefore, no notice for subsequent Board Meetings, had been given to him and also stating that the decision to hold the AGM was taken in the Board Meeting held on 28-8-1998. The petitioner issued a telegram on 4-9-1998 asking the company to defer holding of AGM to enable consultation with shareholders for issue of right shares. Similar fax was issued to the company on 5-9-1998. By a fax dated 7-9-1998, the petitioner, while objecting to the holding of AGM yet informed the company that the petitioner was interested in subscribing to the right shares and sought for a letter of offer in this regard (Exhibit P-14). One Mr. Rajendra R. Patel from the petitioner's group also wrote to the company vide his letter dated 8-9-1998 (Exhibit P-15) conveying his interest in subscribing to the right shares. By a letter dated 9-9-1998 the petitioner and Mr. Mahendra Patel sent postal orders to the company for meeting expenses in forwarding letters of offer for right shares, (Exhibit P-16). However the petitioner was surprised when the notice for the AGM was belatedly received by him addressed to his Surat address in which the words 'rights issue' had been substituted by the words 'further issue'. Later, the petitioners found that the company had filed a return of allotment on 18-9-1998 according to which all the 5,000 shares had been allotted to the respondent's group on 6-9-1998, thus, reducing the petitioner's group from 60 per cent shares to 30 per cent, while the holding of the respondent's group went up from 30 per cent to 65 per cent. Mr. Vidhya Shankar pointed out that when the petitioners had in writing evinced their interest in subscribing to the further shares, there was absolutely no justification in respondent's allotting further shares to themselves only. He further pointed out that neither the explanatory statement nor in the pleadings, any justification has been given for issue of further shares. Therefore, the issue was made only for the sole purpose of creating a new majority. He further pointed out that even though the company contended that the notice for all the meetings had been sent to the Surat address of the shareholders from the petitioner's group, the company was fully aware that the petitioner was stationed at Coimbatore while two members from the petitioner's group were residing abroad. Even otherwise, the company has not produced any evidence of having sent notices for either the Board Meetings or the General Body Meeting. He contended that the respondents have taken a stand that the petitioners had vacated the office on 20-6-1998 only with a view to ensure that he was not kept in the knowledge of the company's proposal to issue further shares. Even though according to the company, the petitioner vacated his office on 20-6-1998, yet the petitioner was never informed of the same and Form No. 32 was filed with ROC only on 4-9-1998, i.e., after the receipt of the petitioner's communication as indicated earlier. Therefore, he questioned the veracity of holding of the three meetings allegedly not attended by the petitioner. He also pointed out that while the proposal of issue of further shares was approved in the AGM held on 5-9-1998, the shares were allotted on the next date even though it was a Sunday and even without ascertaining whether the consideration towards these shares has been received. He also pointed out that even though the Bench had given directions to the respondent company to furnish the details of applications received for shares and also the date and mode of payment, the company has not yet furnished this information.

 

3. Summing up his arguments Mr. Vidhya Shankar Submitted as follows :

The directors, with mala fide intention of gaining majority in the shareholding had issued the further shares notwithstanding the fact that the petitioners were willing to subscribe to additional shares. The mala fide intention of the respondents is apparent from the fact that no justification has been provided by the company for increasing paid-up capital of the company. Even though originally the petitioner received a copy of the notice from the auditors of the company indicating that there was a proposal to issue further shares on right basis, yet the notice received from the company after the conclusion of the AGM had omitted the words 'right issue'. The very fact that the company is in the nature of the quasi-partnership with specified percentage of shares, any disturbance in the shareholding position without the consent of the partners is a grave act of oppression, meriting winding up of the company on just equitable grounds. Therefore, the allotment of further shares should be declared as null and void and shareholding as was existed before the issue of further shares be restored. He relied on the following case laws in support of his submissions :

(1) St. Ganapathy Mudaliarv. S.G. Pandurangan [1999] 1 Comp. LJ. 350 (CLB) :

Allotment of additional shares in a family company to certain shareholders to the exclusion of others, is an act of oppression and that when proper notices are not issued for a Board Meeting, provisions of Section 283(l)(g) cannot be invoked.

(2) Mrs. Rashmi Seth v. Chemon (India) (P.) Ltd. [1992] 3 Comp. LJ. 89 (CLB) :

The directors cannot utilize the fiduciary powers over the shares purely for the purpose of destroying an existing majority or creating a new majority and that is an act of oppression.

(3) Binod Kumar Agarwal v. Ringtong Tea Co. (P.) Ltd. [1996] 85 Comp. Cas. 289 (CLB).

(4) Mrs. Farhat Sheikh v. Esemen Metalo Chemicals (P.) Ltd. [1996] 87 Comp. Cas. 290 (CLB).

Creating of a new majority by issue of further shares is an act of oppression.

(5) Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd. [1951] Comp. Cas, 740.

The directors of a company are in a fiduciary position vis-a-vis the company and must exercise their power to issue further shares for the benefit of the company. If they issue the shares for the purpose of acquisition of control over the affairs of the company, then it will be held that they have acted in violation of their fiduciary duties.

 

4. Mr. Mihir J. Thakore, the senior advocate, appearing for the respondent-company submitted as follows :

This petition is not maintainable in terms of Section 397/398, since the conditions prescribed in these sections are not satisfied. There is no evidence in the petition that it is just and equitable that the company should be wound up and that such a winding up would not be in the interest of the shareholders. The provisions of Section 397 can be invoked only when the affairs of the company are being conducted in a manner oppressive to any member. In the present case, the complaint is of a single act of allotment of shares, an isolated act and as such cannot be considered to be an act of oppression as has been decided in Maharani Lalita Rajya Lakshmi v. Indian Motor Co. (Hazaribagh) Ltd. [1962] 32 Comp. Cas. 207 (Cal.). The provisions of this section can be invoked only when the substratum of the company is lost or there is a lack of probity or there is a deadlock in management. In this petition, there is no averment by the petitioner to the effect that he has been affected by any of the above acts. It has been held in Nagavarapu Krishna Prasad v. Andhra Bank Ltd. [1983] 53 Comp. Cas. 73 (AP), that acquiring large block of shares in a company with a view to gain control cannot be considered to be an act of oppression. Since the petitioner has not alleged any ground other than relating to the allotment of shares, or that the affairs of the company are being conducted in a manner affecting the petitioner, the petition is not maintainable as decided in Chander Krishan Gupta v. Pannalal Girdhari Lal (P.) Ltd. [1984] 55 Comp. Cas. 702 (Delhi), Rai Saheb Vishwamitra v. Amamath Mehrotra[1986] 59 Comp. Cas. 854 (All.), C.P. Gnanasambandam v. Tamilnad Transports (Coimbatore) (P.) Ltd. [1971] 41 Comp. Cas. 26 (Mad.). The words "are being conducted" suggest a course of oppressive conduct which means the same must exist on the date of the petition. In other words, the alleged wrong doing should continue till the date of the petition which is not the position in the present case. Further, mere allotment of shares alone cannot justify winding up of the company on a just and equitable ground which is a pre-requisite under Section 397 of the Act, as is held in Shantiprasad Jain v. Kalinga Tubes Ltd. [1965] 35 Comp. Cas. 351 (SC), N.R. Murty v. Industrial Development Corpn. of Orissa Ltd. [1977] 47 Comp. Cas. 389 (Ori.). Further, a company under the control of the petitioner has filed a winding up petition which means that the petitioner cannot now claim in this petition that winding up would not be in the interest of the petitioner.

In regard to the application of the principle of partnership is concerned, he submitted that the same cannot be applied in the instant case inasmuch as there is no identifiable group of partners in the erstwhile partnership nor there exists now identifiable groups of shareholders in the company. Therefore, the claim of the petitioner that quasi-partnership principles should be applied, cannot be considered. Even though the petitioner claims that his group controls 60 per cent shares in the company, yet it is an admitted position that originally there were only two directors from the petitioner's group as against six directors from the respondent's group. In other words, the alleged majority group had voluntarily handed over the majority on the Board to the Respondents. Further, there is nothing either in the articles or otherwise to provide for percentage shareholding in the company and as a matter of fact article 7 permits the Board to allot shares at their discretion. It has been held in Ebrahim v. Westbourne Galleries Ltd. [1972] 2 All. ER 492 (HL) that the relief under Section 397 should be granted only when shareholding is more or less equal and that there is a complete deadlock in the affairs of the company on account of lack of probity. In the present case, there is a diverse shareholding, there is no deadlock in the management and there is no lack of probity on the part of the directors. In view of this, this petition has to be dismissed as far as Section 397 is concerned. Since the petitioner has not alleged any act of mismanagement in the affairs of the company, this petition is not maintainable in terms of Section 398 also. Since the respondents, being in a majority on the Board, always had control over the company with the further issue of shares, they continued to control the affairs of the company and as such the question of any oppression against the petitioner's group does not arise as was held in Smt. Shanti-devi Pratapsinh Gaekwad v. Sangramsinh P. Gaekwad [1996] 1 Comp. LJ 72 (Guj.). In this connection, the learned counsel cited few other cases also.

 

The learned counsel further submitted as follows:

 

The company needed funds to expand its business and consulted the petitioner for mobilization of additional funds for the company. He did not evince any interest to subscribe to further shares and, therefore, it became the responsibility of the directors to find ways and means to mobilize further funds. Since the respondent's group was willing to subscribe to further shares, the shares were allotted to the respondents. Therefore, it is wrong to contend that the shares were allotted only with a view to convert the majority into a minority. The principles of partnership cannot be applied in a limited company as has been held in Gadadhar Dixit v. Vtkal Flour Mills (P.) Ltd. [1989] 66 Comp. Cas. 188 (Ori.) in Kilpest (P.) Ltd. v. Shekhar Mehra [1996] 87 Comp. Cas. 615, 10 SCL 233 (SC). The company never intended to issue shares on the right basis, as the petitioner had shown his unwillingness to subscribe for further shares. The fax of AGM notice (Exhibit P-7) according to which the company had proposed right issue cannot be relied upon, inasmuch as the same was allegedly received from the auditors of the company and that it has not been signed by any directors of the company. Relying on this unsigned notice the petitioner has contended that the company had proposed issue of shares on a 'right basis' which is not a fact. The correct notice issued by the company at Exhibit P-17 would indicate that further shares were to be allotted as per the provisions of articles of the company. Since the entire case of the petitioner rests on the notice allegedly received from the auditors at Exhibit P-7 which has been conclusively said to be a faked one, the petitioner has no cause of action. As far as issue of notices for the AGM is concerned, the learned counsel pointed out that the addresses of the shareholders as per the records of the company are at Surat and, therefore, the notices were sent to Surat. The articles of the company require only three days' notice for convening the General Body Meeting and, accordingly, notices for the meeting on 5-9-1998 were sent on 31-8-1998. Since the company has acted in accordance with the articles of association of the company and also in terms of Section 53, the petitioner cannot complain of non-receipt of notice.

As for the grievance of the petitioner in regard to his removal as a director, the learned counsel pointed out that the petitioner was not removed but he vacated his office in terms of Section 283(1)(g), since he did not attend the three consecutive meetings of the Board held on 3-11-1997,16-2-1998 and 26-6-1998 in spite of the fact that the notices of the said meetings were sent to him. As per the practice of the company, notices were posted to the address of the petitioner at Surat and since there was no request from the petitioner for grant of leave of absence, no leave of absence was granted to him for any of these meetings. Further, in terms of either Section 397 or Section 398, no directorial complaint can be entertained under the provisions of these sections. Since the petitioner has brought on to himself his cessation of office by not attending three consecutive meetings, he cannot now complain of the same. Accordingly, the learned counsel sought for dismissal of the petition.

 

5. We have considered the pleadings and arguments and the written submissions of the counsel. The respondents have raised various objections on the maintainability of the petition that a single act of allotment of shares alone cannot be a ground for a petition under Section 397; that it can also not be a ground for winding up of the company on just and equitable grounds; that directorial complaints cannot be agitated in a 397 petition; that application of quasi-partnership principles is not called for in the present case inasmuch as there is no deadlock in the management of the company; that the petitioner himself has filed a winding up petition against the company, etc. Therefore before we deal with the merits of the case, we shall consider these objections.

The main allegation in this petition is that the petitioner's group holding 60 per cent shares has been converted into a minority of 30 per cent by issue of further shares exclusively to the respondent's group. Even though, it is a single act, conversion of majority into minority or creation of a new majority has always been held to be an act of oppression in a number of cases by this Board and that even though it is single act, since it has continuous effect, such allotment can be challenged in a petition under Section 397.

In regard to the objection that petitioners have filed a winding up petition, it is seen from the reply of the respondents that the said winding up petition has been filed by a company in which the petitioner is a director and it was on the ground of non-payment of dues to that company. That the petition does not seem to have been filed on just and equitable grounds in terms of Section 433(/) but under Section 433(e). In other words, that the petition has been filed in the capacity of a creditor while this petition has been filed in a capacity as a member. Even otherwise, as this Board has held in Dipak G. Mehta v. Anupar Chemicals (India) (P.) Ltd. [1999] 98 Comp. Cas. 575 (CLB) filing of a winding up petition cannot be a bar to filing a petition under Section 397. As for applicability of a quasi-partncrship principle, it is not that there should always be a deadlock in the management of the company. No doubt, that could be one of the grounds and not the exclusive ground. The application of quasi-partner-ship principle would depend on the facts of a case. Therefore, merely because there is no deadlock in the management of the company, it does not mean that a petition on the ground of quasi-partnership principle cannot be filed. In regard to the stand that directorial complaints cannot be agitated in a Section 397 petition, it would also depend on the facts of a case. This Board has been taking a view that in closely-held family companies and companies in the nature of quasi-partnership or in companies wherein the articles provide for permanent directorship, removal of a director could be challenged in a proceeding under Section 397. Therefore, we cannot dismiss this petition on any of the grounds taken by the respondents on the maintainability of the petition.

Even though the petitioner has raised the issue relating to his cessation of office, yet, there is no prayer in the petition relating to his induction as a director. Therefore, we are not considering the complaint of the petitioner as far as it relates to his cessation of his office. The only other grievance of the petitioner in the petition is the issue and allotment of further shares. On this issue, the complaint of the petition is that he has not received the notice of the general body meeting held on 5-9-1998 in which issue of further shares of 5,000 at Rs. 100 each was taken and that originally as per the fax copy of the notice received from the auditor of the company, the issue has been proposed as a right issue but in Ihc notice issued by the company, the word 'right' has been changed into 'further'. He has also further alleged that the notice period was too short for the shareholders of his group who were residing abroad to react to the proposal. His further allegation in this regard is that he, being a director, was not given any notice of the meeting of the Board in which the decision to propose issue of further shares was taken. Finally, his grievance is that in a company of the nature of quasi-partnership when the petitioner was willing to subscribe to the shares of the company, the respondents had allotted shares to their own group, which has resulted in converting a minority into majority and as such is a grave act of oppression to the petitioner and his group.

We do not propose to examine as to whether notices were issued to the petitioner and his group or not. It is on record that the company had taken over the business of a partnership firm in which the petitioner's group held 60 per cent shares and the respondents' group 30 per cent and a third party 10 per cent share. The same proportion was kept at in the shareholding in the company also after its incorporation in 1988. For nearly 10 years, there was no change in the shareholding position. Even though, the respondents have contended that the petitioner's group cannot be identified as a single group, yet, there have been communications from the two other shareholders of the petitioner's group each holding 750 shares, that they belong to the petitioner's group. If so, the petitioner's group collectively holding 3,000 shares and constituting 60% per cent shares in the company did not attend the AGM in which the proposal to allot shares on a preferential basis was approved. Even assuming that the general body has authorised the company to make preferential allotment, which, according to us, was possible only because none from the petitioner's group holding majority shares, attended that meeting. In exercising their fiduciary duties, in facts of this case that the company is a quasi-partnership of 3 groups of shareholders, the Board of Directors should have at least ascertained the willingness of the petitioner's group to subscribe to the shares of the company before allotting shares exclusively to the respondents' group. Further, we also note that the petitioner had written to the company signifying his interest in acquiring further shares in the company. The manner and the haste in which the general body meeting was held and shares were allotted immediately thereafter to the respondent's group alone, clearly demonstrates that the purpose of allotment was only with a view to gain majority shareholding in the company. Therefore, the petitioner is justified in complaining of oppression meriting the grant of the prayer of the petitioner to either set aside the issue/allotment of shares or to order transfer of proportionate shares to the petitioner's group so that the original shareholding percentage is maintained. However, we do not propose to do so for the following reasons.

 

6. In view of the present disputes between the parties, the restoration of the shareholding percentage would only escalate the disputes between the parties. In a Section 397 petition, the interest of the company is paramount and with a view to protect its interest, one of the directions that is normally given is that one group should go out of the company, Usually, it is against the majority shareholders that allegation of oppression is made and herefore, the minority group which is alleging oppression is directed to go out of the company. However, in the present case, it is the majority which has complained of oppression by the minority. Even though the petitioners held 60 per cent shares, it had voluntarily allowed the respondents to have majority of the Board of the company right from the beginning and for a long time. Only one representative of the petitioner's group was on the Board. In other words, in spite of having majority shareholding, the petitioner's group had allowed the respondents' group to run the company. Further, in the petitioner's group, two of them are residing abroad and even the petitioner has shifted his residence to Coimbatore where he is managing his own company. Therefore, even though, in a number of cases we have held that the majority should buy out the minority, in the facts of the present case, we are of the view that we should direct the other way around. Therefore, taking into consideration the interest of the company and that the disputes between the shareholders would affect the progress of the company, we are of the view that the petitioner's, group should be directed to sell its shares to the respondents group on a valuation to be made by an independent valuer.

This petition has been filed by the petitioner holding 750 shares and is supported by Shri Ramanlal Patel holding 750 shares. Others from the petitioner's group are not before us even though letters from S/s Jitendar Patel and Rajcndra Patel, each holding 750 shares, stating that they belong to the petitioner's group have been filed before us. Therefore, since the petitioner and Shri Ramanlal Patel are before us, we direct them to sell their shares to the respondents. In regard to the others from the petitioner's group, since they are not before us, we give them the option to go out of the company. Once they exercise their option, the same will be binding on the respondents.

The valuation of the shares will be determined by the statutory auditors of the company, based on the balance sheet as on 31-3-1999, being proximate to the date of the petition. For valuing the shares, the additional shares allotted on 6-9-1998 shall be ignored. The statutory auditors of the company, while determining the value of the shares, will give personal hearing to both the parties and also will take into consideration the written submissions, if any, made by them. The statutory auditors will initially prepare a draft valuation report after taking into consideration the submissions made by the parties and circulate the same to them for their comments. After considering the comments, the valuer will prepare a final valuation report which shall be binding on both the parties. This exercise should be completed by 30-11-2001. Once the valuation report is submitted, the respondents should purchase the shares of the petitioner and Shri Ramanlal Patel at the value so determined within a month of the submission of the report by remitting the consideration by demand draft in exchange of the share certificates with blank transfer instruments. In regard to the others in the petitioner's group, the respondents should make an offer, in writing, to purchase their shares at the value so determined within 15 days of receipt of the valuation report, and these shareholders should react to the said offer within 15 days thereafter. The respondents should purchase the shares of those who have accepted the offer within 15 days of receipt of the reply to the offer by remitting the consideration by demand drafts in exchange of the share certificates along with blank instruments of transfer.

With the above directions, this petition is disposed of without any order as to costs and with liberty to apply in case of any need to work out this order.

 

 

We look forward for a rewarding and a fruitful professional association in the above field of Company law, Taxation Laws and other related laws provided given a chance of executing professional assignments.

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