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397/398 - the role of Company Law Board - Indian Company Law

Durga Rao 
on 05 April 2010

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        As we all aware, section 397/398 of the Companies Act, 1956 deals with oppression and mismanagement and the protection to the minority against the majority. The law makers could not have expected that a situation will come where a majority are harassed or oppressed by the minority. Sections 397/398 and other connected provisions of companies act, 1956 meant to provide relief to the minority shareholders against the majority when minority are oppressed or the property of the company is mismanaged. Sections 397/398 of the Companies Act, 1956 deals with very important issue touching the corporate world. A minority shareholder who has invested so much in the company can not be ignorant of the acts of the majority to oppress him or mismanage the company’s property. At the same time, the promoters or the majority requires protection against the minority when they resort to illegality and try to oppress the majority.

        I have written many articles on few issues touching the issue of oppression and mismanagement and the relief as provided under section 397/398 of the Companies Act, 1956. I just want to again reiterate the complications in dealing with a proceeding under section 397/398 of the Companies Act, 1956 by the Company Law Board now and the National Company Law Tribunal in future if the Tribunal is established. Barring very few things, I don’t think that the complications under section 397/398 will go away with the establishment of National Company Law Tribunal and it is to be seen as to how the National Company Law Tribunal deals with the issues like winding-up, amalgamation, oppression and mismanagement and other connected issues. It is a complicated responsibility of Company Law Board to ensure that the object of section 397/398 is met when a petition is presented to it alleging oppression and mismanagement.  I had the privilege of observing so many proceedings before the Company Law Board and heard the majority share holders in the company as to how they are harassed by the minority and heard from the minority from the company as to how majority has siphoned of company’s funds and as to how they could do nothing to recover their due or in getting their rights protected.

        Firstly, when shareholders present a petition to the Company Law Board under section 397/398 of the Companies Act, 1956, it will take so much time to understand the case and that is why, it is seen very often that a Board passing an interim order giving liberty to the other party to apply for the order getting vacated when the Board is satisfied that there exist a prima facie case. Reading hundreds and thousands of papers will be a difficult job for the Company Law Board unless there exist two competent counsels who stick to their point and assist the Board in arriving at a conclusion. The technicalities, the complications, the attitude, the transfer of presiding officers etc. will contribute for a long delay in getting petitions under section 397/398 disposed of despite the fact that the constitution of special tribunal like Company Law Board is expected to deal with the issues speedily as compared to traditional courts. Some cases under section 397/398 will be very complicated to deal with and ultimately an exit option may be provided to a group at the valuation done by the independent auditors. There is problem with exist option too when the Board found that it is impossible to ensure that the both groups in a Company go smoothly. Many applications under section 397/398 are filed in respect of private limited companies or closely held public companies as listed public companies are well regulated in view of SEBI regulations, the listing agreement and plethora of other requirements and shareholding pattern. Many private limited companies will not even maintain books of account properly and there tend to be under valuations, overvaluations and concealment of certain transactions in order to evade tax payments basically. As the true transactions of the Company are not recorded in many cases, there will be difficult in availing the exist option. That is why, the petitioners before the Company Law Board under section 397/398 of the Companies Act, 1956 presses for orders and corrective steps in the Company. Again, we all know the practical difficulties in getting the orders of the court executed. Even the orders of the High Court are floated at times leaving only an option to move for contempt and many litigants know the loopholes in contempt proceedings. Many reforms are actually needed to make the law really effective.

        I just want to give a brief of two cases which I have personally seen and listened to the people concerned.

 

Promoter is thrown-out:

 

        I have seen a case where a promoter holding 100% is thrown-out from the company. In the case I am referring to, the promoter is a technocrat and established a company. While he was looking for investors, one individual has approached him that he will bring in money and also raise substantial debt and equity for the company’s expansion. Accordingly, an MOU and Share Purchase Agreements are entered into between the Company and the outsider and the outsider has not been allotted any shares, but, been made as an additional director as provided under Company’s Articles.  The outsider who has promised to bring in so much investment into the Company has done nothing as agreed in the MOU and Share Purchase Agreements and when the promoter questions the same, the outsider has filed fictitious forms with the ROC as if there were Board Meetings and decisions were taken to mortgage all Company’s properties and as if a decision was taken to make further allotment of shares. With the filing of fictitious forms with the ROC, the promoter could do nothing for the company and he could not concentrate on expansion of the Company and he had to run from pillar to post.  The promoter had to approach the Company Law Board for getting the fictitious charge set-aside and the case is going on for months now and fortunately, it may get disposed of soon. Time is very valuable for the Companies and the stakes are high in many cases. As such, every case under section 397/398 is different and seen on a different footing.  Some cases can be disposed of very soon and even within days if possible and some cases tend to proceed for months and years.

 

Apparent Mismanagement:

 

In another case, a closely held private company consists of family members as its shareholders. One Mr.A held some 50% of the shareholding while his brother and his group held the remaining 50% shareholding in the Company. Mr.A was not concentrating on the affairs of the Company thinking that his rights and interest are secured to mandatory corporate regulations to be followed. Mr.A was living in abroad and had to travel abroad very frequently due to health problems. Suddenly, Mr.A has found that the very valuable property of the Company is sold for a throw away price to a third party. Mr.A had challenged the sale transaction, but, the third party who has purchased the property has started even developmental activity as there was no restraint from the Board or as Mr.A could not convince the Board for getting a restraint order like injunction. The case is pending before the Board for years and the majority group engages competent and costly lawyers and they keep on filing applications and now it is really difficult for the Hon’ble Company Law Board to read all the papers, find-out all the proceedings and passing final orders in the matter. Mr.A has a clear case to prove that the property is sold illegality and in violation of Articles of Association and the provisions of Law, but, still he could not get his rights secured and hoping that his rights will be preserved and protected when the Company Petition under section 397/398 is finally disposed of.

 

Complications:

 

Now, I want to just list-out few important issues and complications under section 397/398 of the Companies Act, 1956 as under:

1.    Nature of remedy under sections 397/398. Basically, the provisions are meant to prevent the continuing oppression and mismanagement by the majority against the minority. But, who remedies the wrong doing and powers of the Company Law under section 397/398 read with section 402 and other provisions are interesting to know and dealwith.

2.    Who all can approach the Tribunal under section 397/398?

3.    Can the majority approach the Tribunal under sections 397/398?

4.    How to entertain the plea questioning the maintainability of the applications.

5.    How to deal with the dispute with regard to membership?

6.    Conditions precedent for maintaining an application under the sections?

7.    How to construe the world ‘oppression’?

8.    What usually constitutes oppression?

9.    How to construe the ‘mismanagement’?

10.           What usually constitutes ‘mismanagement’?

11.           Whether mere irregularity or non-compliance of the provisions of the Act be taken as oppression and mismanagement?

12.           How to construe ‘public interest’ under the section?

13.           Need of giving full particulars in an application under sections 397/398.

14.           Whether the composite petition is maintainable under the section?

15.           Whether the events subsequent to filing the application be considered?

16.           Principles of Res subjudice and Res judicata?

17.           Whether the rules under the Code of Civil Procedure applies to an application under section 397/398.

18.           Is it correct to say that the Tribunal can not decide the disputed facts?

19.           Construing the issue of proceeding against the legal representatives or impleading the legal representatives of the applicant.

20.           Whether the affairs of the subsidiary be questioned by the members of the holding company via a via?

21.           Difference between the proceedings under section 433 and section 397/398?

22.           Whether the arbitration clause can oust the jurisdiction of Tribunal under the section?

23.           Application of law of limitation?

24.           The proper approach while entertaining an application under section.

25.           The proper approach under the section in respect of s.25 companies.

26.           Essentials to be looked into while entertaining the application.

27.           The role of precedents while entertaining an application under section 397/398.

28.           Dealing with the issue of consent under section 399.

29.           Dealing with the issue of membership and prima facie proof.

30.           Powers enumerated under section 402 and need of providing section 402 as section 397/398 itself is elaborative when it comes to dealing with the powers of Company Law Board.

Note: I have just given the complications under section 397/398 of the Companies Act, 1956 once again and the opinions expressed are my personal.




Category Corporate Law
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Durga Rao 

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